[In the Arbitration under Chapter 11]{.smallcaps}

[of the North American Free Trade Agreement]{.smallcaps}

[and the UNCITRAL Arbitration Rules]{.smallcaps}

[between]{.smallcaps}

+-----------------------------------+-----------------------------------+
| [Methanex                         |                                   |
| Corporation,]{.smallcaps}         |                                   |
|                                   |                                   |
| > *Claimant/Investor,*            |                                   |
| >                                 |                                   |
| > *-and-*                         |                                   |
|                                   |                                   |
| [United States of                 |                                   |
| America,]{.smallcaps}             |                                   |
|                                   |                                   |
| > *Respondent/Party.*             |                                   |
+-----------------------------------+-----------------------------------+

**[Statement of Defense of]{.smallcaps}**

**[Respondent United States of America]{.smallcaps}**

Mark A. Clodfelter

*Assistant Legal Adviser for International*

*Claims and Investment Disputes*

Barton Legum

*Chief, NAFTA Arbitration Division, Office*

*of International Claims and Investment*

*Disputes*

Alan J. Birnbaum

Andrea J. Menaker

*Attorney-Advisers, Office of International*

*Claims and Investment Disputes*

[United States Department of State]{.smallcaps}

Washington, D.C. 20520

August 10, 2000

> **[Contents]{.smallcaps}**

[I. Preliminary Statement]{.smallcaps}

II\. Facts

A. The Nature of Methanex's Business

1\. The Methanol Market

2\. Methanex

3\. Methanex's US Investments

B. MTBE

C. The California Market for MTBE

D. MTBE's Effects On Public Health And The Environment

1\. Risks To Drinking Water Supplies And Public Health

2\. Groundwater Contamination

E. California's Actions Regarding MTBE

1\. Senate Bill 521

2\. University of California Report

3\. Public Testimony

4\. Executive Order

5\. Subsequent California Legislative Action On MTBE

6\. Actions By California Regulatory Agencies

F. Other State And Federal Government Actions Regarding MTBE

III\. Points At Issue

A. Objections To Jurisdiction And Admissibility

> 1\. The Bill And The Executive Order Are Not Measures "Relating To"
> Methanex Or Its Investments
>
> 2\. Article 1116 Grants No Jurisdiction Over Claims For Injuries
> Allegedly Suffered By An Enterprise
>
> 3\. Inadequate Waiver: Failure To Satisfy A Jurisdictional
> Precondition Of Article 1121
>
> 4\. Methanex's Article 1110 Claim Fails To Identify An Expropriated
> "Investment" Within Chapter 11's Grant Of Jurisdiction
>
> 5\. Methanex Has Not Incurred A Loss Or Damage By Reason Of The Bill
> Or The Executive Order
>
> 6\. Methanex's Claims Are Not Admissible Because Its Alleged Injuries
> Are Too Remote

7\. Methanex Has No Admissible Claim Under Article 1105

B. There Is No Liability For The Acts Alleged

1\. There Has Been No Expropriation Of Methanex's Investments

2\. The Measures Do Not Breach Any Applicable Standard of Treatment

C. Methanex's Damages Claims Are Without Merit

IV\. Relief Sought

[In the Arbitration under Chapter 11]{.smallcaps}

[of the North American Free Trade Agreement]{.smallcaps}

[and the UNCITRAL Arbitration Rules]{.smallcaps}

[between]{.smallcaps}

+-----------------------------------+-----------------------------------+
| [Methanex                         |                                   |
| Corporation,]{.smallcaps}         |                                   |
|                                   |                                   |
| > *Claimant/Investor,*            |                                   |
| >                                 |                                   |
| > *-and-*                         |                                   |
|                                   |                                   |
| [United States of                 |                                   |
| America,]{.smallcaps}             |                                   |
|                                   |                                   |
| > *Respondent/Party.*             |                                   |
+-----------------------------------+-----------------------------------+

**[Statement of Defense of]{.smallcaps}**

**[Respondent United States of America]{.smallcaps}**

In accordance with the Tribunal's First Procedural Order and as
contemplated by Article 19 of the UNCITRAL Arbitration Rules, Respondent
United States of America respectfully submits the following Statement of
Defense to the claim of Methanex Corporation ("Methanex") pursuant to
Chapter 11 of the North American Free Trade Agreement (the "NAFTA").

# I. Preliminary Statement

1 There is no merit to Methanex's claim that the NAFTA was violated by
the California legislature's authorization of funding for a university
study of the public health and environmental effects of methyl tertiary
butyl ether ("MTBE") and the California Governor's subsequent executive
order calling for certain state agencies to take preliminary steps
toward a phase-out of the use of MTBE in California gasoline.

2 Methanex's claim does not remotely resemble the type of grievance for
which the States Parties to the NAFTA created the investor-State dispute
resolution mechanism of Chapter 11. Methanex's case is founded on the
proposition that, whenever a State takes action to protect the public
health or environment, the State is responsible for damages to every
business enterprise claiming a resultant setback in its fortunes if the
enterprise can persuade an arbitral tribunal that the action could have
been handled differently. Plainly put, this proposition is absurd. If
accepted by this Tribunal, no NAFTA Party could carry out its most
fundamental governmental functions unless it were prepared to pay for
each and every economic impact occasioned by doing so. The NAFTA Parties
never intended the NAFTA to bring about such a radical change in the way
that they function, and Methanex cannot show otherwise.

3 The Tribunal should reject Methanex's novel attempt to obtain
compensation for public-health measures concerning a product that
Methanex does not even manufacture. Methanex may be disappointed that
California decided to protect its drinking water supply through the
means it chose rather than those Methanex advocated. But the "NAFTA was
not intended to provide foreign investors with blanket protection from
this kind of disappointment, and nothing in its terms so provides."[^1]

4 As demonstrated below, Methanex's claims are not within the
jurisdiction of this Tribunal and lack legal and factual merit.

***[Jurisdiction And Admissibility]{.underline}***

5 Methanex's claims are not within the jurisdiction of this Tribunal for
several reasons. *First*, Methanex grossly mischaracterizes the
California measures at issue in suggesting that they ban MTBE.
California Senate Bill 521 (the "Bill") merely authorized state funding
for a university study of MTBE. Executive Order No. D-5-99 (the
"Executive Order") directed California agencies to take certain steps
toward issuing final and effective regulations concerning the use of
MTBE in gasoline. No final regulation banning MTBE in gasoline, however,
is in effect. The California actions at issue are not measures "relating
to" Methanex or its investments. Methanex's claims are therefore not
within the scope of Chapter 11 as defined by NAFTA Article 1101(1).

