ECONOMIC IMPLICATIONS OF PERU'S EXPROPRIATION OF US OIL PROPERTIES

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001600010087-5
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 17
• Document Creation Date: December 22, 2016
• Document Release Date: October 1, 2009
• Sequence Number: 87
• Publication Date: October 1, 1968
• Content Type: IM

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Y - 1 V O - ! V
Confidential
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
Economic Implications of Peru's Expropriation
of US Oil Properties
Confidential
ER IM 68-137
October 1S68
Copy No. ` 1
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WARNING
This document contains information affecting the national
defense of the United States, within the meaning of Title
18, sections 793 and 794, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
ceipt by an unauthorized person is prohibited by law.
GROUP I
Ejtluded Iron aalomalit
downgrading and
detlctti(talion
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
October 1968
Economic Implications of Peru's Expropriation
of US Oil Properties
Summary
Seizure of the principal properties of the US-
owned International Petroleum Company (IPC) by Peru's
new military regime probably will delay the economy's
recovery from its present recession and, if arrange-
ments for adequate compensation are not made promptly,
could create new and major economic difficulties for
the regime. Refusal to make such arrangements would
jeopardize the continuation of aid from the United
States and international lending institutions and
would discourage direct foreign investment.
The IPC, a subsidiary of Standard Oil of New
Jersey, is Peru's largest oil firm, with total assets
valued (by the company) at $200 million. The expro-
priation involves the company's La Brea y Parinas
oilfield and its large Talara refinery, but not its
half-interest in a second, larger field or its exten-
sive wholesale and retail distribution facilities.
So far, the regime has failed to take the initiative
in offering compensation for the seizure. It has in-
dicated, however, that government claims for back
taxes and penalties in excess of $144 million would
be applied against the value of the expropriated prop-
erties when compensation is eventually determined by
Peruvian courts. The validity of these claims is
strongly denied by the company.
Note: This memorandum was produced sol ly by CIA.
It was prepared by the Office of Economic Research
and was coordinated with the Office of Current
Intelligence.
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The expropriation is d?.laying US aid and current
negotiations with the International Monetary Fund
for stand-by credits of $75 million and with US and
European banks for refinancing some $150 million in
debt-servicing obligations, all of which Peru badly
needs to alleviate its balance-of-payments difficul-
ties. If prompt and adequate compensation is not
forthcoming, the United States could be forced to
suspend economic aid and the US sugar quota. If the
United States took this step, the stand-by credit
and debt refinancing negotiations would be jeopar-
dized, and Peru would face a drying up of direct
foreign investment, including pending copper invest-
ments that could total more than $600 million over
the next several years.
The regime should have no major long-term diffi-
culty in operating the seized oil properties. Lack
of cooperation from IPC, which retains control of a
large part of the oil supply going to the Talara
refinery and a nationwide marketing system for petro-
leum products, probably would provoke the regime
into nationalizing these properties as well. The
regime stands to gain some $20 million to $25 mil-
lion annually in profits formerly retained by the
company after payment of Peruvian taxes. These prof-
its, however, will not necessarily provide a net
gain in government revenues -- at least for a number
of years. If the regime compensates IPC adequately,
these profits will have to be used, at least in part,
for this purpose. If the regime does not provide
compensation, the added profits could be more than
offset by losses from suspension of US economic aid
and the US sugar quota as well as declines in direct
foreign investment.
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Introduction
1. One of the first major acts of Peru's
new military regime, which ousted the government
of President Belaunde Terry on 3 October 1968, was
to expropriate the principal facilities of the
US-owned International Petroleum Company (IPC),
a subsidiary of Standard Oil of New Jersey. The
regime has announced that government claims for
back taxes, the validity of which is strongly
denied by the company, would be applied against
the value of the expropriated facilities in de-
termining compensation. The seizure, which
climaxes a lengthy dispute between the company
and successive Peruvian governments, has had an
immense popular appeal that has effectively uni-
fied much of the public in support of the regime,
at least temporarily.
2. The regime has offered public and private
assurances to other foreign firms in Peru that
IPC is the only firm to be subjected to ex-
propriation and that their facilities, operations,
and existing contracts with the state will be re-
spected. Nevertheless, the seizure -- particularly
the indication that adequate compensation may not
be offered -- worsens Peru's already strained re-
lations with the United States. It also threatens
Peru with adverse economic measures by the United
States and international financial institutions
that would make recovery frcm the present economic
recession more difficult.
