Life afta’ NAFTA: USMCA Protects U.S. Investors in Mexican Energy Sector

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Mexico’s energy market has opened to foreign investment in recent years, and U.S. investors have taken note. Under the United States-Mexico-Canada Agreement (“USMCA”) signed last month, which will replace the North American Free Trade Agreement (“NAFTA”), these investments should be protected.

In 2013, Mexico passed an expansive energy reform bill, ending Pemex’s national monopoly on production and sales and giving many international investors the chance to access the Mexican energy market for the first time. Since this reform, U.S. exports of gasoline and natural gas to Mexico have grown exponentially, and U.S. energy companies—many of which are headquartered in Texas—have taken advantage of opportunities to enter into government contracts to develop Mexico’s offshore oil and gas resources. U.S. investment in Mexican energy is a natural partnership: As Mexican energy demand has grown in recent years, its national production has dropped, leading to an increased reliance on foreign imports. The story north of the border is markedly different. Largely as a result of the U.S. shale boom, natural gas production has increased dramatically, and U.S. companies now supply 65 percent of Mexico’s natural gas. Mexico is also the No. 1 market for U.S. LNG exports, which have more than doubled since 2013.

For the past 25 years, U.S. investments in Mexico, whether in the oil and gas sector or in other industries, were protected by NAFTA. In addition to opening markets between the U.S., Mexico, and Canada, the trade agreement offered both substantive protections for U.S. investors in Mexico, as well as procedural means for U.S. investors to assert claims against the Mexican government. Under NAFTA’s Chapter 11, Mexico agreed that investors would be treated as fairly as domestic investors or other foreign investors and would be guaranteed a minimum standard of treatment, including “fair and equitable treatment” and “full protection and security.” In addition, NAFTA assured investors that their investments would not be expropriated without fair compensation.

Recent political changes threatened to upend these protections. When President Donald Trump triggered renegotiations of NAFTA in May 2017 after labeling it “the worst trade deal ever made,” many worried that an abrupt withdrawal from NAFTA without an adequate replacement agreement would disrupt markets and imperil existing cross-border investments. On Nov. 30, however, leaders of the United States, Mexico, and Canada signed USMCA, which, if ratified, will replace NAFTA and give U.S. investors in the Mexican petroleum industry reassurance. While the new deal has not yet been ratified by the respective legislatures, it appears poised to continue protecting U.S. investors in Mexico’s oil and gas sector.

In particular, Chapter 14 of USMCA maintains the contours of NAFTA’s substantive protections for investors, namely guarantees of national treatment, most favored nation treatment, and a minimum standard of treatment including fair and equitable treatment and full protection and security. The protections against unlawful expropriation also remain, accompanied by a detailed explanation as to when government actions falling short of outright seizure will trigger the same consequences of expropriation.

The method for resolving many categories of disputes arising under the new trade agreement have changed, however. Under NAFTA, investors from signatory states had recourse to international tribunals to resolve their disputes against another signatory government. These tribunals were frequently made up of arbitrators with nationalities different from those of the parties, particularly that of the chair or president of the Tribunal. For most disputes arising under USMCA, the new trade agreement limits the availability of international arbitration to investors, favoring resolution of disputes in national courts. Between the U.S. and Canada, the possibility for investors to assert claims before international tribunals is entirely eliminated. The only recourse is to local courts. The USMCA also omits provisions for investment arbitration between Mexico and Canada, although other treaties between the two countries provide avenues for international tribunals to hear investment claims.

For most U.S. investors in Mexico (and for Mexican investors in the U.S.), arbitration will be available, but only after exhausting local remedies and only for certain types of claims. An important exception exists under USMCA for U.S. investors that have qualifying government contracts in Mexico in the oil and gas sector. These investors will be able to assert claims before international tribunals for a violation of any of the substantive protections contained in USMCA’s Chapter 14 and will be excused from the requirement applicable to most investors to first exhaust local remedies before triggering arbitration.

In practice, these special provisions for U.S. oil and gas investors should make it easier for American companies investing in Mexico under the 2013 energy reforms to pursue claims at an international level. In short, USMCA’s substantive guarantees and right of access to international tribunals offer increased protection from the risks of a changing political climate.

Other provisions of USMCA should also reassure the energy industry. USMCA continues the prohibition of tariffs on energy products between the U.S., Mexico, and Canada, allowing the market for U.S. energy exports to continue growing as Mexican consumption continues rising. Rules on national origin certification allow additional flexibility for US customs authorities in certifying the origin of petroleum products entering the U.S. from Mexico and Canada. As for those investors with existing claims who prefer to pursue them under NAFTA, USMCA makes clear that existing NAFTA disputes may continue, and provides a three-year phase-out period in which investors may assert pre-existing claims under NAFTA’s dispute-resolution provisions.

USMCA has yet to enter into force, as it still requires legislative approval from the U.S., Mexico, and Canada. It may face an uphill battle with Democrats in the majority in the House of Representatives from January. For now, however, the deal is well-placed to preserve gains for U.S. investors in the Mexican energy market.

Jennifer M. Smith is a partner in the Houston office of Hogan Lovells and a member of the firm’s Litigation practice. For more than 25 years, she has advocated for companies involved in complex international commercial disputes all over the world. Jennifer is well-versed in the business and cultural realities of cross-border disputes, as well as on having a deep understanding of almost every facet of the energy industry. She can be reached at jennifer.smith@​hoganlovells.com.

An associate in the Houston office of Hogan Lovells, Catherine Bratic is a member of the firm’s International Arbitration Group. She focuses her practice on commercial and investment arbitration representing both companies and states in arbitration proceedings under the rules of the ICC, ICSID, AAA, and UNCITRAL. She can be reached at catherine.bratic@​hoganlovells.com.

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