6 *Second*, Methanex is far too removed from the California actions at
issue to invoke the jurisdiction of this Tribunal. Methanex manufactures
and markets methanol, not MTBE. A future ban of MTBE in California's
gasoline will impact Methanex only indirectly, as a result of a
decreased desire on the part of MTBE manufacturers directly affected by
a ban to buy methanol from Methanex. Under fundamental principles of
customary international law, Methanex lacks standing because any injury
would result solely from these measures' potential effect on Methanex's
prospective contractual counterparties.

7 *Third,* the injuries claimed by Methanex -- to the extent they are
cognizable at all -- are derivative of injuries allegedly suffered by
Methanex's subsidiaries. Article 1116 of the NAFTA provides no
jurisdiction over claims by a shareholder in its own right for alleged
injuries to an enterprise. Moreover, Methanex cannot demonstrate that it
has suffered a loss "by reason of, or arising out of" California's
actions as required by Article 1116.

8 *Fourth,* Methanex has failed to present a valid waiver of its
subsidiaries' municipal remedies -- a formal requirement for this
Tribunal to be seized of jurisdiction.

9 *Fifth,* Methanex's claim under Article 1110 fails to identify any
expropriated "investment" within Chapter 11's definition of that term.

10 *Finally*, Methanex's claim under Article 1105(1) is inadmissible
because no customary international legal standard governs the *process*
by which States make legislative or executive decisions. Because the
actions at issue also implicate no substantive customary international
legal standards, Methanex's 1105(1) claim is inadmissible.

***[Liability]{.underline}***

11 Methanex's claims also fail on the merits. *First*, the measures at
issue here in no sense can be viewed as an expropriation within the
meaning of Article 1110. Methanex still owns and fully controls both of
its enterprises in the United States. Methanex closed its Fortier plant
before the issuance of the Executive Order for reasons that had nothing
to do with any proposed ban of MTBE in California's gasoline. That plant
never supplied California customers in any event. In addition, most
methanol is sold for uses other than MTBE. Methanex's marketing
subsidiary continues to be able to sell methanol anywhere it wishes in
the United States -- including California -- to anyone who wishes to
make a purchase. A ban on MTBE in California's gasoline might ultimately
reduce the desire of some MTBE producers for methanol, but neither
municipal nor international law recognizes any property right to the
continued demand for a product by a given set of clientele.

12 Moreover, the California actions are nondiscriminatory environmental
measures to protect public health by safeguarding the public's drinking
water supply. Measures such as these can only in extraordinary
circumstances be found to constitute a compensable expropriation. No
such circumstances are present here.

13 *Second*, Methanex's claims under Article 1105(1) lack merit under
any standard. The Executive Order was issued after several days of
public comment and testimony. It is amply supported by scientific
findings. Methanex's allegations are indistinguishable from those of any
disgruntled party who disagrees with one portion of a comprehensive
governmental action. They fall far short of the exceptional
circumstances required to justify the intervention of an international
tribunal under Article 1105(1).

***[Damages]{.underline}***

14 Methanex's damages claims, based largely on the decline in its share
price, are without factual or legal support. Contrary to Methanex's
suggestion, the financial markets did not react to the announcement of
either the Bill or the Executive Order. The long decline in Methanex's
share price -- which, ironically, has reversed since the announcement of
the California measures -- began in 1995 and reflected Methanex's status
as producer of a single commodity chemical in an industry plagued by
production capacity that exceeded demand. That decline did not result
from the California measures at issue here. Indeed, the global price of
methanol -- and Methanex's fortunes along with it -- has substantially
*improved* since the announcement of the Executive Order. Methanex's
other claims of loss are similarly without support.

# II. Facts 

## A. The Nature of Methanex's Business

### 1. The Methanol Market

15 Methanex produces and markets methanol. Produced principally from
natural gas, methanol is one of the world's largest-volume commodity
chemicals. Methanol is primarily used to produce formaldehyde, acetic
acid and other chemical derivatives. These products in turn are used to
produce a wide variety of finished products, including many forms of
modern clothing and fabrics, plastic bottles and laminated wood
products.

16 The market for methanol is global and highly competitive. Like that
for many commodity chemicals, the market for methanol is characterized
by cycles of oversupply resulting in lower prices and idled capacity,
followed by periods of shortage and rising prices as demand catches up
and exceeds supply until increased prices justify new plant investment.

17 The methanol market has been characterized in recent years by
overcapacity. Methanol prices dropped from highs exceeding \$500 per ton
in 1995 to less than \$200 per ton in 1996. Prices remained below \$250
per ton for the remainder of the decade. Several large, new plants
opened in 1999 and more are expected to go into production in the years
2000 through 2002. Although the demand for methanol derivatives grew
from 1998 to 1999, the increase in demand was insufficient to offset the
excess supply.

18 A consequence of this low-price environment was that older,
higher-cost methanol plants in developed countries were increasingly
closed in favor of lower-cost facilities in developing countries.

19 Methanol is principally transported by sea. Transportation cost is a
significant factor in methanol sales. Methanol produced at higher-cost
facilities in developed countries is generally sold to nearby local
markets. Methanol produced at lower-cost facilities in developing
countries can competitively be shipped to markets in developed
countries.

### 2. Methanex

20 Methanex is the world's largest producer and marketer of methanol.
Its corporate headquarters are in Vancouver, British Columbia, Canada.

21 In recent years, Methanex has followed a strategy of closing or
selling its higher-cost production facilities in North America in favor
of its lower-cost facilities in South America and the Southern Pacific.
Methanex's production activities are now overwhelmingly concentrated
outside of North America.

22 As of 1998, 75 percent of Methanex's production capacity was already
located in Chile and New Zealand. The remainder of Methanex's production
capacity at that time derived from four North American plants: one on
the Pacific coast in Kitimat, British Columbia; one on the Gulf of
Mexico coast in Fortier, Louisiana; and two in Medicine Hat, Alberta.

23 In 1998, the Kitimat plant shipped methanol to customers in
California, the Pacific Northwest and Asia. The Fortier plant serviced
customers in the southeastern United States and along the Mississippi
River. The Medicine Hat plants supplied customers in the Midwestern
Canadian and United States markets.

24 In the Spring of 1999, Methanex opened a new methanol plant at its
facility in Chile, which already housed two other methanol plants. The
new plant is the largest in what is now Methanex's largest and
lowest-cost facility.

