Zama field arbitration puts at stake 'hundreds of millions of dollars'

The controversial decision of the Mexican energy ministry (Sener) to hand over operation of the promising Zama field off the coast of Tabasco to state oil company Pemex could unleash an extensive international arbitration process before the International Centre for Settlement of Investment Disputes (ICSID).

US company Talos Energy, the former operator of Zama, in September presented a notice of intent to the Mexican government stating that it was seeking to contest the decision, which handed over to the federal giant the operation of the most important field discovered by a private player in recent decades.

This will trigger a process of consultations and negotiations that could lead to a full-blown investment arbitration process, Diego Durán de la Vega, a partner at the Hughes, Hubbard & Reed law firm in Washington DC and expert in international arbitration cases, tells BNamericas in this interview. 

According to Durán, the dispute could take half a decade to resolve and put at risk hundreds of millions of dollars of Mexican treasury funds.

BNamericas: Could you analyze Talos' steps for us so far? Have they officially started an international arbitration process?

Durán: Yes. The process begins with a notice of intent to submit the dispute to arbitration. That was precisely what Talos presented these days. This triggers certain things that have to happen. It’s a notice that they intend to present a claim based on an international treaty that protects the investment and to start a period of consultations and negotiations with the Mexican State in this regard. Under the USMCA [or T-MEC free trade agreement] and the Mexico-Belgium-Luxembourg treaty, there is a cooling-off period of six months. This means that Talos has to allow six months to pass from when the facts that give rise to the claims appear until they present their formal demand for arbitration, which they have not yet presented. Those six months are for the parties to calm down and there is an opportunity for them to meet and amicably resolve the dispute. Additionally, Talos has to present the notice 60 days before filing its claim under the Belgium-Luxembourg treaty and 90 days before under the USMCA. All investment protection treaties establish this type of initial phase.

In my experience, Mexico rarely resolves these disputes in consultations and negotiations, unlike other countries. Colombia and Peru are countries that have historically proven to be better equipped and open to reach agreements and avoid disputes. Oftentimes, things work out better for both parties if the dispute is resolved amicably. In addition, litigation costs are avoided. There are cases in which Mexico would have been better off negotiating in this way.

It would be interesting to see if in this case, which is very political and has a high profile, something is achieved in this regard. This would be in line with the style of the current administration in Mexico, which tends to corner the parties and then force negotiations. [Editor’s note: This occurred, for example, in 2019 with the renegotiation of natural gas supply contracts, when the government filed international cases against several companies and ended up reaching an agreement with the parties. Another example is the case of Braskem Idesa's Ethylene XXI petrochemical complex, to which it cut off natural gas supply to force negotiations]. If they do settle, Talos, in exchange for something, will surely give up their claims and simply no case would be filed.

BNamericas: What happens if the parties cannot agree?

Durán: If they do not agree, once the six months have elapsed since Talos became aware of the facts that give rise to the claims and the corresponding days from the notice of intent, Talos will have the possibility to present their demand. The event that sets the tone is the appointment of Pemex as Zama operator in July, which means that January 2022 would be when Talos could present its arbitration claim. That triggers other stages: the arbitration tribunal will be formed with three arbitrators, administered by ICSID, and the process of arbitration will continue.

Once the tribunal is constituted, the parties will agree on a procedural calendar in which it will be established when the claim memorials, counter-memorials, replies, rejoinders, evidentiary stages must be presented, if there are going to be preliminary objections, which require a separate calendar, etc. Usually, when a State is sentenced, it complies with the obligation of the sentence and makes the corresponding payment. Mexico has never breached an award in this type of investment protection dispute.

BNamericas: It’s clear that Talos does not agree with the appointment of Pemex as the operator of Zama. Legally, what exactly is Talos claiming? What is the standard that has been breached according to the company?

Durán: In 2015 the concession was given to the Talos consortium, and two years later, in 2017, is when Zama is discovered. That's where the problems begin. Pemex had a field attached to Zama [the AE-0152-Uchukil concession] and they realize that this is connected underneath with Zama. There was a long discussion with various studies to determine who had a greater stake in the shared reservoir. The latest study [carried out by Texas consultancy Ryder Scott] determined that Pemex had 50.4%, a stake that Talos has apparently accepted, but argues that this tiny difference does not justify Pemex being the operator, since Talos was the one who discovered the deposit. It has been working longer, some six years, and has invested more money, in the order of US$350mn.

