Oil, Gas & Energy Law Intelligence

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Issue
:
Published :

Vol. 2 - issue 1
February 2004

Legal Regime for Hydrocarbons

Operations in Ecuador by D.G.
Lamanna

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LEGAL REGIME FOR HYDROCARBONS

OPERATIONS IN ECUADOR
By DARIO GERARDO LAMANNA
(Manager, Legal Affairs, PETROBRAS Ecuador)

I.- LEGAL AND REGULATORY FRAMEWORK

Oil activities in Ecuador are governed by the provisions of the Law of Hydrocarbons,
by the regulations issued by the President of the Republic for the enforcement of such
Law, by the regulations issued by the Minister of Energy and Mining, and by the
Contracting Guidelines for each bidding modality.
II.- REGULATORY AUTHORITIES
The Executive Branch, headed by the President of the Republic, is in charge of the
regulation and formulation of hydrocarbon policies, as provided in section 5, Art. 171 of
the Political Constitution of Ecuador. The Minister of Energy and Mining, in view of
the powers granted by Art. 9 of the Law of Hydrocarbons, is in charge of submitting to
the consideration of the President of the Republic the national hydrocarbons policy in
all its aspects.
The Ministry of the Environment, the Ministry of Foreign Trade, the State Oil Company
of Ecuador - PETROECUADOR, the National Institute of Cultural Heritage and the
municipal councils of the cantons where oil companies operate also have competence to
regulate aspects related to oil activities.
The Internal Revenue Service (SRI) has competence to regulate tax issues related to
oil activities and to monitor compliance with these obligations.
III.- CONTROL AUTHORITIES
Pursuant to the provisions of Art. 11 of the Hydrocarbons Law, the National
Hydrocarbons Office (DNH), an internal unit of the Ministry of Energy and Mining,
is the technical and administrative department in charge of controlling and monitoring
oil operations either directly or through specialized national or foreign professionals,
firms or companies hired for this purpose. The DNH must oversee compliance with the
regulations concerning the quality, quantity, reliability, continuity, timeliness and safety
of the various oil activities, on the basis of the regulations issued by the Minister of
Energy and Mining.
The National Environmental Protection Office (DINAPA), another internal unit of the
Ministry of Energy and Mining, is the body in charge of approving Environmental
Impact Studies (EIA) and Environmental Management Plans.

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Dr. Daro G. Lamanna

With respect to environmental issues, the Ministry of the Environment also has
competence to control oil activities, within its scope of action.
IV.- HYDROCARBON EXPLORATION AND EXPLOITATION
According to the Political Constitution of Ecuador and the Hydrocarbons Law, the State
is in charge of exploring and exploiting deposits of hydrocarbons and other related
substances, in any physical state they may be in, which are located within the national
territory, including the areas covered by the waters of the territorial sea, which are the
inalienable and imprescriptible property of the State.
This activity is carried out directly by the State Oil Company of Ecuador
PETROECUADOR which can so itself of through third parties via contracts of
association, participation, services contracts for hydrocarbon exploration and
exploitation, or other contractual forms in effect in the Ecuadorian legislation, such as
marginal field contracts or shared management contracts. These contracts are subject
both to the terms and conditions common to all of them, as well as to specific
regulations. In addition, semi-private companies may also be established with national
and foreign companies of renowned competence, legally established in the country.
A.- TERMS AND CONDITIONS COMMON TO ALL HYDROCARBON
EXPLORATION AND EXPLOITATION CONTRACTS:
1.- Selection and hiring
The selection of contractors and the awarding of hydrocarbon exploration and
exploitation contracts, except those for specific works or services, must be made via a
special bidding system, whose structure, requirements and procedures are established in
the relevant regulations issued by the President of the Republic, with the goal of
diversifying the adjudication of contracts between state and private companies.
For this purpose, the Special Bidding Committee (CEL) is composed by the following
officials:
a.
b.
c.
d.
e.

The Minister of Energy and Mining, who acts as Committee chairman;

The Minister of National Defense;
The Minister of Economy and Finance;
The General State Comptroller; and,
The Executive President of PETROECUADOR.

These principal members may delegate their representation only to the official
following in seniority. However, delegates may not delegate their representation.
All contracts must be preceded by reports from the State Attorney General and the Joint
Command of the Armed Forces. Contracts signed must be registered with the
Hydrocarbons Register, which is kept by the National Hydrocarbons Office (DNH).
If deemed convenient to the interests of the State, the Special Bidding Committee
(CEL) may adjudge more than one contract to the same contractor. However, in case the
same contractor signs more than one contract, for income tax payment purposes such
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Dr. Daro G. Lamanna

contractor may not consolidate the losses suffered in one contract with the earnings
made in another.
Likewise, if deemed favorable to the State, contracts may be modified by mutual
agreement between the contracting parties and after approval by the Special Bidding
Committee (CEL). For this they shall need the prior favorable reports of the State
Attorney General, the Joint Command of the Armed Forces, the Governing Council of
PETROECUADOR, and the Minister of Energy and Mining.
2.- Contractual Area
Each contract shall include one block with a land area not to exceed 200,000 ha, divided
in lots measuring 20,000 ha or less each, pursuant to the charts drawn by the Military
Geographical Institute; or a block with a maritime surface not to exceed 400,000 ha,
divided in lots measuring 40,000 ha or less, pursuant to the charts drawn by the Navys
Oceanographic Institute. These lots must have a rectangular shape, with two sides on an
North-South bearing, except when the natural boundaries or those of other reserved or
contractual areas prevent it.
Before the execution of these programs and if the lots are found on land allocated by the
State to indigenous communities or to Afro-Ecuadorian peoples, and in view that such
programs may cause damage to the environment, PETROECUADOR, its affiliates or
the contractors or their associates must hold consultations with these ethnic groups or
communities. To this end, they shall hold public assemblies or meetings to explain and
expose the plans and purposes of their activities, the conditions under which they will
be carried out, their duration and the possible direct or indirect environmental impacts
that they may have on the community or its inhabitants. A minute or other public
document shall be drawn to bear witness of the acts or agreements reached. After the
consultation is made, the Ministry of Energy and Mining shall make the decision most
favorable for the interests of the State.
3.- Return of contract areas
After the exploration phase is completed, the Contractor may only retain the areas
where exploitable commercial hydrocarbons have been discovered, in complete lots,
selected as established in the development plan, unless the Contractor agrees with
PETROECUADOR to carry out new exploratory activities during the first three years of
the exploitation period.
If the contractor fails to carry out the agreed exploratory activities or fails to discover
exploitable commercial fields, the contractor must return to the State the areas retained.
Fields discovered during the exploitation period whose hydrocarbon productivity has
been verified but which have not been developed and put in production within the next
five (5) years after the approval of the development plan for the area, shall also be
returned to the State.
This restriction, as well as the return of areas, does not apply to services contracts for
the exploration and exploitation of hydrocarbons, given the nature of their contractual
relationship, where contractors act as operators for PETROECUADOR, although at the
risk of such contractors.
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Dr. Daro G. Lamanna