3. The IPC is one of Peru's largest industrial
firms and is the largest of the eight US-owned
petroleum companies operating in the country. it
is also Peru's largest taxpayer, accounting for
about 4 percent of the revenues of the central
government in 1966. The company dominates all
aspects of the country's petroleum industry, in-
cluding exploration, extraction, refining, and
distribution. Among its assets, presently valued
by the company at an estimated $200 million, are
(a) the La Brea y Parinas (LBP) oilfield, which
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in 1967 accounted for 27 percent of Peruvian crude
oil production; (b) a half-interest (with the
Lobitas Oil Company, owned by British and Peruvian
interests) in the Lima oilfield, which is located
near the LBP field and accounted for 42 percent of
crude oil production in 1967; (c) a large refinery
at the port of Talara which has a capacity of
60,000 berrels of crude oil per day, refines nearly
all of the crude produced by the LBP and Lima oil-
fields, and accounted for two-thirds of Peru's
production of refined products in 1967; (d) pe-
troleum storage and loading facilities at the ports
of Talara and Callao (near Lima) ; and (e) a country-
wide wholesale and retail distribution system for
refined products. Peru's supply of and demand for
petroleum in recent years are shown in the table.
4. The properties expropriated were the LBP
oilfield, the Talara refinery, and the related
storage and loading facilities in the port of Talara.
These properties together constitute an integrated
extracting, refining, and storage complex. The
company's head offices in Lima, its bank accounts,
and the remaining facilities listed above have not
been expropriated.
Background of the Dispute
5. The expropriation brings to a climax a
century-old dispute between owners of the ..,BP oil-
field and the state over the division of the
profits from its exploitation. To a considerable
extent, the dispute turns on the ownership of
subsurface mineral rights in the LBP area. Under
Peruvian law, as under the laws of most Latin
American countries, subsurface mineral rights are
considered.to be the property of the state, and
their exploitation by private individuals is sub-
ject to regulation and special taxation.
6. Nevertheless, the LBP properties, in-
cluding subsurface mineral rights, were deeded to
a private individual in 1826 and were sold to a
British firm in 1888. Attempts by Peruvian
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Peru: Petroleum Supply and Demand
1963-67
Million 42 US Gallon Barrels
1963
1964
1965
1966
1967
Supply (excluding stocks)
Production of crude oil
21.5
23.1
23.1
23.0
25.9
Imports of crude oil
0.7
0.5
0.8
0.7
1.2
Imports of refined product
s 4.2
5.1
5.7
8.1
7.7 a/
Total
26.4
28.7
29.6
31.8
34.8
Demand
Domestic demand 22.7
25.5
26.3
29.1
30.4
Exports of crude oil 2.9
2.7
2.4
2.0
3.7
Exports of refined products 0.8
0.5
0.9
0.7
0.7
Total 26.4
28.7
29.6
31.8
34.8
a. Peru's partial dependence on imports of refined products
will be reduced in 1968 as a result of the completion in
December 1967 of a new state-owned refinery with an annual
capacity of 7.3 million barre%s.
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governments to impose higher taxes on the property
led in 1918 to submission of the dispute by the
British and Peruvian governments to a court of
international arbitration. The court's ruling,
which was handed down in 1922, confirmed the claim
of the British firm to ownership of the subsurface
mineral rights, granted Peru a $1 million settle-
ment of back taxes, and established a new tax rate
on
the LBP property that was
to hold until
1972.
On
LBP
the basis of this ruling,
property in 1924.
IPC purchased
the
7. The dispute remained relatively dormant
until 1959. Although the Peruvian Congress passed
a law in 1932 authorizing the President to request
a revision of the arbitration award, it was not
acted on. In 1957, IPC offered to give up its
ownership of the LBP field, requesting that it be
permitted to operate the field under the same
concession status as its Lima field and all other
oilfields in Peru. The request was rejected by
the government because IPC would pay smaller taxes
as a concessionaire than as a property owner.
Following a large government-authorized increase
in petroleum prices in 1959, however, the dispute
became a major political issue, as nationalist
politicians sought expropriation of the LBP oil-
field and the Talara refinery as a means of captur-
ing the additional profits.
The Dispute Under Belaunde
8. President Belaunde, who took office in
June 1963, sought to negotiate a settlement of the
dispute with the company that would satisfy Peruvian
nationalists but would not significantly alter the
division of its profits. He did not want to
jeopardize his program of attracting direct foreign
investment and obtaining economic aid from the
United States and international lending institutions.