25 At the same time, Methanex began a program of closing down
higher-cost facilities. As of March 1, 1999, Methanex closed the Fortier
plant indefinitely. It remains idled. In the week of March 15, 1999,
Methanex permanently closed one of its two plants in Medicine Hat. In
June 1999, Methanex announced the sale of its Kitimat plant for \$1 and
other consideration. In July 2000, Methanex announced the closure of the
Kitimat plant.

26 It appears that Methanex now exclusively supplies the California
market with methanol that it has either produced in Chile or New Zealand
or purchased from other producers of methanol.

27 Methanex's profitability and its stock price in recent years have
reflected its status as a producer of a single commodity chemical in an
industry characterized by overcapacity. Until recently, its
profitability and stock price have slowly and steadily declined, and
market interest in Methanex shares has dwindled.

28 In 1994, Methanex reported net income per share of \$2.20. Its
average share price was \$12.70 and over 266 million of its shares
traded on the NASDAQ exchange. By contrast, in 1999 it reported a second
consecutive annual loss (\$0.47 per share in 1999); its average share
price was \$3.37; and fewer than 10 million of its shares traded on the
NASDAQ.

29 Trading in Methanex shares during the weeks of the announcements of
the issuance of the Bill and the Executive Order was consistent with
longer-term trends. It in no way suggested the sudden spike in volume
and dramatic change in share price that mark a material market reaction
to an external event.

30 The week before the announcement of the Bill, Methanex's shares
closed on the NASDAQ exchange at \$8 7/8. The Governor approved the Bill
after the close of the markets on October 8, 1997. The closing price for
Methanex's shares that day was

\$8 3/4. The following day, Methanex's shares closed *up* 13 cents at
\$8 7/8, with 203,000 shares traded. That trading volume was *less* than
the average daily volume of 233,600 shares for that week.

31 The week of the announcement of the Executive Order, Methanex shares
opened on the NASDAQ exchange at \$3 9/16. The Executive Order was
announced after the close of the markets on March 25, 1999. The
following day, Methanex shares opened at \$3 9/16 and then closed down
19 cents at \$3 3/8, with 23,200 shares traded. That trading volume was
*less* than the average daily volume of 26,100 shares for the week.

32 Methanex's fortunes have gradually improved since the announcement of
the Executive Order. In 1999, Methanex's net losses per share improved
from \$0.23 in the first quarter, to \$0.13 in the second quarter, to
\$0.06 in the third quarter and to \$0.05 in the fourth quarter.
Methanex's sales volume increased by 10 percent in 1999 compared to
1998. Fueled by strong demand and rising prices for methanol in all
markets -- including that for MTBE -- Methanex reported net *income* of
\$0.11 per share and record production and sales of methanol for the
first half of 2000. Its share price increased by over 75 percent in
April and May 2000. In August 2000, Methanex's shares closed on the
NASDAQ at levels approaching \$5 per share -- higher than the closing
prices in March 1999 before the announcement of the Executive Order.

### 3. Methanex's US Investments

33 Methanex alleges that it indirectly owns two investments in the
United States: Methanex Fortier, Inc., a corporation that owns the
methanol production facility in Fortier, Louisiana ("Methanex Fortier");
and a marketing subsidiary called Methanex Methanol Company, based in
Dallas, Texas ("Methanex US").

34 Methanex Fortier is incorporated under the laws of the State of
Delaware. Methanex allegedly indirectly owns all of the shares of
Methanex Fortier.

35 Methanex ceased production at the Fortier plant before the Executive
Order was issued. It did so because of its opening of a massive,
low-cost plant in Chile. The Fortier plant did not supply customers in
California in any event, its market being limited to customers in the
southeastern United States and along the Mississippi River.

36 Methanex US is allegedly a Texas general partnership of two
companies, Methanex Inc. and Methanex Gulf Coast Inc., both incorporated
under the laws of the State of Delaware. Methanex allegedly indirectly
owns all of the shares of both partners.

37 Methanex US principally functions as a marketing office for sales in
the United States of methanol produced by Methanex's facilities in Chile
and Canada. It appears that Methanex US also has an auxiliary role as a
trading office, purchasing methanol on the open market and selling it to
Methanex customers in the United States. Methanex US appears to consist
of no more than a number of desks in leased office space manned by
employees with telephones and computers: it apparently has no
significant assets and, on a stand-alone basis, earns no significant
income from its activities.

## B. MTBE

38 MTBE is a hazardous chemical compound produced from methanol and
isobutylene. MTBE is used as a fuel additive for two reasons, both born
of regulation. First, it is a source of octane, which improves a fuel's
resistance to uncontrolled combustion (engine knock). Second, MTBE is an
oxygenate: it increases the oxygen content of gasoline.

39 MTBE's use as a source of octane in the United States resulted from
federal environmental and public health regulations requiring a
substantial reduction of the use of lead in gasoline. MTBE has been used
in the United States since the 1970s as an octane-enhancing replacement
for lead, primarily in mid- and high-grade gasoline.

40 MTBE's use as an oxygenate in the United States also resulted from
federal environmental and public health standards. In 1990, the United
States enacted amendments to the federal Clean Air Act that required
increased oxygen content in gasoline under two programs for certain
areas of the United States, including California. The programs require
that oxygenates be added to gasoline to reduce harmful emissions in
automobile exhaust.

41 Among other things, the federal programs conditionally require a
minimum oxygen content in gasoline of between 2.0 and 2.7 percent by
weight, depending on the season. Two percent oxygen by weight is
equivalent to approximately 11 percent MTBE by volume.

42 The programs apply to a discrete number of metropolitan areas in the
United States with the most severe ozone or carbon monoxide levels.
These metropolitan areas include Los Angeles, Sacramento and San Diego.
Certain other areas with high ozone levels can opt into one of the
programs.

43 Ethanol is the principal oxygenate used in the winter, with the
exception of greater Los Angeles, whose refiners have chosen to use
MTBE. MTBE is the principal oxygenate used at other times of the year.
Tertiary amyl methyl ether ("TAME") is also used, although infrequently,
as an oxygenate. Other oxygenates -- including ethyl tertiary butyl
ether, diisopropyl ether and tertiary butyl alcohol -- are available,
but have been used little, if at all.

44 For years, California has regulated the content of gasoline sold in
the state in order to combat air pollution -- a particularly difficult
problem for California because of its large population centers and its
unique topographic and climatic conditions. California's regulations are
almost always more stringent than the federal regulations, which also
apply in the state.

45 Since June 1996, California has required the use of California Phase
2 Reformulated Gasoline ("CaRFG2"), which typically has an oxygen
content of 1.8 to 2.2 percent. Thus, since June 1996, MTBE has usually
constituted about 11 percent by volume of California gasoline.