All contractors or associates who return areas to the State are bound to deliver to the
Ministry of Energy and Mining all the background information, records and all
geological, geophysical, drilling or other studies related to the areas returned.
4.- .Duration
a) Crude oil exploration and exploitation contracts contemplate two periods:
(i) the exploration period, which may last up to four (4) years, extendable for up to two
(2) more years, prior justification by contractor and authorization from
PETROECUADOR. Operations must begin and continue on the ground within the first
six (6) months from the registration of the contract in the Hydrocarbons Register, which
shall be made within thirty (30) days from the signing of the contract. As stated before,
the contractor may retain areas to carry out additional exploratory work during the first
three years of the exploitation period.
(ii) The exploitation period, which may last up to twenty (20) years.
PETROECUADOR may extend such period in accordance with the provisions of the
development plan for the area and provided it is convenient to the interests of the State.
At the end of the exploration period, the contractor may only retain the areas where
commercial hydrocarbons have been found, in complete lots, selected as established in
the development plan, unless the contractor agrees with PETROECUADOR to carry out
new exploratory activities within the first three years of the exploitation period.
b) Concerning contracts for the exploration and exploitation of natural gas, the relevant
contract must include the technical and economic terms and conditions provided in the
Hydrocarbons Law, where applicable. In these cases, the exploration period may also
last up to four years, extendable for up to two more years, prior justification of
contractor and authorization by PETROECUADOR.
At the end of the exploration period and before the beginning of the exploitation period,
the contractors are entitled to a period for the development of their market and the
construction of the necessary infrastructure. This period shall last five years,
extendable according to the interests of the State, in order for contractors, by themselves
or in association with third parties, to commercialize the natural gas discovered.
The exploitation period for these contracts may last up to twenty-five (25) years,
extendable by PETROECUADOR if favorable to State interests. Contractors will begin
the exploitation period upon authorization of PETROECUADOR.
5.- Exploratory Program
All contracts shall require an exploratory program, which shall be executed as agreed by
the parties.
If stratigraphic or structural traps are detected, the contractor or his associate must drill
at least one exploratory well per each 100,000 ha or fraction above 50,000. The wells
drilled must reach depths that penetrate potentially oil bearing geological formations.
Likewise. For contract areas of 50,000 ha or less, the contractor or his associate must
drill at least one exploratory well.
6.- Development and Production
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Dr. Daro G. Lamanna

The Law provides for an average investment of no less than a value equal to 120 dollars
and 180 dollars per year per hectare, for land and marine surfaces, respectively, during
the first three years of the exploitation period. For this purpose, only the area reserved
for exploitation shall be taken into account. Investments in successive years shall be
agreed between the parties.
Drilling wells at distances of less than 200 m from the boundary of the respective area
of exploration or exploitation requires the prior authorization of the Ministry of Energy
and Mining.
The Ministry of Energy and Mining is in charge of fixing the production rate of
maximum effectiveness at well, deposit or field level, so as to allow its rational
exploitation from a technical and economic point of view, in accordance with the
regulations in effect.
.
The exploitation of fields common to two or more areas of the contract makes it
compulsory to sign operational unified exploitation agreements with the purpose of
achieving greater effectiveness and economy in the operation.
7.- Guarantees
a) Guaranty of seriousness of offer.- Bidders must include in their proposal a bank
guaranty of seriousness of their offer, issued by a financial institution legally organized
or established in Ecuador, for the amount specified by the Special Bidding Committee
(CEL). Such guaranty must be unconditional, irrevocable and immediately payable, and
be valid for the same time of validity of the proposal plus thirty (30) days.
b) Exploration Guaranty: an exploration guaranty in cash, State bonds or other form
satisfactory to the State is required. It must be the equivalent of 20% of the investment
the contractors agree to make during the exploration period. This guaranty shall be
returned to contractor or his associate at the end of the exploitation period and once
contractor has shown that he has complied with all his obligations or when the contract
is terminated, prior justification of failure to obtain favorable results during the
exploration period. This guaranty shall be cashed in case of noncompliance with any of
the obligations stipulated for the period in question.
c) Exploitation Guaranty: the Law requires a guaranty equivalent to 20% of the
investments which contractor agrees to make during the first three years of this period,
which shall be reduced in direct proportion with the fulfillment of the annual program
agreed, or which shall be returned on termination of contract due to lack of commercial
production, duly justified by contractor and accepted by PETROECUADOR. The
contractor or his associate shall lose this guaranty if they fail to comply with the
contractual obligations during the first three years of the exploitation period, without
prejudice of PETROECUADOR's right to collect by coercive measures the amounts
owed by contractor.
8.- Royalties
The State shall receive monthly royalties according to the following scale:

