International Arbitration

Quantum matters – Oil reserves claim against Kazakhstan

Peter Harris Peter Harris

In a claim against Kazakhstan, an ICSID Arbitral Tribunal awarded US$39.2 million in damages to a Kazakh-incorporated oil company, Caratube International Oil Company LLP (CIOC) on 27 September 2017. The claims brought by Mr Hourani, a US national and CIOC’s majority shareholder, were dismissed on jurisdictional grounds.

Background

The proceedings related to a contract for the exploration and production (E&P) of hydrocarbons dating back to 2002 with the Ministry of Energy and Mineral Resources of the Republic of Kazakhstan. Following disagreement between the parties, the contract was terminated in 2008 during the exploration period. CIOC lost control of the site and the oil wells were sealed. CIOC therefore sought damages for expropriation.

Damages calculation

The Parties took differing approaches to the calculation of damages:

Claimant’s Approach

The Claimants requested US$941 million in compensation, representing the fair market value of their investment as at 31 January 2008, i.e. around the time of termination of the E&P contract. The value, calculated using a discounted cash flow (DCF) method, reflected the imminent commercial production of confirmed oil reserves, which the Claimants argued they had been denied towards the end of the exploration stage.

Alternatively, the Claimants argued that they would be entitled to compensation based on the loss of opportunity to obtain profits. They calculated this as being 99% of the quantified lost profits, given the commodity at hand and confirmation of the reserves by industry experts.

The Claimants also requested the award of moral damages of US$50 million for damage to its reputation and for the harassment they allege they had been subjected to by Kazakhstan.

The Claimants requested interest at a rate of LIBOR + 2% compounded semi-annually from termination in 2008 until payment in full of the award.

Respondent’s Approach

According to the Respondent, CIOC was entitled at most to its sunk investment costs, adjusted for cessation risk and contributory fault. The Respondent calculated sunk investment costs of US$20.8 million. This is the difference between CIOC’s total expenditures (US$39.2 million) and the revenues generated by CIOC between 2002 and 2007 (US$18.4 million). The Respondent argued that the net amount of CIOC’s sunk investment costs should be reduced by 80% to take into account cessation risk, resulting in an amount of damages of US$4.2 million. They argued that any damages awarded should be reduced by a further 50% to account for CIOC’s own contribution to its alleged losses.

The Respondent argued that CIOC’s own conduct would render the award of moral damages inappropriate.

The Respondent argued that in the event any damages were awarded, simple interest calculated using the 3-month US Treasury Bond yield plus 1.8% should be applied from termination in 2008 until 5 June 2012, the date of the Caratube I award.

Approach taken by the Tribunal

The Tribunal awarded CIOC its sunk investment costs of US$39.2 million as of 31 January 2008, with no deduction for the revenues generated by CIOC and no discount for cessation risk or contributory fault. The Tribunal found that the Claimants had failed to establish lost profits with the required degree of certainty and had not convincingly established that CIOC was ever a going concern with a proven record of profitability. Furthermore, the Tribunal found that the Claimants had not sufficiently established their claim for damages for lost opportunity.

A minority arbitrator considered that deducting the revenues from CIOC’s expenditures to arrive at sunk investment costs was necessary so that the compensation awarded did not exceed the damage suffered. However, a majority of the Tribunal found that the Respondent had not shown that the revenues generated by CIOC must be deducted from the amount of CIOC’s total investment (i.e. they had not proven that all of the generated revenues had not been reinvested).

The Tribunal chose not to award moral damages on the basis that CIOC had not satisfied the burden of proof to establish the Respondent’s alleged involvement in any acts of harassment against the Claimants.

In relation to the award of interest, the Tribunal found in favour of the Claimants and awarded at a rate of LIBOR + 2% compounded semi-annually for the full period claimed from termination in 2008 until payment of the award in full. This was in line with ICSID standard practice.

Conclusion

This case shows that Tribunals are not willing to accept the award of damages based on fair market value, loss of profits or loss of opportunity when the generation of those profits is not considered to be sufficiently certain or probable. In this case, the damages awarded were assessed by reference to the sunk investment costs suffered by the Claimants, without any deductions for the revenues actually earned, cessation risk or contributory fault.

Case information

Claimant: Caratube International Oil Company LLP and Mr Devincci Salah Hourani

Respondent: Republic of Kazakhstan

Case ref: ICSID Case No. ARB/13/13

Arbitrators: Dr Laurent Lévy (Switzerland, Brazil), President

Professor Laurent Aynès (France), Arbitrator

Dr Jacques Salès (France), Arbitrator

Milanka Kostadinova, Secretary of the Tribunal

References

  1.  International centre for settlement of investment disputes, ICSID Case No. ARB/13/13, 2017

For further information, please contact Peter Harris.