## C. The California Market for MTBE

46 There are two categories of MTBE producers in the United States:
gasoline refiners that produce and mix MTBE into gasoline at their
refineries; and merchant MTBE producers that produce MTBE for sale to
gasoline refiners and wholesalers.

Eighty-five percent of the MTBE used by California refiners is supplied
by merchant MTBE producers in the United States and other countries. The
remaining 15 percent of MTBE is produced by certain California refiners
at their refineries for their own use.

47 Merchant MTBE producers in the United States are, with one exception
(in Wyoming), located on the Gulf of Mexico coast. Practically all of
the MTBE produced or consumed in the United States is transported by
ship to coastal facilities, with some moved inland by barge, rail or
truck.

48 The cost of transporting MTBE produced in the United States from one
United States destination to another is substantial. For example, in
1998 the average total cost per ton of MTBE shipped from the Gulf of
Mexico to the Atlantic coast of the United States was \$9.73, compared
with \$21.92 for MTBE shipped from the Gulf of Mexico to the Pacific
coast. Depending on market conditions, it may be difficult for merchant
MTBE producers located in the Gulf of Mexico competitively to ship their
product to the Pacific coast.

49 The California market for MTBE therefore is principally served by
foreign MTBE producers and, to a much lesser extent, by U.S. merchant
MTBE producers and California refiners that purchase methanol and
produce MTBE for their own use.

50 Demand for MTBE in California and elsewhere in the United States
remained strong throughout 1999 and through the first half of the year
2000.

## D. MTBE's Effects On Public Health And The Environment

### 1. Risks To Drinking Water Supplies And Public Health 

51 The United States Environmental Protection Agency ("U.S. EPA") has
classified MTBE, a known animal carcinogen, as a possible human
carcinogen on the basis of inhalation tests.

52 MTBE has a foul, turpentine-like taste and odor. Even at extremely
low concentrations, MTBE can render water unpotable. In controlled
studies, MTBE's taste has been detected at concentrations as low as 2.0
parts per billion ("ppb"), and MTBE's odor has been detected at
concentrations as low as 2.5 ppb. California has prohibited state public
drinking water agencies from delivering drinking water with an MTBE
concentration in excess of 5.0 ppb.

53 MTBE is a toxic chemical that is highly soluble in water. Because of
its chemical properties, when released into the environment, MTBE
contaminates substantially more groundwater and is substantially more
difficult and costly to clean up than other components of concern in
gasoline, including benzene, toluene, ethylbenzene and xylene
(collectively referred to as "BTEX").

54 MTBE is more soluble in water than BTEX and is capable of traveling
through soil rapidly. In groundwater, MTBE moves at nearly the same
velocity as the groundwater and, therefore, often migrates further than
BTEX.

55 MTBE is highly resistant to biodegradation, much more so than BTEX or
ethanol, the second most common oxygenate in U.S. gasoline. Actively
cleaning up MTBE contamination takes longer and costs substantially more
than cleaning up BTEX.

### 2. Groundwater Contamination

56 Because of its unique chemical properties, MTBE contamination of
groundwater presents a significant risk to drinking water supplies in
California.

57 Gasoline is one of the most ubiquitous toxic substances in the United
States. Because of the vast number of places where it is stored and
people who handle it on a daily basis, a significant number of gasoline
spills and leaks into the environment is inevitable. Indeed, according
to some estimates, the equivalent of a full supertanker of gasoline
(about nine million gallons) is released into the environment in the
United States every year from leaks and spills.

58 Gasoline can be released into the environment wherever it is stored,
transported, transferred or disposed. Specifically, sources of gasoline
releases include underground storage tanks ("USTs"), above-ground
storage tanks, pipelines, spills (*e.g.*, during fueling operations and
from tank trucks, automobile accidents and consumer disposal) and storm
water runoff. In addition, certain types of watercraft, particularly
watercraft with two-stroke engines, introduce gasoline into surface
waters as part of their normal operation, without any accidental leaks
or spills.

59 Both the federal government and California have implemented a number
of programs to minimize the potential for leaks and spills of gasoline
and both enforce laws and regulations intended to prevent and clean up
gasoline releases. Despite the existence and implementation of these
federal and state programs, a substantial number of releases of gasoline
into the environment is inevitable because of the omnipresence of the
fuel.

60 Leaks and spills of conventional gasoline generally pose no
widespread threat to drinking water supplies because the components of
conventional gasoline biodegrade relatively quickly and are not highly
soluble in water. Many spills of conventional gasoline may effectively
be left to undergo bioremediation. In those cases where active
intervention is required, conventional gasoline releases can often be
cleaned up relatively quickly and inexpensively.

61 Leaks and spills of gasoline containing MTBE, however, do pose a
substantial threat to drinking water supplies. MTBE binds tightly to
surface and groundwater, biodegrades slowly and travels deep underground
to reach aquifers. Even a small release of gasoline containing MTBE can
have significant adverse effects. For example, a December 1997 car
accident in Standish, Maine led to the release of about ten gallons of
gasoline containing MTBE. The release contaminated twenty-four private
wells with MTBE. MTBE concentrations at three of the wells exceeded
1,000 ppb -- a level hundreds of times greater than that at which MTBE's
unpleasant taste and odor can be detected by humans.

62 Approximately 30 percent of the 34 million people who reside in
California rely on groundwater as a drinking water source.

63 California has experienced some of the worst and most widespread MTBE
contamination of groundwater of any state in the United States. This
contamination, which stems from a variety of sources, has affected
drinking water wells at dozens of sites in California.

64 For example, MTBE contamination forced the closure of groundwater
wells that prior to 1996 supplied approximately half of the drinking
water of the City of Santa Monica. Some of the wells recorded
contamination at concentrations up to 610 ppb.

65 In Glennville, California, residential drinking water wells were
contaminated with MTBE at concentrations up to 20,000 ppb. Consequently,
since 1997, the town has relied on alternative sources of drinking
water.

66 The South Lake Tahoe Public Utility District shut down 35 percent of
its public drinking water wells because of MTBE contamination. The
contamination forced the district to develop new production wells at
substantial expense.

67 During the summer boating season, MTBE concentrations up to 12 ppb
have been measured in Donner Lake, a source of drinking water for
lakeside residents and downstream communities (including Reno, Nevada).

68 In Shasta Lake, a recreational-use reservoir that is also
California's largest drinking water reservoir, MTBE concentrations have
been reported from 9 ppb to 88 ppb.