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Dr. Daro G. Lamanna

a) Royalties of no less than 12.5% over the gross production of crude oil, measured at
the storage tanks in collection centers, after separating water and other foreign matter,
when average production of the respective month is less than 30,000 barrels per day;
b) Royalties of no less than 14% when the average production of the month reaches
30,000 but less than 60,000 barrels per day; and
c) Royalties of no less than 18.5% when the average production of the month is 60,000
barrels per day or more.
The aforementioned percentages of royalties shall apply to the aggregate production of
each company and its affiliates, subsidiaries and associates, as well as to consortia of
companies and de facto societies.
For free gas deposits and the products obtained therefrom, a minimum monthly royalty
rate of 16% shall be paid.
In service contracts for the exploration and exploitation of hydrocarbons, contractors,
acting as operators of PETROECUADOR, shall not be subject to the payment of
royalties. As the total production of the contract is owned by PETROECUADOR, this
company shall take from the net production the percentage equivalent to royalties
payable to the General State Budget.
In contracts for the provision of specific services, for the additional exploitation and
exploration of marginal deposits or in participation contracts for the exploration and
exploitation of hydrocarbons, contractor does not pay royalties either. However, in the
case of participation contracts, royalties are paid to the participants therein, taken from
the State participation in the production of the area of the respective contract.
Royalties, income taxes, State participation and in general all taxes dependent on the
sales prices of hydrocarbons in the foreign market shall be regulated by the actual sales
or reference prices according to prevailing conditions.
The reference price of hydrocarbons shall be the weighted average price of the last
month of foreign sales of hydrocarbons made by PETROECUADOR. In the case of
natural gas, the reference price of substitute energy sources shall be taken into
consideration.
Reference prices may be discussed with production companies from time to time as
justified by prevailing conditions.
The royalties and the royalty equivalent that companies and PETROECUADOR must
pay, respectively, for their own consumption and for hydrocarbon losses in their normal
operations shall be regulated by the sales prices in the countrys domestic market.
9.- Other payments to the State
In addition, the State shall receive at least: admission premiums, surface rights,
compensation payments and contributions in compensatory works:

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Dr. Daro G. Lamanna

a) As admission premium for the exploration of hydrocarbons, the State shall receive,
within thirty days after the date of registration of the respective contract in the
Hydrocarbons Register, a minimum amount of fifty sucres per hectare. Within thirty
days after the beginning of the exploitation period, the State shall receive, as admission
premium, no less than one hundred-fifty sucres per hectare of surface retained for that
period;
b) During the exploration period, the State shall receive a surface right of no less than
ten sucres per hectare per year. Such payment shall be made for the entire year in the
month of January. In case the first payment does not correspond to a full year, it will be
paid in proportion to the respective months;
c) During the exploitation period, the State shall receive, per hectare per year, a surface
right of no less than fifty sucres during the first five years and one hundred sucres after
the sixth year;
d) For the use of water and natural building materials found in the area of the contract
and owned by the State, contractors or their associates shall pay in advance, within the
first thirty days of each year, starting on the registration of the contract, the minimum
amounts of twenty-four thousand dollars during the exploration period, and sixty
thousand dollars during the exploitation period. Both amounts shall not be reimbursable
in the case of service contracts for the exploration and exploitation of hydrocarbons. In
case the first payment does not correspond to a full year, it shall be made in proportion
to the respective months. Off-shore operations shall not give rise to this payment;
e) In addition, all contracts must stipulate compensation works according to government
plans, for a specific amount, in accordance with the size of the contract area and its
closeness to discovered deposits. In no case shall this contribution be less than two
hundred sucres per hectare of reserved area, and shall be invested within the next five
years.
All the monetary amounts specified in sucres in the Law shall be converted into US
dollars, at a rate of twenty-five thousand sucres per dollar.
Contractors having contracts for specific services, additional exploitation and
exploration of marginal fields or of participation for the exploration and exploitation of
hydrocarbons are exempted from these payments. Contractors with services contracts
for the exploration and exploitation of hydrocarbons are also exempted, but they must
pay each year to the State, from the beginning of the exploitation period, a nonrefundable contribution equivalent to 1% of the amount paid for the services prior to the
deduction of employees' participation and income tax. This amount shall be destined to
promote research and development of scientific and technological services in the field
of hydrocarbons and, in general of Mining, by the Ministry of Energy and Mining.
10.- Other Obligations:
a) To hire, within six months from the beginning of operations, to be carried out directly
or through contracts, a minimum number of Ecuadorian personnel equivalent to ninetyfive percent of workers, ninety percent of administrative staff and seventy-five percent
PETROBRAS ENERGA ECUADOR Legales
Dr. Daro G. Lamanna

of technical staff, unless there are no national technicians available. Within two years
ninety-five percent of the administrative staff must be Ecuadorian;
b) To carry out a technical and administrative training program, at all levels, according
to the regulations of the Law, so that within the first five years of the period of
exploitation, the execution of operations is wholly carried out by Ecuadorian workers
and administrative staff and by a minimum of ninety percent of national technical
personnel. The ten percent of foreign technical staff shall foster the transfer of
technology to national personnel.
c) To submit deposit exploration and development plans to the approval of the Ministry
of Energy and Mining, before the beginning of their execution;
d) To provide the Ministry of Energy and Mining, every quarter or when requested,
reports on all topographic, geologic, geophysical, drilling, production, reserve
assessment and estimates works and other activities;
e) To provide the Ministry of Energy and Mining, when required, economic data related
to all relevant issues as well as exploration or exploitation costs;
f) To use modern and efficient machinery and to apply the most adequate methods to
obtain the highest productivity, observing the reserve conservation policy established by
the State;
g) To allow public use, as required by the corresponding Ministry, of communication
roads, airports, maritime and inland ports they may build;
h) To submit, within the first three years of the exploration period, the
aerophotogrammetric mosaic of the land area of the contract, using the scale and the
specifications as determined by the Military Geographical Institute. The
aerophotogrammetric survey, if not already done, shall be made by or under the control
of the Military Geographical Institute and the negatives shall be the property of the
State;
i) To make a final delimitation of the area of the contract and to deliver the
corresponding charts within the first five years of the exploitation period, following
geodesic methods or other scientific methods, according to the Regulations of the
Ministry of Energy and Mining. This work shall be carried out, on behalf of the State,
by the Military Geographical Institute or the Navys Oceanographic Institute, as the
case may be. If the aforementioned charts already exist, the company must update them;
j) To contribute, during the exploration period, to the development of national technical
education and to the granting of scholarships, in the country or abroad, for specialized
studies in the hydrocarbons industry;
k) to submit for the approval of the Ministry of Energy and Mining, until December 1 of
each year, a detailed program of the activities to be carried out during the following
calendar year, including the investment budget. In addition, during the exploitation
period, the contractor must submit each year for the approval of the corresponding
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Dr. Daro G. Lamanna