Talos alleges that, under Mexican regulations, the Mexican energy ministry would have to have made a series of considerations to determine who was given the operation of the field and not only designate Pemex because it has a 50.4% stake. Sener should also have taken into account factors such as economics, competitiveness, efficiency, legality, transparency, best practices and best use. It has also been argued that Talos has a better availability of resources to properly exploit and operate the deposit.

BNamericas: Through arbitration, can the operator's designation be reversed?

Durán: This is very difficult to achieve. What is sought in these arbitrations is to compensate for the damage caused. So Talos will most likely only be able to obtain, if it wins the dispute, that the damages caused by losing Zama's right to operate are quantified. This will be subject to opinions of experts in the fields of hydrocarbons, engineering, and quantification of damages, and at the end of the day what the court determines as the correct amount, if it agrees with Talos, it is going to condemn the Mexican State to pay. These contracts are long term, so we could be talking about billions of dollars at stake.

BNamericas: Once the arbitration process is triggered, could you tell us what is at stake for both parties?

Durán: This is a type of claim that investors do not make lightly. An investment arbitration is very expensive and slow and lasts around three to five years compared to an international commercial arbitration, which can last one or two years and with much lower costs. They are extremely complex cases, with a lot of money at stake, highly politicized and with many interests involved. In addition, there are political considerations related to entering into litigation against a State in which investments have been made. This is accentuated at this time by the way in which the current government of Mexico positions itself in the face of this type of situation. It is clear that it does not like that investors use this type of mechanism to go against Mexico. In this vein, a few months ago, the president [Andrés Manuel López Obrador] said that those who represent foreign interests against Mexico were "traitors to the homeland." The current government tries to discourage this type of arbitration and views it negatively, which is incongruous, since it is about guarantees that Mexico gave investors from various countries precisely to encourage foreign investment.

Therefore, Talos has not started this process lightly. Many others in the energy sector have not wanted to initiate investment arbitrations with everything that has happened in the electric and oil and gas industries. They keep this measure as their last resort.

At stake here is the operation and control of one of the largest oil fields in the country's history. This is the most important discovery of a deposit in 70 years. The money and power of operating this field is very important, and something that Talos is not going to let go of easily. There are many hundreds of millions of dollars at stake, if not more.

BNamericas: The Talos consortium will continue to be part of the field's unification, and so will also receive revenues from the operations of Pemex. Does this mitigate in any way the damages that Talos could claim?

Durán: I don't think so, since one thing is the right to exploit Zama, and another to operate it. Therefore, I understand that Talos will continue to receive the benefits of the exploitation of Zama, even if it is not the one who operates it. I imagine that, if the only thing that Talos claims is related to its right to operate Zama, what it obtains from its exploitation will in no way mitigate the damages that must be compensated.

BNamericas: Talos made reference to two treaties that would be relevant: USMCA or T-MEC and the bilateral investment protection agreement between Mexico and the economic union between Belgium and Luxembourg. Why these treaties and not others?

Durán: This is important, because this is interesting to see which treaty applies. It’s a consortium led by Talos. We’re talking about foreign companies that invested in Mexico, and to know which treaty applies, you have to see who are protected investors. Although the treaties are similar, there may be differences between them in determining who are the protected investors. There are some that are limited to where the foreign company is incorporated, but there are others that also cover the shareholders of those companies. [Partners] Premier Oil is from the UK, Talos is from the US and Sierra Oil, which had a 40% stake in the contract area that contains Zama, sold it to Wintershall, a BASF subsidiary. They are both German. It would be thought that the relevant treaties are the Mexico-United Kingdom, T-MEC and Mexico-Germany treaties. However, Talos reported that its notice of intent is based on the T-MEC treaties and that between Mexico and Belgium-Luxembourg.

The T-MEC, and not NAFTA, applies because annex C of chapter 14 of the T-MEC establishes that, for the purposes of investors with qualified contracts with governments – only for certain industries, including hydrocarbons – the three-year sunset provision related to investments that were made before the entry into force of the T-MEC – legacy investments – does not apply, so they have to make their claims through the mechanism established for said investments in the T-MEC. Talos is working on this assumption.

I don’t know why they haven’t used the treaty with the United Kingdom, in the case of Premier Oil, and the treaty between Mexico and Germany for Wintershall. Regarding the treaty between Mexico and Belgium-Luxembourg, this treaty is surely relevant because some shareholder of a consortium company comes from that jurisdiction.