China Commits to Ecuador: Out With the Old, in With the New

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Environmentalists love to berate large multinational companies for expanding heavily into the Amazon rainforest. It’s easy to vilify oil companies like Chevron (NYSE: CVX), mining giants like Vale and logging companies for endangering the natural habitat of 30% of the world’s animal species. Yet national governments are just as accountable for the protection of these natural resources as large companies.

However, if there’s one lesson that is reiterated throughout history, it’s that governments generally value their economies more than their environment. The world’s largest economies often cozy up with countries that are rich in natural resources and lax in regulation, guaranteeing long-term returns for their investors.

Since the 1960s, American oil companies such as Texaco (now a subsidiary of Chevron) increased their diplomatic ties with Amazon nations such as Ecuador to gain long-term oil contracts. Today, Chinese oil giant China National Petroleum & Chemical Corp (NYSE: SNP) is doing the same, forging overseas alliances with Ecuador, Peru and Chile to increase its drilling presence across the Amazon.

While some Americans have been quick to criticize China’s expansion into the rainforest, it would be a hypocritical argument. Across Latin America, it’s merely a case of severing ties with old partners while embracing a new one.

Out with the old, in with the new

Ecuador is putting up a third of its Amazon rainforest for sale, with the auction on 16 oil concessions, spanning across 3 million hectares and closing on July 16. The biggest buyer is expected to be China, which has steadily increased its investments in the nation over the past several years. China has also given out massive loans to Ecuador, Argentina, Venezuela and Brazil, which can be repaid through “long-term commodity sales.”

In other words, China will continue lending to Ecuador’s government as long as it allows state-owned China National Petroleum and China National Offshore Oil to drill for oil in the rainforest. Ecuador currently owes China $8.8 billion, which nearly guarantees that most of those oil concessions will go to China by the end of the summer.

The deal marks a return to the status quo similar to the one the Ecuadorian government shared with Texaco between 1964 and 1992. Texaco left the country in 1992 after drilling in the rainforest for 28 years, and was subsequently sued by residents of the Ecuadorian Amazon, who claimed that its drilling operations had caused severe health problems for over 30,000 residents in the region.

Texaco spent $40 million on cleanup efforts through the 1990s, despite being absolved of further responsibilities by the Ecuadorian government. However, the affected residents continued suing the company, which was acquired by Chevron in 2001. An Ecuadorean court has since ruled that Chevron must pay $19 billion in damages, which the company has refused to pay on grounds that Texaco’s offenses were a result of lax Ecuadorian environmental laws.

Using the Bilateral Investment Treaty as a shield (and a weapon)

After Chevron inherited Texaco’s troubles, the company retaliated against the Ecuadorian government by claiming the Bilateral Investment Treaty between Ecuador and the United States should have protected it from the $19 billion ruling. As a result, an international arbitration tribunal ordered Ecuador to pay Chevron $96.35 billion plus compound interest in damages. The Ecuadorian government has refused to pay the charge, claiming that the verdict encroached on its sovereignty, and that it is seeking to end the Bilateral Investment Treaty with the United States to prevent future arbitration.

Chevron was not the only company to use the Bilateral Investment Treaty to its advantage against Ecuador. In 2006, Ecuador abruptly canceled Occidental Petroleum’s (NYSE: OXY) operating contract, claiming that it broke the terms of its initial agreement by transferring a 40% stake of its operations to Encana Corp. without approval from the Ecuadorian energy ministry. Occidental protested the government’s decision, and a World Bank tribunal (ICSID) ruled that Ecuador illegally canceled the company’s exploration-and-production rights, and awarded the company $1.77 billion in damages. Just as with the Chevron case, the Ecuadorian government is requesting an annulment of the ruling.

China shrewdly cultivates a symbiotic relationship

Besides Chevron and Occidental, Ecuador still has two other cases pending with the ICSID - one with ConocoPhillips subsidiary Burlington Resources and another with French oil company Perenco. Both companies claim that the Ecuadorean government illegally confiscated their assets in 2009.

Since it’s clear that Ecuador’s government doesn’t plan to honor its Bilateral Investment Treaties, China has been smart to let its money do the talking. Instead of tying down the country with restrictive, reciprocal agreements, China is forming a symbiotic relationship with Ecuador that is far stronger than Texaco and Occidental’s prior investments in the country.

In other words, the more western oil companies urge Ecuador to pay treaty-related damages, the better China looks as a business partner. Therefore, Ecuador is welcoming China National Petroleum and China National Offshore Oil to drill across the Amazon rainforest with open arms.

China has also shrewdly taken advantage of anti-American sentiment across the globe to expand its oil operations. It is Sudan’s largest trading partner, heavily imports oil from Iran, and is the world’s largest consumer of Iraqi oil. In other words, China reserves political judgment in favor of mutual economic growth, which has been an attractive option for countries with controversial regimes.

The Foolish Bottom Line

In conclusion, Latin American governments like Ecuador are every bit as accountable for the deforestation of the Amazon rainforests as multinational oil giants. Today, China has outdone America by going a step further by cultivating controversial symbiotic relationships with national governments, which guarantee it clearance to drill for oil in environmentally sensitive areas.

That’s not to say that America is any better. America has been embroiled in Middle East conflicts to secure oil reserves for over four decades. Our oil companies have also repeatedly expanded into emerging nations with more relaxed regulations to generate higher revenue growth.

In the end, there’s not much that will stop Latin American countries from auctioning off their precious rainforest land to loggers, farmers, miners and oil companies. These nations, being the emerging economies that they are, will desperately grasp for ways to grow their GDP, and the Amazon rainforest will soon become a major casualty of that desire.

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