Ministry, the updated five-year program for the activities to be developed, including
their budget, together with the operating program referred to in the previous paragraph.
l) To submit, also during the first month of each year, a detailed report of the operations
carried out during the preceding year, including data on exploration, production,
reserves, domestic sales, exports, personnel and other information about the works;
m) To keep books in the Spanish language and updated records of financial accounts
and costs, with the respective ledgers and vouchers, and to preserve them for the entire
period of the contract and up to ten years after that.
n) To submit to the Ministry of Energy and Mining, within the first quarter of each year,
the general balance, the statement of results and the inventories corresponding to the
economic exercise of the preceding calendar year;
o) to invest a minimum of ten percent of their net profits, according to the results of the
financial statements, in the development of the same or of other hydrocarbon industries
in the country;
p) To build hygienic and comfortable living quarters for employees and workers in
stable work camps, as per the plans and specifications approved by PETROECUADOR.
q) To supply housing, food and transportation facilities in work camps to inspectors and
other State officials;
r) To welcome students or graduate students from higher technical institutes related to
the hydrocarbons industry, in the number and for the periods agreed with
PETROECUADOR, so that they can make practices and studies on field work and the
industry. Transportation, housing, food and medical expenses shall be on the account of
the companies;
s) To submit to the approval of the Ministry of Energy and Mining, programs and
projects and their respective financing to prevent exploration and exploitation activities
from adversely affecting the economic and social organization of populations living in
the areas where the aforementioned activities take place or any local renewable and
non-renewable natural resources. Likewise, New population settlements as necessary
must be planned. For the above-mentioned approval the Ministry of Energy and Mining
shall rely on the reports issued by the respective regional development organisms and
the Ministry of Social Welfare.
t) To conduct oil operations according to the environmental protection laws and
regulations and the security of the country and with respect to international practice in
areas of preservation of fish farming and the agricultural and cattle industry. To this
end, the Law provides that contracts must contain the respective guarantees. According
to the Law of Environmental Management, in order to begin any activity which may
entail an environmental risk, the relevant permit must be obtained from the Ministry of
the Environment.
u) To prepare environmental impact studies and environmental management plans to
prevent, mitigate, control, rehabilitate and compensate environmental and social
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Dr. Daro G. Lamanna

impacts arising from their activities. These studies shall be evaluated and approved by
the Ministry of Energy and Mining in coordination with the environmental control
agencies and their environmental follow-up shall be entrusted directly or by delegation
to auditing firms qualified for that purpose.
v) According to the Law of Environmental Management, all contractors who, in the
course of their work determine that their activities may cause or are causing
environmental damages to the ecosystem, are bound to report such damages to the
Ministry of the Environment or to the relevant institutions of the autonomous sectoral
regime. Competent authorities shall adopt the required measures in order to redress the
problems detected. In case of failure to comply with this provision, the offenders may
be fined with twenty to two hundred general minimum vital wages.
11.- Property
a) Final importation: During the period of exploration and during the first ten years of
the period of exploitation, companies that have signed hydrocarbon exploration and
exploitation contracts may import free from any customs duties any equipment,
machinery, implements and other materials necessary to execute such contracts.
b) Temporary importation: it means the temporary introduction in the country of oil
machinery or equipment, under the Organic Customs Law.
c) Availability: Contractors or their associates may not sell, encumber or withdraw
during the term of the contract any part of the property referred to in the previous
paragraph, without the authorization of the Ministry of Energy and Mining. With a
favorable report of PETROECUADOR, property imported duty free may be transferred
or sold, when such property is no longer of use in the work of the interested company.
First, an appraisal must be made by delegates of PETROECUADOR and the Ministry
of Economy and Finance, so as to charge the proportionate part of the customs duties
previously exempted on the value of the property appraised. If the transfer is made to
another company exempted from paying customs duties, only the favorable report of
PETROECUADOR will be required. The State or PETROECUADOR shall have
priority in the purchase of such items; such purchase shall be made without paying the
assessed taxes.
d) Reversion to the State: At the end of an exploration and exploitation contract due to
expiry of the term or for any other reason arising during the term of exploitation,
contractor shall give to PETROECUADOR, at no cost and in good state of production,
the wells in activity at that time, and in good state of repair, all the equipment, tools,
machinery, facilities and other real and personal property that may have been purchased
for the purposes of the contract, as well as to transfer those goods indicated by
PETROECUADOR to the places indicated by the company. If the contract is terminated
during the exploration period, the obligation of contractor is limited to deliver to
PETROECUADOR, at no cost and in good state, the wells, camps and infrastructure
works.
e) Payments in special cases: during the last ten years of the term of a hydrocarbons
exploration and exploitation contract, PETROECUADOR may agree with contractor or
his associate to make investments under special amortization conditions and to pay the
non-amortized part at the end of the contract.
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Dr. Daro G. Lamanna