69 Because of MTBE's affinity for water and resistance to
biodegradation, cleanup of MTBE contamination takes longer and is more
difficult and costly than cleanup of conventional gasoline.

70 For example, the EPA estimates that over \$60 million has been spent
to date to address the MTBE contamination at one of the two
MTBE-contaminated well fields that together had supplied approximately
half of Santa Monica's drinking water. The final cleanup of that well
field is expected to cost more than \$160 million.

## E. California's Actions Regarding MTBE

### 1. Senate Bill 521

71 California Senate Bill 521 (the "Bill"), approved by the Governor on
October 8, 1997, provided \$500,000 from the Motor Vehicle Fuel Account
in the California Transportation Tax Fund to the University of
California to conduct a study and assessment of the human health and
environmental risks and benefits associated with the use of MTBE. The
Bill also required the Governor to certify, after considering the
report, the peer-review comments and public testimony, whether using
MTBE in gasoline in California posed a significant risk to human health
or the environment and, if so, to take "appropriate action." (A copy of
the Bill is attached hereto as Exhibit A.)

### 2. University of California Report

72 As contemplated by the Bill, the University of California issued a
competitive, peer-reviewed request for proposals and commissioned the
following studies:

-   John Froines, Ph.D., University of California, Los Angeles: *An
    Evaluation of the Peer-Reviewed Research Literature on the Human
    Health, including Asthma, and Environmental Effects of MTBE*;

-   John Reuter, Ph.D. and Daniel Chang, Ph.D., University of
    California, Davis: *An Integrated Assessment of Sources, Fate &
    Transport, Ecological Risk and Control Options for MTBE in Surface
    and Ground Waters, with Particular Emphasis on Drinking Water
    Supplies*;

-   Arturo Keller, Ph.D., University of California, Santa Barbara:
    *Evaluation of Costs and Effectiveness of Treatment Technologies
    Applicable to Remove MTBE and Other Gasoline Oxygenates from
    Contaminated Water*;

-   Irwin Suffet, Ph.D., University of California, Los Angeles:
    *Drinking Water Treatment for the Removal of Methyl Tertiary Butyl
    Ether from Ground Waters and Surface Water Reservoirs*;

-   Catherine Koshland, Ph.D., University of California, Berkeley:
    *Evaluation of MTBE Combustion Byproducts in California Reformulated
    Gasoline*; and

-   Arturo Keller, Ph.D. and Linda Fernandez, Ph.D., University of
    California, Santa Barbara: *Risk-Based Decision Making Analysis of
    the Cost and Benefits of MTBE and Other Gasoline Oxygenates*.

73 These studies were compiled into the University of California report
entitled *Health & Environmental Assessment Of MTBE: Report To The
Governor And Legislature Of The State Of California As Sponsored By SB
521* ("UC Report"), which was issued in November 1998.

74 The UC Report concluded that there are significant risks and costs
associated with water contamination due to the use of MTBE.
Specifically, the authors found that if the use of MTBE were to continue
at its current level, there would be an increased danger of surface and
groundwater contamination. The UC Report concluded that the cost of
treatment of MTBE-contaminated drinking water sources in California
could be enormous. Moreover, the UC Report concluded that MTBE is an
animal carcinogen with the potential to cause cancer in humans.

75 To remedy the serious problems facing California's water supply, the
UC Report recommended consideration of phasing out MTBE in gasoline over
an interval of several years. The UC Report reached this conclusion in
light of the substantial costs associated with cleaning up MTBE
contamination if MTBE were not phased out and the ability to achieve
comparable air quality benefits without relying on MTBE.

### 3. Public Testimony

76 Public hearings on the UC Report were held on February 19, 1999 in
Diamond Bar, California, and on February 23-24, 1999 in Sacramento,
California.

77 Over the course of the three days of hearings, representatives of
CARB, the California Energy Commission, the Office of Environmental
Health Hazard Assessment, the State Water Control Resources Board, the
Department of Health Services and the State Fire Marshal gave remarks
and served as panel members.

78 Authors of the UC Report also made presentations regarding their
findings. The panel members and members of the public had an opportunity
to ask questions of the presenters at the hearings.

79 Representatives of the Oxygenated Fuels Association, an organization
whose members produce MTBE and other oxygenates, were among those who
posed questions to the panel of presenters. Other questions were
presented by methanol producers, such as Neste Oil, and MTBE producers,
such as Huntsman Corporation.

80 After the question and answer sessions, members of the public gave
oral testimony. Those testifying included persons affected by MTBE water
contamination and individuals associated with the chemical and oil
industries, among others.

81 Also, the public was accorded the opportunity to submit written
testimony to the panel. The Oxygenated Fuels Association provided a
written submission. Methanex also participated in the debate concerning
the potential regulation or prohibition of the use of MTBE in California
gasoline.

82 In addition, California and federal agencies were given an
opportunity to review and comment on the UC Report. On February 22,
1999, the California Air Resources Board ("CARB") provided comments to
the California Environmental Protection Agency ("Cal EPA") regarding the
UC Report. The UC Report was independently reviewed by the U.S.
Geological Survey and the U.S. Agency for Toxic Substances and Disease
Registry at the Centers for Disease Control.

### 4. Executive Order

83 On March 25, 1999, the Governor of California found that, "on
balance, there is significant risk to the environment from using MTBE in
gasoline in California." This determination, embodied in a certification
dated March 26, 1999, was based on the findings in the UC Report, the
peer-review comments on the UC Report by the U.S. Geological Survey and
the U.S. Agency for Toxic Substances and Disease Registry and the oral
and written testimony given at the public hearings.

84 Executive Order No. D-5-99 (the "Executive Order") was signed by the
Governor on March 25, 1999. (A copy of the Executive Order is attached
hereto as Exhibit B.) The Executive Order called for three principal
categories of action by state agencies. First, it directed the
California Energy Commission, in consultation with CARB, to develop a
timetable for the removal of MTBE from gasoline at the earliest possible
date, but not later than December 31, 2002. The Executive Order also
called for CARB to adopt California Phase 3 Reformulated Gasoline
("CaRFG3") regulations.

85 Second, the Executive Order directed CARB to request the
Administrator of the U.S. EPA to grant California an immediate waiver
from the Clean Air Act's requirement of a specified oxygen content in
reformulated gasoline. The Executive Order also called for Cal EPA to
work with U.S. Senator Feinstein to gain passage of legislation that
would grant authority to the U.S. EPA Administrator to waive permanently
the Clean Air Act's requirement for a specified oxygen content in
reformulated gasoline in states that achieve equivalent air quality
benefits using different means.

