On 9 October 2014, an International Centre for Settlement of Investment Disputes (ICSID) tribunal comprised of H. E. Judge Gilbert Guillaume (President), Professor Gabrielle Kaufmann-Kohler and Dr. Ahmed Sadek El-Kosheri ruled on the compensation payable by Venezuela to ExxonMobil for the nationalization of ExxonMobil’s Cerro Negro and La Ceiba projects.  ExxonMobil had claimed US$14.5 billion and Venezuela had offered US$353 million. The Tribunal’s ruling that Venezuela pay ExxonMobil US$1.6 billion has been declared a victory by both sides.
This article summarizes the key findings of the award.
Summary of Background Facts
Between 1976, when Venezuela officially nationalized its oil industry, and 1990, all petroleum activities in Venezuela were conducted exclusively by PDVSA, without any participation from private or international companies.
The Government of Venezuela, recognizing the benefits of foreign investment to explore new oil fields, adopted a series of measures in the 1980s (collectively known as “Oil Opening”) to allow foreign investors to participate in the Venezuelan oil industry by means of an operating services agreement or association agreement with PDVSA.
Cerro Negro: In October 1997 Mobil Cerro Negro, an ExxonMobil subsidiary, became a party to the Cerro Negro Association Agreement with PDVSA. The Cerro Negro Project, contemplated by the Cerro Negro Association Agreement, included (i) exploiting and developing the extra-heavy crude oil fields in the Cerro Negro area; (ii) constructing and operating an upgrader in the Jose Industrial Complex; (iii) laying and operating pipelines between the Cerro Negro area and the Jose Industrial Complex; and (iv) selling the resulting products of Mobil Cerro Negro and PDVSA-CN to Chalmette Refining. The Association Agreement authorized the parties to expand the capacity of the Project to produce extra-heavy crude as well as its capacity to upgrade that crude into synthetic crude oil. An expansion project could be undertaken by unanimous agreement of the participants or, alternatively, under certain conditions, by fewer than all of the participants. Importantly, the Association Agreement required PDVSA to compensate Mobil Cerro Negro (and its partner Petro-Canada) for the economic consequences of governmental measures defined as “Discriminatory Measures”.
La Cieba: On 10 July 1996 Mobil Venezolana, together with other international partners, entered into the La Ceiba Association Agreement with PDVSA to explore, develop and exploit oil fields in the La Ceiba area, an area with light and medium crude oil potential, on a share-risk-and-profit basis. A Development Plan for the La Ceiba project was approved by Administradora La Ceiba on 27 January 2007. The Development Plan then should have been submitted to the Control Committee for final approval. However, as asserted by ExxonMobil, the Venezuelan Government frustrated that step and soon thereafter expropriated Mobil Venezolana’s interests in the La Cieba Project.
For both the Cerro Negro and La Cieba projects, the Exxon Mobil subsidiaries executed Royalty Reduction Agreements which granted a reduced exploitation tax (royalty) of 1%.
Subsequent to ExxonMobil’s commitment to the Cerro Negro and La Cieba projects, Venezuela implemented the following fiscal measures which affected the value of ExxonMobil’s investment:
Increased Royalty: In 2004 and 2005 Venezuela unilaterally terminated the Cerro Negro and La Cieba Royalty Reduction Agreements and thereafter hiked the royalty rate to 16 2/3%. The average monthly production from Cerro Negro above 120,000 barrels per day would be subject to a royalty rate of 30%.
Extraction Tax: In May 2006, Venezuela imposed a further increase in the royalty rate through the creation of an “extraction tax” of 33 1/3%. Royalty payments were to be credited to the liability of the extraction tax.
Increase in Income Tax: In August 2006 Venezuela increased the Income Tax Rate applicable to participants in the Orinoco Oil Belt (including the Cerro Negro and La Cieba projects) from 34% to 50%.
Production and export curtailments: In 2006 and 2007 Venezuela imposed a series of production and export curtailments on the Cerro Negro Project.
Expropriation: On 26 February 2007 President Chávez issued Decree-Law No. 5200 which ordered the associations located in the Orinoco Oil Belt (such as the Cerro Negro Association), and the At-Risk-and-Shared-Profits Associations, (such as the La Ceiba Association), be “migrated” into new mixed companies in which PDVSA or one of its subsidiaries would hold at least a 60% participation interest. The Decree-Law gave Mobil Cerro Negro and Mobil Venezolana until 26 June 2006 (i.e. four months) to agree to participation in the new mixed companies, failing which “the Republic, through Petróleos de Venezuela S.A. or any of its affiliates [...] shall directly assume the activities of the associations”. On 27 June 2007, as no agreement had been reached, the Government of Venezuela seized the investments of Mobil Cerro Negro in the Cerro Negro Project and the investments of Mobil Venezolana in the La Ceiba Project.