10

f) Conservation: Negligence, carelessness or malfeasance in the conservation of

property subject to reversion and which is virtually the property of the State can result
in civil and criminal liability under the law.
g) Benefit in favor of third parties: Indigenous communities and Afro-Ecuadorian
populations settled in the areas of direct influence where hydrocarbon exploration or
exploitation works are conducted, may benefit from the infrastructure built by
contractors or their associates, after the oil exploration or exploitation stage is
completed, provided there are no more stages following.
12.- Transfer
The transfer of a contract or the assignment to third parties of the rights arising from a
hydrocarbons exploration and exploitation contract is null and void if not preceded by
an authorization by the Ministry of Energy and Mining, without prejudice of a
declaration of forfeiture, as described below.
The State is entitled to receive a premium for the transfer, and the beneficiary company
must sign a new contract in economic conditions more favorable to the State and
PETROECUADOR than those contained in the original contract.
This legal provision stipulates the following payments to the State:
a) If the assignment is made during the period of exploration or research, construction
of infrastructure or market development, in the case of natural gas contracts, the
assignor must pay the State a premium of five thousand US dollars (US$ 5,000) for
each one percent of participation in the contract assigned to third parties, and the
assignee must increase the amount of the training investments calculated for the year
the assignment takes place in proportion with the percentage of participation purchased.
b) If the assignment is made during the exploitation period, the assignor shall pay the
Ecuadorian State, as transfer premium, an amount equal to 1 per mil of the net profits
obtained during the year preceding the year when the transfer or assignment takes place,
for each one percent of participation assigned or transferred to third parties, calculated
on the basis of the Income Tax Return. This premium in no case shall be less than five
thousand US dollars (US$ 5,000) for each one percent (1%) of participation, for one
time only. The funds shall be deposited in the Single Current Account. The assignor
shall give the Ministry of Energy and Mining, as improvement of the economic terms of
the original contract, five thousand US dollars (US$ 5,000) for each one percent (1%) of
participation, for one time only.
c) On contracts for the additional exploitation and exploration of marginal fields, the
amounts corresponding to transfer premiums and improvement of economic terms of
the original contract shall be equal to ten percent (10%) of the amounts above indicated.
In association contracts, if the assignment is proposed during the exploitation period,
CEPE shall have a preferential right thereon, pursuant to Art. 15 of the Hydrocarbons
Law, under the same terms and conditions specified in the assignment application. In
this case, CEPE shall be exempt from paying any premium and from improving the
economic terms of the original contract.
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Dr. Daro G. Lamanna

11

When contractor is a consortium or an association of companies, the partial or total

association of the rights arising from the contract among those companies, or the
assignment to mother companies, affiliates, or subsidiaries of the companies that are
part of the consortium or association, shall only require the authorization of the Minister
of Energy and Mining and shall not be subject to the payment of the premium or the
improvement of the economic terms of the contract to the State, as far as this does not
imply transfer to third parties of rights arising from the original contract.
Likewise, if the assignor is one company and the partial or total assignment of the rights
arising from the contract is made in favor of a mother company, affiliate or subsidiary
of the assignor, only the authorization of the Minister of Energy and Mining is
required, and the assignor shall not be subject to paying the premium or improving the
economic terms of the contract in favor of the State, as far as this does not imply
transfer to third parties of the rights arising from the original contract.
13.- Forfeiture
The Ministry of Energy and Mining may declare the forfeiture of the contract, if
contractor:
1. Fails to pay royalties, admission premiums, surface rights, participation and other
commitments established under the Law or the contract; or fails to comply with any of
the obligations specified in paragraph IV(a)(10) hereof;
2. Fails to deposit the corresponding bonds or guarantees in the form and the term
stipulated in the contract;
3. Fails to begin exploration activities as provided in the contract or if once such
activities have begun, suspends them for more than sixty days without justification.
4. Suspends exploitation operations for more than thirty days, without just cause,
previously accepted by the Ministry, except force majeure or Act of God, which shall be
notified to PETROECUADOR within a maximum term of ten days;
5. Fails to resume exploitation operations within a maximum term of thirty days, once
the causes that prompted the suspension thereof have ceased;
6. Fails to invest the minimum annual amounts, fails to drill wells or fails to execute the
tasks relevant to the exploration and exploitation period as established in the contract;
7. Prevents or hinders surveillance and auditing by authorized State officials, or fails to
supply data and other information about any other business related to the oil activity;
8. Incurs in falsehoods due to bad faith or fraud, in statements or reports on technical
data on exploration, exploitation, industrial activities, transportation or
commercialization, or on economic data related to investments, costs or profits;
9. Fails to invest the profits, as stipulated in the contract;
10. Has recurred to fraud or other illegal means to sign the contract;
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11. Transfers rights or signs private contracts or agreements for the assignment of one
or more of its rights without the authorization of the Ministry;
12. Becomes part of consortia or associations to carry out exploration or exploitation
operations, or withdraws from them, without the authorization of the Ministry of Energy
and Mining; and,
13. Repeatedly violates the Law and its regulations.
Prior to the declaration of forfeiture of a contract, the Ministry of Energy and Mining
shall notify contractor, fixing a term of no less than thirty nor more than sixty days,
from the date of the notice, for contractor to comply with his neglected obligations or to
clear all charges against him.
The declaration of forfeiture of a contract implies the immediate return to the State of
the areas of the contract, and the delivery of all equipment, machinery and other
exploration or exploitation devices, industrial or transportation facilities, at no cost for
PETROECUADOR, and also, the automatic loss of the bonds and guarantees delivered
under the Law and the contract, which shall be kept by the State.
14.- Other cases of Noncompliance
Noncompliance of the contract which does not result in forfeiture or which does not
violate the Law or the Regulations shall be penalized with a fine imposed by the
National Director of Hydrocarbons of between two hundred and three thousand US
dollars, according to the seriousness of the infraction, in addition to indemnities for
damages and the repair of the damages caused. Indemnities payable for damages caused
on lands, crops, buildings or other property due to the exploration or development of oil
production activities shall be established by experts designated by the parties. In case
of disagreement, the Ministry of Energy and Mining shall appoint an arbitrator.
The penalties imposed by the National Director of Hydrocarbons can be appealed
before the Minister of Energy and Mining, whose resolution may in turn be appealed
before the District Tribunals of Administrative Disputes.
15.- Settlement of Disputes:
Legal acts of sector institutions may be challenged either in administrative or legal
grounds. When an act is challenged on administrative grounds, it shall be done so in
accordance with the regulations of the Legal Administrative Regimen of the Executive
Power. When based on legal grounds, it shall be filed with the District Tribunal for
Administrative Disputes.
Conflicts arising from contracts governed by this Law may be settled via the application
of mediation and arbitration systems. Also, an international arbitration procedure can
be stipulated, subject to the international agreements signed and ratified by Ecuador, as
is the case of the ICSID.
B.- SPECIAL FEATURES OF THE VARIOUS CONTRACTUAL MODES
As indicated above, the law contemplates the following modalities for hydrocarbon
exploration and exploitation works: association contracts, participation contracts,
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services contracts for the exploration and exploitation of hydrocarbons, for the
additional exploration and exploitation of marginal fields, shared management
contracts, or the incorporation of semi-private companies.
1.- Participation Contract:
Under this contract, contractor assumes at his sole risk all the investments, costs and
expenses required to execute exploration, development and production activities. Once
production begins, the contractor shall have the right to a participation in the production
of the contract area, which shall be calculated on the basis of the percentages offered
and agreed in the contract, on the basis of the volume of hydrocarbons produced. This
participation, valued at the sales price of hydrocarbons in the area of the contract, which
in no case may be below the reference price, shall constitute the gross income of
contractor, from which deductions will be made and the income tax will be paid,
pursuant to the regulations provided in the Law of Internal Tax Regime. The
participation of contractor may also be paid in cash, upon agreement with
PETROECUADOR.
The other portion of the production in the area of the contract belongs to
PETROECUADOR. However, this does not imply that PETROECUADOR has to
assume any part of the investment or of the costs or expenses required for the
exploration and exploitation of hydrocarbons. The participation of PETROECUADOR
in the production of the contractual area shall never be less than the percentage
corresponding to royalties which must be paid to the State, as stated before.
In case of return or total abandonment of the area of the contract by contractor, the State
shall owe nothing and the contractual relationship shall be terminated..
2.- Association Contract:
In these contracts, PETROECUADOR contributes with rights over areas, deposits,
hydrocarbons or other rights of its own, and the associated company assumes the
commitment of making the investments agreed between the contracting parties. In
exchange for these contributions, the parties shall participate in the production
according to the scale of participation agreed by the parties. If the associated company
wishes to make expenses or investment exceeding the minimum amounts stipulated, the
scale of participation in the results of the production established in the associations
contract shall not be modified.
In case of abandonment or total return of areas due to lack of productivity,
PETROECUADOR shall owe nothing to the associated company and the association
contract shall be terminated.
3.- Services Contract:
Under this contractual mode, contractor agrees to provide, with his own economic
resources and at his sole risk, oil exploration and exploitation services in the area of the
contract. If contractor finds commercially exploitable fields, he will be entitled to the
reimbursement of his investments, costs and expenses and to payment for his services.
This reimbursement shall be made solely with respect to the gross revenues produced
by the deposits found in the area of the contract, from which the corresponding amounts
shall be deducted before making any distribution of funds. If it is convenient to the
interests of the State, the reimbursement and payment for services to contractor may be
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made in kind or in a combination form. Contractor shall have a preferential option to