Most of the time, Belaunde's position had the
support of a majority of the Congress, although
Congress unanimously passed a resolution in 19613
that rejected the arbitration award of 1922 and
passed a bill in August 1967 that expropriated
the LBP properties. These congressional actions
were not given practical effect, and the govern-
ment's negotiations with IPC dragged on fruitlessly
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until late 1967. In November 1967, however, the
government initiated legal proceedings to recover
an unspecified amount of back taxes (estimated by
IPC at $1.2 million) and $144 million in "unjust
enrichment," which represented the company's total
profits (after Peruvian taxes) from the LBP
properties over the preceding 15 years.
The Act of Talara
9. In August 1968 the Belaunde government
and IPC reached a settlement that became known au
the Act of Talara. Its terms closely resemble
those of a compromise offer made by the company
in mid-July. IPC exchanged its claims to the LBP
oilfields (including both surface facilities and
subsurface mineral rights) for a quit-claim for
back taxes and "unjust enrichment" and a 40-year
concession to (a) operate its refinery, (b) con-
tinue wholesale and retail distribution of pe-
troleum products, and (c) seek and develop pe-
troleum deposits in the Amazon region previously
reserved for the State Petroleum Company (EPF).
These concessions, which resemble those extended
to other foreign oil companies in Peru, authorized
IPC to enlarge and improve its refinery, expand its
drilling operations, and import duty-free any
necessary equipment and materials, including any
crude petroleum required to use the refinery's
full capacity.
10. The settlement also provided that the EPF,
which was to take over operations of the LBP
properties by December 1968 at the latest, would
sell at least 80 percent of the LBP output to the
Talara refinery for a period of 6 years at $1.97
per barrel, less a maximum of $0.89 per barrel
to be paid by EPF to IPC for services rendered.
The price of $1.97 seems to have been a fair price,
since it approximates that paid during 1967-68 by
buyers of oil produced in neighboring Colombia.
Although it is not clear whether the service
charge to be paid to IPC was reasonable, this
feature was not criticized by the opponents of
the settlement.
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11. A few hours after the signing of the agree-
ment on 13 August, the government accepted the
formal transfer of the LBP properties to the state
at a public ceremony. As the benefits received
by IPC gradually became known, a storm of protest
arose from nationalist politicians. Their main
criticisms were that IPC should have been forced
to give up the Talara refinery or at least make a
large payment to settle the government's claims for
back taxes and "unjust enrichment."
12. Irregularities in the handling of the
original document were deftly exploited by
nationalist politicians to cast suspicion on the
propriety of the agreement. The president of EPF,
who was a signer of the agreement, charged that
one page containing an amplification of the terms
at which EPF would sell crude petroleum to IPC
was never published. Public mistrust of the
settlement continued to grow in spite of the gov-
ernment's offer to rewrite the contract to clarify
the terms of sale of oil to IPC and to specify that
IPC would pay EPF for oil extracted from the LBP
fields beginning 13 August rather than when EPF
took over operations. Military dissatisfaction
with the settlement also became apparent. Although
a majority of Congress supported the settlement and
voted down a motion of censure of the government,
the cabinet resigned on 1 October in an unsuccess-
ful attempt to forestall a coup. The Act of Talara
was nullified by the military regime when it seized
power two days later. The regime also indicated
that the three principal cabinet members involved
in the settlement would be prosecuted.
Peru's Economic Relations with the United States
13. Expropriation of the IPC properties may
prove to be a blow to economic progress in Peru,
which has a substantial stake in maintaining good
relations with the United States. The United States
is Peru's most important trading partner, purchas-
ing 42 percent of Peru's exports and supplying
37 percent of its imports in 1967. Almost all
of Peru's sugar exports and important shares of
other leading exports such as copper, cotton, and
coffee go to the United States.
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14. Peru relies to a considerable extent on
foreign private and official capital, nearly all of
which comes from the United States or from public
and private international lending institutions in
which the United States has strong influence. Net
inflows of private long-term capital, which have
come predominantly from the United States, averaged
$33 million annually during 1965-67. The total
book value of US direct investments amounted to $518
million (net of accumulated depreciation) at the
end of 1966. US firms dominate many of the country's
export industries -- including copper, other non-
ferrous metals, and sugar -- and are becoming in-
creasingly important in fishmeal production, manu-
facturing, domestic trade, and banking.