86 Third, the Executive Order directed CARB and the State Water
Resources Control Board to conduct an analysis of the impact of ethanol
on the air, surface water and groundwater. In addition, the Executive
Order directed the Office of Environmental Health Hazard Assessment to
prepare an analysis of the health risks of ethanol in gasoline. The
Executive Order called for these reports to be peer-reviewed and
presented to the California Environmental Policy Council by December 31,
1999.

87 In addition to its principal directives, the Executive Order required
the California State Water Resources Control Board to pursue legislation
to ensure that additional substantial financial resources would be
available to clean up MTBE contamination. The Executive Order also
required the board, in consultation with the California Department of
Health Services, to prioritize areas of the state particularly
vulnerable to groundwater contamination, as well as cleanup-activities
in those areas.

88 The Executive Order did not ban the use of MTBE in gasoline. Instead,
it assigned various state agencies a number of tasks that were
preparatory steps toward the potential issuance of regulations or
legislation addressing problems associated with MTBE contamination of
drinking water supplies.

### 5. Subsequent California Legislative Action On MTBE

89 On October 8, 1999, Senate Bill 989 was approved by the Governor.
Senate Bill 989 comprehensively addressed unauthorized releases from
USTs. Senate Bill 989 included stringent, new requirements designed to
prevent unauthorized UST releases. The bill also included new measures
to help improve the speed with which unauthorized releases are
identified and cleaned up in California. The bill made available nearly
\$1 billion in additional funds to remedy contamination attributable to
gasoline and MTBE.

90 Senate Bill 989 also required the California Energy Commission to
develop a timetable for the removal of MTBE from gasoline at the
earliest possible date. Unlike the Executive Order, the bill did not
specify a deadline for the removal of MTBE in California gasoline.

91 Senate Bill 529, approved by the Governor on October 8, 1999,
established specific requirements for conducting environmental
assessments of any amendments to the CaRFG standards. This law required
the California Environmental Policy Council to review the environmental
assessments for any amendments and determine whether any proposed change
in CaRFG standards would significantly and adversely impact public
health or the environment.

### 6. Actions By California Regulatory Agencies

92 Following the issuance of the Executive Order, CARB held numerous
public meetings on proposed regulations that would, among other things,
eliminate the use of MTBE in gasoline in California. Those public
meetings were held on April 23, 1999 (Los Angeles), May 27, 1999
(Sacramento), June 22, 1999 (Sacramento), August 4, 1999 (Sacramento),
August 31, 1999 (Los Angeles), September 28, 1999 (Sacramento) and
November 15, 1999 (Sacramento). Participants at some of these meetings
included representatives of the methanol industry and the American
Methanol Institute, of which Methanex US is a member. Methanex had the
opportunity to attend and participate in all of these meetings.

93 On June 28, 1999, the California Energy Commission held a public
hearing to discuss findings and recommendations regarding a timetable
for the removal of MTBE from California's gasoline. The California
Energy Commission, in consultation with CARB, determined that in order
to ensure an adequate supply of gasoline for California consumers, the
date for removal of MTBE from California's gasoline should be December
31, 2002.

94 On October 22, 1999, the staff of CARB issued proposed amendments to
the CaRFG2 regulations, which included, among other things, a December
31, 2002 prohibition on using MTBE in gasoline and the adoption of the
CaRFG3 regulations. The proposed amendments were peer-reviewed, as
required by the California Health and Safety Code. The reviewers found
that the proposed amendments would preserve the air quality benefits
achieved through use of MTBE as an oxygenate in gasoline.

95 On December 9, 1999, after a public hearing, CARB endorsed the
proposed amendments to the CaRFG2 regulations with several
modifications. As approved by CARB, the proposed amendments included a
prohibition on the use of MTBE in California gasoline starting December
31, 2002, and adopted the CaRFG3 standards. In fact, the proposed CaRFG3
regulations would prohibit, as of December 31, 2002, the use of any
gasoline oxygenate other than ethanol unless the California
Environmental Policy Council determined, based on an environmental
assessment, that use of that oxygenate would not present a significant
risk to public health or the environment. The proposed CaRFG3
regulations further called for the reduction of the levels in gasoline
of sulfur and benzene, a known human carcinogen.

96 Also, on December 9, 1999, CARB directed its Executive Officer to
make the proposed amendments, including the December 9, 1999
modifications, to the CaRFG2 regulations available for a supplementary
public comment period.

97 On January 18, 2000, the California Environmental Policy Council
determined that no significant adverse environmental impact on public
health or the environment would result from the proposed CaRFG3
regulations or the use of ethanol in California gasoline.

98 The revised, proposed CaRFG3 regulations were formally released to
the public on April 7, 2000. The notice containing the proposed
regulatory text was mailed to all persons who had submitted comments on
the proposed CaRFG3 regulations. The proposed regulatory text was also
made available to the public on the CARB website on April 6, 2000. The
deadline for further public comment was April 24, 2000.

99 The proposed CaRFG3 regulations were based on an extensive
administrative record, including a comprehensive set of scientific
studies concerning the effect of MTBE on air quality, water and human
health. The record supporting the regulations included substantial
public comments collected in many hearings and substantial California
agency responses to those comments.

100 On June 16, 2000, the Executive Officer of CARB signed the CaRFG3
executive order and, on June 26, 2000, forwarded the CaRFG3 regulatory
package to the Office of Administrative Law for review.

101 On August 3, 2000, that office approved the CaRFG3 regulations with
certain technical modifications. That same day, the regulations were
filed with the California Secretary of State. Pursuant to California
law, regulations are formally codified and become effective 30 days
after filing with the Secretary of State. The CaRFG3 regulations will
become effective on September 2, 2000.

102 As of the date of this Statement of Defense, the CaRFG3 regulations
do not have the effect of law, and there is no current or future ban in
effect on the use of MTBE in gasoline in California.

## F. Other State And Federal Government Actions Regarding MTBE

103 Other states and the federal government have also taken steps to
reduce or eliminate the use of MTBE in gasoline.

104 In 1994, the State of Alaska cancelled the oxygenated fuels program
for certain areas after receiving complaints about health problems
associated with MTBE, including headaches and nausea.

105 In November 1998, the U.S. EPA Administrator appointed a Blue Ribbon
Panel to provide independent advice and recommendations on maintaining
air quality while protecting water quality. The panel consisted of
experts on environmental health, petroleum refining, hydrology, air
pollution, USTs and other relevant fields. The experts were drawn from
government, industry, academia and non-governmental organizations. In
September 1999, the panel issued its report: *Achieving Clean Air and
Clean Water: The Report of the Blue Ribbon Panel on Oxygenates in
Gasoline* (the "Blue Ribbon Report").