buy the production of the area of the contract, at a price which in no case may be less
than the reference price, to be established in accordance with the last average monthly
price of foreign sales of hydrocarbons of similar quality made by PETROECUADOR.
V.- TRANSPORTATION OF HYDROCARBONS THROUGH PIPELINES
According to the Hydrocarbons Law, the transportation service for hydrocarbons
through main pipelines may be provided under any of the following options:
- By PETROECUADOR, which may do it directly or delegate it through association
contracts, consortia, operation contracts or other contractual forms contemplated in the
Ecuadorian legislation; or also by organizing for that purpose semi-private companies.
These contracts are awarded subject to the special bidding procedures mentioned
before. Or,
- By national of foreign private companies of renowned competence in these activities,
upon direct authorization issued by the President of the Republic, via Executive Decree,
on the basis of a report issued by the Minister of Energy and Mining. Such companies
assume the responsibility and sole risk for the investment, without compromising public
funds.
When a pipeline is built by a private company on the basis of the authorization granted
by the President of the Republic, the company must provide the transportation service to
all users requiring such service, in the terms and conditions that may be freely stipulated
between the parties. Such terms and conditions may not be discriminatory, although
they might be different according to several factors characterizing several categories of
users.
If the company that operates the pipeline cannot agree with new users on the
transportation rate, the new users may ask the Minister of Energy and Mining to fix
such rates. The Minister shall fix the rates, taking into consideration the costs and
expenses and a reasonable profit over the investment, in accordance with international
oil practice; the Minister may in no case cause damage to the interests of the operator or
the user, nor create discriminatory situations with the current users of the transportation
system.
The State is entitled to ask users who have signed hydrocarbon exploration and
exploitation contracts with the State to hire the transportation of the State participation
in the respective contractual areas with the company that operates the pipeline in at least
the same conditions agreed for the transportation of their own production.
In case capacity exceeds the capacity agreed in such arrangements, operator shall offer
such capacity in the market, in similar terms and conditions, to all possible interested
parties. The State shall have a preferential right to hire this excess capacity in the terms
and conditions offered.
Transportation by secondary pipelines of other contractors.Contractor is entitled to use existing transportation means, according to the contract.
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Under Art. 57 of the Hydrocarbons Law, transportation by oil pipelines and gas
pipelines (regardless if they are main or secondary lines), is a public service and must
be provided on an continuous and uninterrupted form.
The last paragraph of Art. 249 of the Constitution of the Republic provides that the
State shall guarantee that public services provided under its control and regulation must
respond to principles of accessibility and continuity and shall oversee that the prices or
rates charged by such services are equitable.
The public service of transportation of hydrocarbons is subject to the regulations
established by the Ministry of Energy and Mining, as per Art. 9 of the Hydrocarbons
Law.
Paragraph 21 of Art. 1 of the Regulations for Hydrocarbon Operations provides that
transport operating agreements must be signed when a secondary pipeline of a
contractor has excess transportation capacity and is required to transport hydrocarbons
from other contract.
According to the text and the sense of the above-mentioned precepts, and without
ignoring that the property and administration of a private secondary pipeline is
exclusively of private nature, and that the use of its transportation capacity must
respond to terms and conditions freely negotiated and agreed, we must also admit that,
under circumstances of real technical and economic necessity and in view of the nature
of the transportation of hydrocarbons as a public service, destined to satisfy a general
need, the owner of a private pipeline may not refuse the right to transport hydrocarbons
from other areas, when transportation capacity is available. To refuse would mean not
only to go against the particular interest of the contractor requesting such transportation,
but ultimately to oppose the primordial general interest of the nation.
We believe that, given the fact that the transportation of hydrocarbons is a public
service, controlled and regulated by the State through the Ministry of Energy and
Mining, in compliance with the aforementioned constitutional mandate which provides
that this activity must respond to principles of accessibility, the Ministry of Energy can
ask a contractor to allow the transportation in his pipeline of the oil of another
contractor, which cannot be otherwise evacuated.
Establishment of rights of way for transport.The hydrocarbons industry, including the transportation of oil, is declared a public
service under Art. 4 of the Hydrocarbons Law. Therefore, the expropriation of real
property and the constitution of general and special servitudes, as required, are
authorized.
In the contracting guidelines and in the contracts, the State guarantees the right of way,
on land owned by third parties, in view of fulfilling the respective contracts, both for the
installations of the secondary pipeline as for service roads and storage areas.
Contractor has the right and the obligation to build secondary pipelines for the
transportation of oil to collection centers, or to connect with the main pipelines,
according to the provisions of Art. 60 of the Hydrocarbons Law and the Participation
Contract Guidelines.
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The right to constitute servitudes, such as the right of way, is not limited to the surface
of the area of the contract, but it extends to the entire path which the pipeline must
follow, both within and outside the area of the contract, even if it has to cross an area
corresponding to another contractor.
Indeed, a company may not refuse passage of a secondary pipeline through
contracted block, because the contract does not grant him rights on the land, or on
expropriated areas, or on the servitudes established on that block, as these
constituted in favor of PETROECUADOR, which assigns the use thereof to
company.