Summary of ICSID’s Ruling
The Tribunal made a number of key findings regarding jurisdiction, expropriation, fair and equitable treatment, and compensation.
Jurisdictional issues involving alleged treaty shopping:
In its earlier Decision on Jurisdiction, the Tribunal held that its jurisdiction was limited to disputes that arose after Mobil had restructured its Venezuelan assets through the creation of a Dutch holding company in 2005-2006, in order to bring them within the protective ambit of the Netherlands-Venezuela BIT. While the Tribunal considered restructuring an investment to gain access to ICSID arbitration through a bilateral investment treaty a legitimate aim, it likewise stressed that “[w]ith respect to pre-existing disputes, the situation is different and the Tribunal considers that to restructure investments only in order to gain jurisdiction under a BIT for such disputes would constitute, to take the words of the Phoenix Tribunal, “an abusive manipulation of the system of international investment protection under the ICSID Convention and the BITs.”  Accordingly, the Tribunal decided that it had jurisdiction over claims relating to disputes that arose only after the restructuring had taken place (i.e. after 21 February 2006 for the Cerro Negro Project and after 23 November 2006 for the La Ceiba Project).
In deciding its jurisdiction, the Tribunal considered the “distinct measures taken and contested at different dates”.  In relation to the extraction tax adopted by Venezuela in May 2006 (i.e. after the BIT’a protections became applicable), the Tribunal was persuaded by the fact that earlier correspondence sent by Exxon to Venezuela warning of various disputes did not mention that tax. Accordingly, the Tribunal found that the dispute relating to the extraction tax arose after the BIT became applicable, and was within the Tribunal’s jurisdiction.  However, the Tribunal did not have jurisdiction over claims relating to the increase in income tax, as a dispute with respect to those claims had arisen in mid-2005, even though such measures were not formally enacted until August 2006.
Venezuela did not indirectly expropriate Claimants’ investment through its implementation of pre-migration measures.
The Claimants argued that prior to directly expropriating their investment, Venezuela had permanently deprived them of the benefit of discrete rights pertaining to their investments by measures having an effect equivalent to expropriation. These pre-migration measures included imposing a higher income-tax rate, adopting an extraction tax, imposing production and export curtailments, and appointing a new operator for the Cerro Negro Project.
The Tribunal rejected with relative ease Claimants’ contention that the stated measures had an effect equivalent to expropriation within the meaning of Article 6 of the BIT. According to the Tribunal, a measure which does not have all the features of a formal expropriation may be equivalent to an expropriation only if it gives rise to an effective deprivation of the investment as a whole. In the Tribunal’s view, such an indirect expropriation “requires either a total loss of the investment’s value or a total loss of control by the investor of its investment, both of a permanent nature.”  As Claimants had failed to demonstrate such permanent and total losses in relation to the pre-migration measures, the Tribunal held that those measures could not be properly characterized as an expropriation.
Venezuela’s direct expropriation of the Cerro Negro and La Ceiba Projects in June 2007 was lawful
While the parties agreed that the Claimants’ investments were expropriated on 27 June 2007 through the implementation of Decree-Law No. 5200, they disagreed on the legality of the expropriation. The Claimants contended that Venezuela’s measures amounted to an unlawful expropriation under Article 6 of the BIT becausethey (i) were taken without due process of law; (ii) were contrary to Venezuela’s undertakings; and (iii) were taken without any compensation, let alone just compensation. Because of the alleged unlawful nature of Venezuela’s actions, Claimants argued that Venezuela was required to make full reparation for the damages caused, in conformity with international law. By contrast, Venezuela contended that the expropriation was lawful, and that the indemnity to be paid to the Claimants must represent the market value of the investment in June 2007.
The Tribunal noted that the expropriation resulted from laws enacted by the National Assembly and decisions taken by President Chávez, which were aimed at creating new “mixed companies” majority-owned by the State. To accomplish this goal, negotiations with international oil companies (IOCs) were conducted for a period of four months. Nationalization was envisaged only in the event that those negotiations failed.
While Claimants described the negotiations as “a coercive process which did not follow any established legal procedure to determine their rights before title of the assets was transferred to a PVDSA subsidiary,” the Tribunal did not accept this contention. It found that although negotiations with ExxonMobil had failed, negotiations with other IOCs such as Chevron, Total, Statoil, Sinopec and BP had been successful. The Tribunal found that the negotiation process “enabled the participating companies to weigh their interests and make decisions during a reasonable period of time,” and was therefore compatible with the due process obligation of Article 6 of the BIT.