106 The Blue Ribbon Report recommended, among other things, that the use
of MTBE should be reduced substantially to minimize current and future
threats to drinking water. Several Blue Ribbon Panel members concluded
that the use of MTBE in gasoline should be completely eliminated.

107 In late 1998, the State of Maine withdrew from the federal
oxygenated fuels program after discovering that approximately 16 percent
of wells in the state were contaminated with MTBE.

108 On March 20, 2000, the U.S. EPA Administrator and the U.S. Secretary
of Agriculture announced two actions to eliminate or reduce
significantly the use of MTBE in gasoline.

109 First, the U.S. EPA and the U.S. Department of Agriculture issued a
set of legislative principles recommending, among other things,
immediate congressional action to amend the Clean Air Act to provide the
authority to eliminate or reduce significantly the use of MTBE in
gasoline.

110 Second, the U.S. EPA issued an Advance Notice of Proposed Rulemaking
under Section 6 of the Toxic Substances Control Act as a first step
toward regulatory action to eliminate or limit the use of MTBE in
gasoline. The U.S. EPA issued the advance notice to begin a process to
ensure that the nation's water resources would be protected in the
absence of congressional action.

111 To date, several bills proposing to reduce or eliminate the use of
MTBE in gasoline have been introduced in Congress.

112 As of the date of this Statement of Defense, action has been taken
or proposed in at least 18 states to restrict or ban the use of MTBE in
gasoline or to mandate the use of a substitute oxygenate. For example,
on May 24, 2000, New York State banned the use of MTBE in gasoline sold
in New York as of January 2004, and on June 1, 2000, the State of
Connecticut also prohibited the use of MTBE in gasoline in Connecticut
by October 2003.

# III. Points At Issue

## A. Objections To Jurisdiction And Admissibility 

### 1. The Bill And The Executive Order Are Not Measures "Relating To" Methanex Or Its Investments

113 The scope of the NAFTA's Chapter 11 for the claims at issue here is
limited to "measures adopted or maintained by a Party *relating to*: (a)
investors of another Party; \[or\] (b) investments of investors of
another Party in the territory of the Party." NAFTA art. 1101(1)(a)-(b)
(emphasis supplied). Neither the Bill nor the Executive Order is a
"measure . . . relating to" an investment of Methanex in the United
States. Methanex's claims are not within the scope of the United States'
consent to arbitrate Chapter 11 claims.

114 In the context of Chapter 11, the words "relating to" in Article
1101 require that there be, at a minimum, a *legally significant*
connection between the measure and the investment or investor.

115 The Bill fails to satisfy the requirement of a legally significant
connection between a measure and an investment or investor. The Bill
authorized funding for the University of California to conduct research
and prepare a study on the environmental and public health risks and
benefits of MTBE. The Bill in no sense related to Methanex, Methanex US
or Methanex Fortier.

116 Nor is there a legally significant connection between the Executive
Order and Methanex or its U.S. investments. The Executive Order directed
two California agencies to develop a timetable in preparation for the
potential promulgation of regulations addressing MTBE in gasoline. That
directive, however, had no connection to Methanex, Methanex US or
Methanex Fortier that was legally sufficient to give rise to a Chapter
11 claim.

117 Methanex's claims concerning the Bill and the Executive Order are
therefore not within the scope of Chapter 11 or the United States'
agreement to arbitrate claims under Chapter 11.

### 2. Article 1116 Grants No Jurisdiction Over Claims For Injuries Allegedly Suffered By An Enterprise

118 The sole jurisdictional basis invoked by Methanex is Article 1116 of
the NAFTA. Methanex, however, has no standing to invoke the Tribunal's
competence under this Article.

119 NAFTA provides two separate avenues of relief to investors. Article
1116 permits a "claim by an investor of a Party *on its own behalf*"
that "*the investor* has incurred loss or damage." (Emphasis supplied.)
Article 1116 does not recognize claims by a shareholder for injury
suffered by a corporation.

120 By contrast, Article 1117 permits a claim by an investor, "*on
behalf of an enterprise*" that the investor owns or controls, that "*the
enterprise* has incurred loss or damage." (Emphasis supplied.) The claim
and the damage asserted under Article 1117, thus, are those of the
*enterprise*, not the investor. Indeed, as Article 1135 makes clear, any
award under Article 1117 for an injury to an enterprise must be paid to
the enterprise, not to the investor. *See* art. 1135(2)(b).

121 Methanex does not allege any loss that is in any way distinct from
the purported losses suffered by Methanex US and Methanex Fortier.
Methanex's alleged loss in customer base, in good will, in the market
for methanol in California and elsewhere, in a loss of return on
"capital investments," in an increased cost of capital and in an
unexplained "loss . . . of a substantial amount of its investment" are
all derivative of alleged injuries to Methanex US and Methanex Fortier.

122 In sum, Methanex can claim no loss independent of that allegedly
suffered by the enterprises at issue. Article 1116, therefore, provides
no basis for the Tribunal's jurisdiction over the claims asserted.

### 3. Inadequate Waiver: Failure To Satisfy A Jurisdictional Precondition Of Article 1121 

123 Article 1121(1)(b) of the NAFTA provides that an investor may submit
a claim under Article 1116 only if the investor and, where the claim is
for loss or damage to an interest in an enterprise of another Party that
the investor owns or controls directly or indirectly, the enterprise,
waive their rights to initiate or continue any domestic proceedings
seeking the payment of monetary damages allegedly caused by the measure.
Article 1121's requirements are jurisdictional: failure to satisfy any
one of the Article's requirements is fatal to a Chapter 11 tribunal's
jurisdiction.

124 Methanex, in Schedule I to its Notice of Arbitration, submitted an
instrument that purports to waive its own rights and the rights of
Methanex US and Methanex Fortier. The instrument is signed by Randall
Milner, Corporate Counsel and Assistant Corporate Secretary, on behalf
of Methanex Corporation.

125 This instrument does not effectively waive the rights of either
Methanex US or Methanex Fortier. Methanex US is a Texas general
partnership, and Methanex Fortier is a Delaware corporation. Under
established corporate law, a shareholder as such has no power to waive
the rights of a corporation or a general partnership of corporations the
shares of which the shareholder holds.

126 Neither Methanex, Inc. nor Methanex Gulf Coast Inc., the general
partners of Methanex US, has provided a waiver on behalf of Methanex US.
Nor has any director or officer of Methanex Fortier acting in that
capacity provided a waiver on behalf of Methanex Fortier. The instrument
submitted by Methanex cannot effectively waive the rights of Methanex US
or Methanex Fortier under applicable laws. The requirements of Article
1121 have not been met, and, thus, this Tribunal lacks jurisdiction over
Methanex's claim.