his
the
are
the

The delimitation of the area of the contract only serves to determine the surface where
the company is entitled to carry out the activities specified in the contract.
Accordingly, there are no impediments for a secondary pipeline of a contractor to cross
the contract area of another contractor, provided the general procedures for the
establishment of servitudes or the expropriation, if needed, are complied with, or via
agreements with owners, settlers or holders.
Rates.The transportation rate for a private secondary pipeline must be agreed between the
owner of the pipeline and the user. The legal provisions which determine the
intervention of the State to fix the rate in case of disagreement between the parties is
clearly defined in the case of the main pipelines. In any case, the State, following the
constitutional mandate of Art. 249, can and may persuade the parties to reach an
equitable and acceptable agreement.
VI. THE ECUADORIAN STATE OIL COMPANY PETROECUADOR
The Ecuadorian State Oil Company PETROECUADOR - and its affiliates were
created via a special law in view of the execution of exploration, production,
industrialization, commercialization and transportation activities.
Its goal is to develop hydrocarbon activities aimed at making the best use of resources
belonging to the inalienable and imprescriptible patrimony of the State, for the
economic and social development of the country.
The following are PETROECUADOR organs: the Board of Directors, the
Administrative Council, the Executive Presidency and other technical and
administrative units as necessary for the administration of its business.
The Board of Directors is composed by the Minister of Energy and Mining, who will
chair it, by one delegate of the President of the Republic, by the Minister of Economy
and Finance, by the Minister of Foreign Trade, Industrialization, Fisheries and
Competitiveness, by the Head of the Joint Command of the Armed Forces, by the
Secretary General of Planning of CONADE and by one representative for the workers.
Its functions are to establish the business policies of PETROECUADOR, and to
approve its policies, plans and budgets.
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The Administrative Council is the organ in charge of planning and coordinating the
activities of PETROECUADOR, and is composed by the Executive President and four
members appointed by the Board of Directors of PETROECUADOR, proposed by its
Chairman.
The Executive President shall be appointed by the Board of Directors of the company
from a threesome proposed by its Chairman. He is the legal representative of the
company and directly responsible for the technical, financial and administrative
management thereof.

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VI. ENVIRONMENTAL AND COMMUNITY ISSUES

1. Environmental Impact Assessments (EIA)
Before beginning any hydrocarbons operations, an Environmental Impact Assessment
(EIA) and an Environmental Management Plan must be prepared, following the
provisions of the Environmental Regulations for Hydrocarbons Operations.
In addition, governmental and business policies provide for the specific compliance of
the following laws and regulations: on hydrocarbons; water; forestry and preservation
of natural areas and wildlife; environmental pollution prevention and control; agrarian
reform and colonization; noise pollution prevention and control; air quality standards;
solid residue pollution; and the Environmental Management Law.
2. Consultation and participation
In addition to the requirements listed above, a process of consultation and participation,
provided in the National Constitution and in the Regulations for Consultation and
Participation, must be complied with.
The main goal of this process is to establish a procedure to negotiate an agreement with
the indigenous populations of the area for the prevention, mitigation, control and
rehabilitation of adverse socio-environmental impacts, and at the same time to promote
the positive aspects generated by hydrocarbon activities. The competent governmental
agent is the Ministry of Energy and Mining.
The Regulations provide for two series of negotiations:
a. A negotiation prior to issuing the invitation for the bidding process (called prebid consultation). The government agent in charge of the bidding process must
also handle the pre-bid consultation.
b. A negotiation prior to the approval of the Environmental Impact Assessment
(called pre-operational consultation). The company executing hydrocarbon
activities is responsible for the execution of the pre-operational consultation.
The agreements resulting from the negotiation process may include compensation
mechanisms mainly in the areas of health and education. This compensation must be
coordinated with local development plans and executed by the indigenous communities
or jointly with government plans.
Resolutions and agreements reached in the pre-operational consultation must be
formalized, notarized and registered with the Undersecretariat of Environmental
Protection; they shall be binding for the parties and may be enforced by judiciary or
administrative means.
VII. ASSIGNMENT OF RIGHTS OR SALE OF OIL ASSETS
1.- Sales of rights and obligations under contract
Art. 79 of the Hydrocarbons Law provides that the transfer, sale or assignment to third
parties of the rights arising from a contract may be made with the authorization of the