15. Inflows of official capital also have been
significant. During US fiscal years 1963-67, Peru
was authorized a total of $247 million in US eco-
nomic aid and military assistance -- $137 million
in loans and $110 million in grants. Authorized
loans from public international lending institutions
such as the International Bank for Reconstruction
and Development and the Inter-American Development
Bank amounted to $211 million during the same period.
In addition, the government of Peru received large
loans from private US banks.
16. Another benefit that Peru obtains from the
United States is the subsidy deriving from its
sugar quota in the US market. In 1967, Peru exported
338,000 metric tons of sugar to the United States,
for which it received $46 million, or 6 percent of
its total export earnings. Of this total, $33
million represented payments in excess of those that
Peru would have received if the sugar had been sold
at world market prices.
17. Nevertheless, Peru's relations with the
United States have been strained in the last two
years. In 1967, when the LBP oilfield was nominally
expropriated, US economic aid was suspended temporarily
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under the provisions of the Hickenlooper amend-
ments.* Again, last apring, US aid was temporarily
suspended when Peru ran afoul of the Symington and
Conte-Long amendments** for purchasing French
Mirage jet aircraft and other military equipment.
18. Relations between the two countries also
have been irritated by Peruvian seizure of US fish-
ing vessels off Peru's coast. Along with Chile and
Ecuador, Peru claims a 200-mile offshore territorial
limit that is not recognized by the United States.
Recent Peruvian seizures of US fishing vessels were
a factor in the passage last August of the Pelley
amendment to the US Fishermen's Protective Act.
The amendment provides that fines and other expenses
incurred by ship owners as the result of the seizure
of US fishing vessels by a country receiving US eco-
nomic aid may under some circumstances be deducted
from that aid.
Recent Peruvian Economic Performance
19. Peru has made its nationalistic move against
IPC at a time of recession, following a long period
of rapid economic growth. During 1961-66, gross
domestic product grew an average of 6.3 percent
annually -- the highest rate in South America. As
this advance continued, however, strains began to
develop. Balance-of-payments difficulties emerged
as imports increased faster than exports, and slug-
gish government revenues led to rising budgetary
deficits and mounting inflationary pressures. In
* The Hickenlooper amendments provide that US
economic aid is to be suspended if a recipient
country that expropriates the assets of a US-owned
firm fails within six months to take steps (including
arbitration) to provide equitable and speedy com-
pensation in convertible foreign exchange.
** The Symington amendments provide that US economic
aid is to be suspended if a country is diverting
this aid to finance military purchases or if
military expenditures are interfering materially
with its economic development. The Conte-Long
amendments provide that US econo,r~c aid is to be
reduced by the amount expended by the recipient
country for the purchase of "sophisticated" mili-
tary equipment such as supersonic jet aircraft.
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1967 the rate of growth dropped to 4.0 percent,
partly because bad weather cut agricultural pro-
duction. In addition, declining export earnings
and a capital flight worsened the balance-of-
payments difficulties and led to 31-percent
devaluation of the sol in September. Public and
private investment dropped, and the expansion of
construction and manufacturing slowed.
20. The slowdown has been accentuated in 1968.
Agricultural production has continued to decline
because of serious drought. Political obstacles
to the balancing of the government budget have
led to repeated cabinet shuffles and an erosion of
business confidence. Although the devaluation
stimulated exports and sharply curbed imports,
continued capital flight restricted recovery of
the balance of payments. Private investment
outlays continued to be depressed by a clampdown
on private credit. Production was restrained by
shortages of imports, the cost of which was raised
by the devaluation and the subsequent imposition of
a substantial surcharge on customs duties. Con-
sumer prices have risen an average of more than 1
percent a month since the first of the year.
21. Last June the Belaunde government began a
strong attempt to stabilize the economy with the
aid of special powers granted by the congress.
Under these powers, which allowed rule by decree
for 60 days, the government imposed sizable tax
increases and cut expenditures. It also initiated
a request to the International Monetary Fund for
a new, expanded stand-by credit of $75 million and
began negotiations with a number of private US and
European banks to refinance some $150 million in
debt service payments that fall due during the next
year and a half. In addition, it requested $10
million worth of rice from the United States under
Public Law 480. Finally, it increased the pressure
on three large US-owned copper companies to proceed
with planned investments totaling more than $600
million over the next several years. All of these
negotiations were pending at the time of the coup,
and the new regime has taken steps to continue them.