The Tribunal likewise held that Venezuela’s expropriatory measures were not contrary to Respondent’s undertakings carried with regard to Claimants’ investments; indeed, Venezuela had reserved its sovereign right to expropriate.
Finally, the Tribunal noted that “the mere fact that an investor has not received compensation does not in itself render an expropriation unlawful. An offer of compensation may have been made to the investor and, in such a case, the legality of the expropriation will depend on the terms of that offer.” 
To decide whether an expropriation is lawful or not in the absence of payment of compensation, the Tribunal had to consider the facts of the case before it. Ultimately, the Tribunal found that Venezuela made proposals during the negotiations and that Claimants had failed to submit evidence demonstrating that such proposals were incompatible with the requirement of “just” compensation of Article 6(c) of the BIT. The fact that the two sides did not reach agreement on the compensation to be paid, and that Exxon thus resorted to ICSID arbitration, was not enough to transform a lawful taking into an unlawful one. As a result, ExxonMobil’s claim for unlawful expropriation was rejected.
This key finding will undoubtedly be seized upon by Venezuela in pending disputes against it. The distinction between lawful and unlawful expropriation is a critical one for the purposes of compensation. A tribunal finding an unlawful expropriation may set the valuation date after the taking if the value of the assets has appreciated since the time of the taking, and award full compensation to restore the claimant to the position it would have been in had the unlawful taking not occurred. In contrast, a tribunal finding a lawful expropriation is typically restricted by most BITs to award compensation based on the value of the investment immediately before the taking, even if the investment has appreciated significantly thereafter. In light of the rising oil prices over the course of the last decade, this distinction can be momentous.
The ExxonMobil tribunal’s finding of lawful expropriation can be contrasted with the majority of the ConocoPhillips tribunal, which found that Venezuela failed to negotiate with ConocoPhillips in good faith, and that Venezuela had offered only book-value, rather than fair market value, compensation for its assets. Based on those findings, the arbitrators concluded that Venezuela’s expropriation was unlawful, thereby enabling ConocoPhillips to seek, in a further stage, compensation based on more advantageous numbers than those which applied in 2007.
The characterization of Venezuela’s taking as lawful will undoubtedly be viewed as a major victory for the resource rich state.
Fair & Equitable Treatment
In addition to expropriation, ExxonMobil argued that Venezuela had breached the standard of Fair and Equitable Treatment (FET) provided for in BIT Article 3. The Tribunal analyzed Claimants’ FET claims with respect to the (i) Extraction Tax; (ii) production and export curtailments; (iii) coercion and the expropriation measures; and (iv) severance payments.
The Extraction Tax
Claimants’ FET claim related to the extraction tax was rejected on the merits. The Tribunal held that the FET provision of the BIT (Article 3) did not extend to tax or fiscal measures. In so doing, the Tribunal considered significant the fact that Article 4 of the BIT “comprehensively regulates the standards of treatment with respect to fiscal measures by providing for national and most favored nation treatment, and a list of applicable exceptions.”  In the Tribunal’s opinion, applying Article 3 to Article 4 would lead to an incoherent reading of the BIT insofar as certain exceptions in Article 4 would be rendered meaningless, as they could be circumvented by relying on the broader provisions of Article 3. Moreover, a redundancy would appear in that both articles contain an exception for treatment in customs and economic unions.
As a result, the Tribunal found that fiscal measures like the extraction tax were only subject to the national and most favoured nation treatment obligations of BIT Article 4, and were carved out of Article 3’s FET obligations. As the extraction tax claim was based exclusively on Article 3(1) of the BIT and not on Article 4, it was rejected.
The Production and Export Curtailments
The Tribunal opined that the FET standard “may be breached by frustrating the expectations that the investor may have legitimately taken into account when making the investment” and that such legitimate expectations “may result from specific formal assurances given by the host state in order to induce investment.”  The Tribunal reasoned that because the Cerro Negro Project Association Agreement fixed the level of extra-heavy oil production at 120,000 barrels per day, Claimants reasonably and legitimately could have expected to produce at least that volume when deciding to invest in Venezuela. As a result, the production and export curtailments imposed from November 2006 “were incompatible with the Claimants’ reasonable and legitimate expectations, and thus breached the FET standard contained in Article 3(1) of the BIT.”  The Tribunal awarded ExxonMobil US$9,042,482 in relation to the production and export curtailments, as compared to the of the $53.6 million sought by Claimants for that claim. The tribunal further underscored the Claimants’ assurances to refund sums already obtained from PDVSA through the ICC award in relation to this claim.
