Protection of investments in oil & gas under the new USMCA

April 2020  |  SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2020 Issue

With the imminent ratification of the US-Mexico-Canada Agreement (USMCA), it is worth analysing the new manner in which investment disputes related to the energy sector (including oil and gas, and power generation) are regulated by this treaty.

Chapter 14 of the USMCA, which will substitute Chapter 11 of the North American Free Trade Agreement (NAFTA) that regulated the investment protection system of the free trade zone, was undoubtedly influenced by the international trend to reduce the scope, complicate or even eliminate the direct access of foreign investors to investor-state arbitration. However, there is a notable exception in this regard applicable only to Mexico and the US, which relates to investments made in the oil and gas sectors, the telecommunications sector and for other infrastructure projects arising from government contracts.

This is not a coincidence. It is part of the renegotiation by the Trump administration to obtain more benefits from Mexican counterparts, in sectors which were either excluded from NAFTA or whose regulation was not optimal. In this regard, it is important to bear in mind that in the context of NAFTA Mexico made express reservations to exclude the oil and gas sector from the treaty.

The availability of investor-state arbitration in the investment protection chapter of the USMCA is limited to Mexico and the US. Canada opted not to form part of Chapter 14 of the USMCA, which basically eliminated the possibility of receiving or filing new investor-state arbitration claims with the US. However, Canada and Mexico are both parties to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). In the CPTPP, the Mexican government incorporated the energy reform enacted by Mexico in 2013, under the administration of the former President Peña Nieto. This reform allowed foreign investment in oil and gas under the licences and contracts regulated in the Mexican Hydrocarbons Act and other related legislation. Therefore, Canadian investors are well protected by CPTPP investment protection.

Focusing on the USMCA, Mexican and US investors will continue to have recourse to investor-state arbitration under USMCA Chapter 14. However, as a general rule, the scope of, and access to, this mechanism has become much more difficult compared to NAFTA. Some substantive claims have been excluded. In addition, a new procedural requisite was added obliging the investor to first bring a claim before a competent court or administrative tribunal of the recipient country. Only if a final decision from a court of last resort has been rendered or 30 months have elapsed from the date on which the domestic proceeding was initiated would the investor be able to bring its investor-state arbitration claim.

In the oil & gas sector, under Chapter 8 of the USMCA the US and Canada recognises Mexico’s ownership over all hydrocarbons in its subsoil, as well as Mexico’s right to amend its constitution and domestic legislation as it sees fit. This recognition had more of a political purpose than an actual effect on foreign investment in this sector. The Mexican government at the time of USMCA approval used the recognition contained in Chapter 8 as evidence that, during the negotiation of the new treaty, it achieved the goal of preserving its sovereign control of Mexico’s oil and gas. However, the harsh reality of the treaty for Mexico is very different. Although Mexico may always remain the ‘owner’ of hydrocarbons located in its territory, the sovereign decisions it may have to take could result in large indemnifications if they affect the rights of US foreign investors.

The key protection for US investors in oil & gas, power generation and infrastructure projects is in the form of ‘government contracts’. Government contracts are those agreements between investors and Mexican authorities in the oil and natural gas sectors – mainly related to exploration, extraction, refining, transportation, distribution or sale – involving the supply of power generation services to the public, the supply of telecommunications services to the public, the supply of transportation services to the public and the ownership or management of roads, railways, bridges or canals that are not for the exclusive or predominant use and benefit of the government.

In the event of government contracts, none of the general restrictions for investor-state arbitration claims, either in scope or procedural requisites, apply. Indeed, for the energy sector, investor-state dispute settlement (ISDS) protection not only includes national treatment, most favoured nation (MFN) treatment and protection against direct expropriation, but also guarantees of fair and equitable treatment and protections against indirect expropriation. In addition, exhaustion of local remedies as a procedural requirement will not apply to claims related to the energy and infrastructure sector.

Moreover, Mexico agreed to an MFN clause, to afford to US private investors treatment regarding energy that is no more restrictive than the treatment Mexico grants to parties of other trade agreements it has concluded. In this regard, and as has already been explained, the CPTPP basically incorporated all the rights and obligations contained in the energy reform of 2013; US investors are entitled to enforce any act or omission of the Mexican government that may affect said rights. In other words, the Mexican government cannot issue or enforce any foreign investment rules in the energy sector that may imply a revocation to those contained in the 2013 energy reform (which opened the sector to foreign investment).

Based on the USMCA investment protection framework for energy and infrastructure investments, it is clear that US foreign investors are in a privileged position compared to where they were under NAFTA. In fact, some recent political decisions, such as the moratorium adopted by the Mexican government to continue with the leases or assignation of new zones for the exploration and extraction of oil in Mexican territory, may be alleged as USMCA violations once the treaty comes fully into effect.

Of particular importance, the USMCA would protect US foreign investors in contracts executed by them with the National Commission of Hydrocarbons of Mexico, particularly in connection with the ‘administrative rescission’ clause. Under the Mexican Hydrocarbons law, administrative rescission entitles the Commission to rescind an oil & gas exploration and extraction agreement if certain obligations or standards are not met. Due to the nature of this rescission, as a practical matter, it is a decision that may be taken unilaterally by the Commission and against which the investor seeking remedy would have to bring an action before local courts.

This restriction to challenge administrative rescissions only before local courts could be traced back to the notorious Commisa case, in which the Mexican government adopted for the first time the position that administrative rescissions should be deemed as sovereign acts (acts of authority) which cannot be subjected to private or alternative dispute resolution methods such as arbitration. In this regard, it is safe to assume that the US administration was aware of the restrictions that existed in the 2013 energy reform enacted by Mexico. Indeed, the US was very careful to include the possibility of resorting to ISDS in the event of an administrative rescission or any other sovereign acts of the Mexican government.

Finally, and in connection with the protection that Canadian companies may have in the oil & gas sector under the CPTPP, it is not yet clear whether its scope is the same as that provided by the USMCA. For instance, administrative rescission under the CPTPP is considered to be an acceptable restriction imposed by the Mexican government on foreign investment in the sector. Thus, Mexico may argue that it intended to restrict the access of ISDS in connection with said rescission.

Marco Tulio Venegas Cruz is a partner at LITREDI, S.C. He can be contacted on +52 (55) 5206 7051 or by email: mtv@litredi.legal.

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Marco Tulio Venegas Cruz

LITREDI, S.C.

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