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Prospects
22. The direction of the new regime's economic
policies has not yet clearly emerged. So fay, the
regime has stated that it will recognize Peru's
international obligations and will continue the
Belaunde government's policy of encouraging direct
foreign investment. Nevertheless, the highly
nationalistic tone of some of its public statements
condemning "government subservience to foreign and
domestic monopolists" has not been reassuring.
23. Expropriation of the IPC properties probably
will increase Peru's economic problems and delay its
recovery from the recession. Even if the regime
quickly arranges adequate compensation for the
company, the reaction in the United States and
international financial circles to the expropriation
probably will delay pending US aid, the IMF stand-
by credit, and the debt refinancing negotiations
and will slow the inflow of direct private invest-
ment. Moreover, agreement to compensate IPC will
increase Peru's outstanding external debt, which
now exceeds $900 million, and will add to the already
heavy burden of debt ser7icing obligations on the
country's balance of payments. In view of the bleak
outlook for Peru's export earnings over the next
year or two, particular]',y if world copper prices
decline as expected, the prospects for the economy's
performance are dim at best.
24. If the regime fails to offer prompt and
adequate compensation to IPC and/or expropriates
other US firms, the country faces suspension of all
US economic aid and cancellation of its US sugar
quota.* If the United States takes such action, the
negotiations for the International Monetary Fund
stand-by credit and for debt refinancing also would
be jeopardized, and Peru would face a drying up of
* The US Sugar Act of 1948 (as arr.snded) provides
for cancellation of a country's US sugar quota in
circumstances similar to those penalized by the
Hickenlooper amendment.
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the inflow of direct private investment and a
probable cut-off of naw loans from international
financial institutions such as the International
Bank for Reconstruction and Development. Such
drastic measures would impose major hardships on
the economy that might cause the regime to seek
economic aid from the Communist world. Aid from
Communist countries, however, would not include
hard currencies and thus would not help Peru to
meet its international financial obligatiors.
Moreover, Peru -- like other Latin American coun-
tries -- would find that serious political and
economic difficulties stand in the way of large-
scale trade with Communist countries and the utili-
zation of economic development credits that they
might offer.
25. Peru's action could have repercussions on
US investments in extractive industries elsewhere
in Latin America, although much depends on what
the United States and Peru do next and how the
Peruvian economy fares under the new regime. The
strong current of nationalism that contributed to
Peru's action also i.s flowing in most other South
American countries. And aside from the heated
questions of nationalism and anti-Americanism,
people in less developed countries the world over
have the practical aim of getting a much larger
share of the benefits accruing from exploitation
of their mineral resources. This trend has been
reflected in the postwar period by substantial in-
creases in the share of oil revenues going to some
producing countries in the Middle East. The same
motive lies behind Venezuela's decision in 1968
to use service contracts rather than the customary
concession arrangements for future petroleum develop-
ment. Although the Peruvian expropriation does not
i:tunediately imperil US investments in most countries
of Latin America, it does constitute a fresh in-
spiration for nationalists long intent on taking
over US copper investments in Chile as well as in
Peru. Apart from its didactic value, the action
probably has strengthened popular support for
nationalization of those investments.
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26. Peru should have no great long-term
difficulty in operating the oil properties taken
over from IPC. Only 40 of IPC's 4,000 employees
are non-Peruvians, and the State Petroleum Company
has some experienced personnel upon which it can
draw. Any remaining lack of technical personnel
probably could be filled readily from private oil
companies in Peru or in other Latin American
countries. A failure of IPC to cooperate ir, supply-
ing crude oil to the refinery or in distributing
the refinery's products could cause temporary dis-
ruptions to oil supplies, but this failure probably
would provoke the regime into expropriating the
remainder of the company's properties. Beyond a
possible short transitional period, therefore, the
seizure should not require a significant enlargement
of the country's present small net imports of petro-
leum in order to maintain the supply of petroleum
or the economic activities dependent on it.
27. The Peruvian government will not necessarily
realize any net gain in revenues as a result of ex-
propriating the LBP properties -- at least for a
number of years. Government revenues from these
properties could rise as much as $20 million to $25
million annually, assuming that the profits of IPC
had been divided about equally between the company
and the government. But much or all of this gain
might be offset by payments to IPC if it is compen-
sated for the LBP properties. And if it is not
compensated adequately, the Peruvian government may
lose more from the suspension of US aid and the US
sugar quota than it gains in petroleum revenues.
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