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corresponding Ministry, otherwise it is invalid, giving rise to the declaration of

forfeiture.
The aforementioned Article also provides that the State shall receive a premium for the
transfer and that the beneficiary company must sign a new contract in economic terms
more favorable to the State and to PETROECUADOR, than those contained in the
original contract.
Art. 1 of the Regulations for the Transfer or Assignment of Rights and Obligations of
Hydrocarbons Contracts, issued via Decree 1363, published in Official Registry 293
dated March 27, 2001, reiterates the aforementioned legal provision. Also, Art. 13
states that transfer or assignment contracts signed without following the procedure
stipulated in the Regulations are not legally valid.
Art. 2 of the Regulations states that any total or partial transfer or assignment may only
be made in favor of duly qualified national or foreign companies, according to the terms
and requirements stipulated under the law and the regulations and under economic
conditions more favorable to the State.
The process begins with a request from the seller or from seller and buyer together to
the Minister of Energy and Mining requesting him to authorize the sale or assignment.
The Minister then requests a report form the National Hydrocarbons Office, which
sends the documentation to the Contracts Administration Unit of PETROECUADOR,
which prepares a technical, economic and legal evaluation of the proposed buyer.
Once the qualification of PETROECUADOR and the favorable reports of the National
Hydrocarbons Office and the Legal Advisors of the Ministry of Energy and Mining
have been obtained, the Minister of Energy, via Ministerial Agreement, authorizes the
viability of this legal act.
When the ministerial agreement is obtained, the required payments are made and the
transfer contract is converted into a public deed with the intervention of the Executive
President of PETROECUADOR, authorized by the Administrative Council of the
entity.
The deed containing the transfer or assignment of the rights of the contract is registered
in the Register kept by the National Hydrocarbons Office. The transfer, sale or
assignment becomes effective on the date this is accomplished.
2.- Sale, assignment or transfer of stock
This can be made via a common contract for the sales of stock of a company which has
an oil contract with PETROECUADOR.
The transfer of stock must be notified to the Superintendency of Companies; however,
this notice by itself does not constitute an act of legalization or is a requirement for the
legal validity of the transfer, it is rather a formality to keep the relevant control agency,
in this case the Superintendency of Companies, informed.

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According to Art. 187 of the Law of Companies of Ecuador, the person considered as
owner of the stock is the person whose name appears in the Stock and Stockholders
Book of the Company .
Art. 188 of the same Law provides that ownership of a stock is transferred via an
assignment note signed by the transferor, and that such assignment must be written on
the relevant stock certificate or in a page attached to it, and recorded in the Stock and
Stockholders Book. This is because the transfer of ownership of a stock only becomes
effective on the date it is recorded, as specified in Art. 189 of the same Law. Art. 189
also states that such registration is valid only once it has been signed by the legal
representative of the company, at the presentation and delivery of a notice where
assignor and assignee notify of the transfer of the stock subject of the assignment.
In addition, the Law of Companies (Art. 189 above), prohibits the establishment of
requirements or formalities for the transfer of stock that are not expressly stipulated in
that Law, and any statutory or contractual stipulation which establishes those
formalities or requirements is invalid.
Any total or partial sale of stock must be notified to the Ministry of Energy and Mining
and to PETROECUADOR.
When the sale affects all or most of the stock, the provisions of paragraph 2, Art. 7 of
the Regulations for the Transfer or Assignment of Rights and Obligations of
Hydrocarbons Contracts, Decree 1363, apply: companies or consortia involved in
transfers or assignments of any stock or participation, provided such transfer or
assignment implies a current or future change in the operation of the contract, or
changes its corporate name or purpose, must submit to the provisions of this Executive
Decree with respect to the payment of premiums and improvement of the economic
terms of the contract. Therefore, there shall be no exception that prevents payment of
the amounts provided in this Decree, in the percentages and quantities stipulated
herein.
The transfer or sale of stock does not in itself imply any change in the corporate name
or the legal status of the assignor company, as it remains independent from its
stockholders. The legal fiction of change in the legal status has only one purpose, that
is, to generate the payment of the fees established in the law in the case of the transfer
of rights and obligations of a contract.
It is not necessary to sign a new contract, as this is not a transfer of the rights and
obligations of the contract, but a sale of stock.
The formalities begin with a notice sent by the contractor to the Ministry of Energy and
Mining, informing of the sale of the stock. If required, a ministerial agreement is issued
ordering payment of the transfer premium and the improvement of the economic terms
of the contract.
In order to issue the ministerial agreement, the Minister relies on the reports issued by
the National Hydrocarbons Office and the Legal Department of the Ministry.
Once the ministerial agreement is issued, the agreed fees are paid.
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3.- Sales of assets of contractor incorporated to contract.3.1.- Legal status of property with respect to oil contracts.At the termination of a contract, the goods purchased are subject to a double regimen
with respect to the State:
a).- During the exploration period. If the contract is terminated while contractor is still
in the exploration period, contractor is not obligated to hand over to the State the goods
it purchased to fulfil the purposes of the contract, except camps and infrastructure
works.
b).- During exploitation period. If contract is terminated during the exploitation period
or due to the conclusion of the duration of the contract, (which includes the periods of
exploration and exploitation), contractor must hand over to the State all the equipment,
tools, machinery, installations and other movable and immovable property purchased
for the development of the contract.
3.2.- Sale.During the term of validity of an oil contract, the property of the contractor can be sold,
encumbered or donated, but only with the prior authorization of the Ministry of Energy
and Mining, as mandated by Art. 30 of the Hydrocarbons Law. In this case, the Ministry
acts via the National Hydrocarbons Office as the agency in charge of controlling all the
activities of the oil companies in the country.
Contracts also stipulate that a list of these goods must be submitted to
PETROECUADOR.
For the purposes of the sale, any goods purchased by the contractor under the definitive
importation regime (for consumption) must be distinguished from those imported under
the temporary regime.
In the first case, the prior authorization of the Ministry of Energy and Mining is
required before the signing of a common sales contract.
In the case of goods imported in the country under the temporary regime, they can be
sold in two ways:
a).- Outside the temporary importation regimen.- Seller nationalizes the goods (that is,
pays the relevant taxes), and reaches an agreement about the price with the buyer.
Obviously, these goods cannot be reexported as they have already been nationalized.
b).-Under the temporary internment regimen.- In the case of a sale between two
contracting companies, both seller and buyer have the right to apply this regime.
In general, the Organic Customs Law allows the constitution of a new beneficiary of the
regimen., who after the 5 years stipulated by the Hydrocarbons Law, would have either
to reexport or nationalize the goods, by paying the relevant taxes.
In all cases the authorization of the Ministry of Energy and Mining is needed.
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Goods under temporary internment, by their own nature, are not subject to Art. 29 of the
Hydrocarbons Law concerning reversion to the State, unless they are nationalized.
From the moment the contract moves to the exploitation period, the goods purchased
outside the temporary internment regimen are affected by the provisions of the
Hydrocarbons Law concerning reversion at the end of the contract.

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