The Expropriation Measures and Severance Payments
The Tribunal easily rejected Claimants’ contention that the same measures that gave rise to the ultimate expropriation of Claimants’ investments should be deemed to constitute a violation of the FET standard as well. The Tribunal referred to its finding that the expropriation was conducted in a lawful manner, and noted that the FET claims based on the expropriation measures had been too briefly and too unconvincingly developed to enable the Tribunal to rule in Claimants’ favour. The Tribunal likewise gave little weight to Claimants’ contention that the removal of the operator of the Cerro Negro project was arbitrary and that ensuing severance payments that came due should be compensable events. As a result, those claims were dismissed.
The Tribunal considered that the “just compensation” under Article 6 of the BIT had to be determined immediately after the failure of the negotiations between the Parties and before the expropriation, i.e., on 27 June 2007, and it must correspond to the amount that a willing buyer would have been ready to pay to a willing seller at the time in order to acquire the expropriated interests. As noted previously the Tribunal’s adoption of the 27 June 2007 valuation date had a significant impact on the damages ExxonMobil was entitled, especially in light of the significant increases in oil prices post-2007.
The Tribunal undertook a detailed analysis of the quantum for the largest head of claim relating to the expropriation of the Cerro Negro Project. The parties agreed that quantum should be assessed on a discounted cash-flow (DCF) basis. Accordingly, they evaluated the net cash flows that would have been generated by the investment over its remaining life, i.e., until June 2035, and discounted them to their present value. While the parties agreed on the general DCF approach, they disagreed on the determination of net cash flows and discount rates. So far as the net cash flow (prior to discounting) was concerned, the main disagreements concerned the volume of production and the projected oil prices, both relating to the revenue side of the equation. The Tribunal determined (by reference to relevant agreements and physical conditions of the project) that the volume of future production could not be increased from the initial production level of 120,000 barrels per day of extra-heavy oil to 344,000 barrels per day by 2014, as suggested by Claimants. On that basis, the Tribunal accepted that the net cash flow should be assessed by reference to an average monthly production of 120,000 barrels per day of extra-heavy oil. The Tribunal also determined that the projected oil prices had to take into consideration the position in the market at the time immediately prior to the expropriation (including the position of OPEC, of which Venezuela is a member), and therefore adopted Claimants’ expert evidence on the point. The Tribunal also held that on the facts, a number of expenses, such as costs of operations, investments, special contributions and income tax, should be deducted from the gross revenue to arrive at a the projected net cash flow for the Cerro Negro Project from 2007 to 2035 of USD 7,399.8 million.
The issue of appropriate discount to be applied in that case concerned primarily the so-called confiscation risk. The Claimants said that the confiscation risk should not be included in the assessment of the country risk, whereas the respondent asserted the opposite. The Tribunal considered that the confiscation risk would be taken into consideration by a willing buyer at the relevant time (immediately before the confiscation), and therefore such confiscation risk should be included in the country risk for the purposes of calculating the applicable discount. On that basis, the Tribunal held that the deep discount of 18% should be applied in that case.
The Tribunal rejected Venezuela Respondent’s defence based on a price cap under the Cerro Negro Association Agreement. In the Tribunal’s view, that agreement involved different parties and, on proper construction, the relevant cap did not apply to the claims in the instant case. A final point concerned the risk of double recovery by the claimant, as it received compensation in respect of the measures in dispute under a separate ICC arbitration against the state-owned PDVSA. However, the Tribunal noted that Claimants had been contractually required to pursue claims available to it to mitigate damages and to indemnify PDVSA in respect of any “net benefits” that it might receive as a result of such legal actions. The Tribunal noted that Claimants had agreed to comply with the indemnity provisions and, on that basis, the Tribunal was satisfied that no double recovery would result from granting relief in the instant proceedings.
In relation to the La Ceiba Project claim, the Tribunal agreed with Claimants that the quantum should be assessed by reference to the actual value of Claimants’ investments at the date of expropriation; a DCF calculation was not warranted given the early stage of development of that project. The Tribunal awarded Claimants USD 179.3 million, which corresponded to Claimants’ invested capital.
Whilst the monetary relief granted by the Tribunal was significantly lower than Claimants’ claims, it was still considerable by any standard. On that basis, each side claimed a victory. The Tribunal’s own view may perhaps be best understood from its decision on costs. Each side was ordered to bear its own legal costs and pay half of the arbitration costs.