### 4. Methanex's Article 1110 Claim Fails To Identify An Expropriated "Investment" Within Chapter 11's Grant Of Jurisdiction

127 Methanex's claim under Article 1110 is not within the scope of
Chapter 11 because it fails to allege a direct or indirect expropriation
of anything that constitutes an "investment" under the NAFTA.

128 Methanex does not claim -- because it cannot -- that Methanex US or
Methanex Fortier has been nationalized or expropriated. Instead, it
claims that the California measures "constitute\[\] a substantial taking
of Methanex US' and Fortier's *business*." [^2] At bottom, Methanex's
claim is that the California actions will eliminate the market for MTBE
for use in California gasoline and, therefore, reduce the amount of
methanol sold by Methanex US or Methanex Fortier to MTBE producers in
the future.

129 Methanex's claim fails to identify any interest that meets even the
expansive definition of "investment" for purposes of Chapter 11. Article
1139 specifies the legal rights and interests that can constitute an
"investment" for purposes of Chapter 11. The colloquial notion of a
"business" of an enterprise, as alleged by Methanex in its Statement of
Claim, does not appear in Article 1139's definition. The definition in
no way encompasses a mere hope that profits may result from prospective
sales to a particular market segment in the future.

130 Because Methanex has failed to identify any "investment" that has
allegedly been nationalized or expropriated, its claim under Article
1110 does not fall within the United States' consent to arbitration in
Section B of Chapter 11.

### 5. Methanex Has Not Incurred A Loss Or Damage By Reason Of The Bill Or The Executive Order

131 Article 1116(1) of the NAFTA provides that an investor may submit a
claim to arbitration under Chapter 11 only when that investor "has
incurred loss or damage by reason of, or arising out of, \[a breach of
Section A of Chapter 11\]."

132 The Bill appropriated money to the University of California for it
to conduct a study. No alleged injury to Methanex could have been "by
reason of, or arise\[n\] out of," the mere funding of a study.

133 The Executive Order similarly could not have caused Methanex any
cognizable loss or injury. The Executive Order directs California
agencies to develop a timetable for the elimination of MTBE in gasoline
no later than December 31, 2002. Currently, and certainly as of the date
that Methanex filed its claim, there is (and was) no measure in effect
banning the use of MTBE in California's gasoline.

134 Since the issuance of the Executive Order, CARB has issued proposed
CaRFG3 regulations which include a prohibition on the use of MTBE in
gasoline in California as of December 31, 2002. The CARB regulations,
however, are not the subject of Methanex's Notice of Arbitration or
Statement of Claim and have not become effective as of the date of this
Statement of Defense in any event.

135 Given the nature of the Bill and the Executive Order, Methanex can
allege no compensable injury or damage.

### 6. Methanex's Claims Are Not Admissible Because Its Alleged Injuries Are Too Remote

136 Under a well-established principle of customary international law
applicable to Article 1105(1) and 1110 claims such as those advanced
here, only acts that are the proximate cause of injury to an alien can
engage the responsibility of a State under international law and give
rise to standing to claim for such an injury. NAFTA incorporates this
principle in Article 1116, which recognizes that an investor may submit
a claim only for loss or damages "by reason of, or arising out of," a
breach of Section A of Chapter 11.

137 International tribunals applying this principle have repeatedly
found that a claimant lacks standing in circumstances where its alleged
injury resulted solely from an action's adverse effect on a person with
whom the claimant has a contractual relationship. For example, as the
International Court of Justice recognized in the *Barcelona Traction*
case, "Creditors do not have any right to claim compensation from a
person who, by wrongdoing to their debtor, causes the loss. In such
cases, the interests of the aggrieved are affected, but not their
rights."[^3]

138 Application of this principle here compels a finding that Methanex's
claims are inadmissible. Methanex produces methanol, not MTBE. Its
claimed injuries derive entirely from the effects Methanex anticipates
from a prospective MTBE ban on MTBE producers that have bought methanol
from Methanex in the past. Indeed, the causal link is even more
attenuated here than in the cases referenced above: to the extent that
the challenged actions affect Methanex US and Methanex Fortier at all,
they do so not by causing a *breach* of *existing* contracts with
methanol customers, but only by reducing the likelihood that MTBE
producers will enter into contractual relations with Methanex's
subsidiaries *in the future*. Given this and the other circumstances of
this case, Methanex's claim is far too removed from the measures at
issue to be admissible.

### 7. Methanex Has No Admissible Claim Under Article 1105

139 Methanex's claim under Article 1105(1) is inadmissible because it
fails to identify -- because there is none -- any customary
international law standard of treatment incorporated into that Article
that is applicable to the challenged actions. A measure can breach
Article 1105(1), entitled "Minimum Standard of Treatment," only if it
fails to accord "treatment in accordance with international law."
Because there is no standard of customary international law implicated
by the measures at issue, Methanex fails to state a breach of Section A
of Chapter 11, as required by Article 1116. Its claim therefore is not
admissible.

140 Methanex asserts essentially two complaints concerning the Bill and
the Executive Order. First, it complains about the *process* by which
the measures were adopted. It asserts that the Executive Order was
"based on a process which lacked substantive fairness"; "was based
solely on the UC Report" and that the report in turn lacked "a proper
risk characterization"; relied on "an extraordinarily scant database . .
. and broad assumptions"; "contained a badly flawed exposure assessment
and cost/benefit analysis"; and failed adequately to "discuss
alternative solutions and remediation." Statement of Claim ¶¶ 32-33.
Second, Methanex complains about the *substance* of the measures,
asserting that the measures were "arbitrary" and "go\[\] far beyond what
is necessary to protect any legitimate public interest." *Id*. ¶ 33.

141 Entirely apart from their lack of factual merit -- for California's
notice and comment procedures were amply fair and adequate -- Methanex's
assertions implicate no standard of customary international law
incorporated into Article 1105(1). Customary international law imposes
no constraints on the *processes* by which States adopt executive or
legislative measures: the community of nations includes monarchies and
dictatorships, as well as democracies. Each of these forms of government
is capable of issuing laws and regulations that are valid under
customary international law, whether or not they follow the procedures,
such as public notice and comment, favored by many democracies.
Methanex's assertions directed to the process by which the challenged
measures were issued are misplaced.

142 Customary international law does impose a discrete number of
substantive constraints on legislative and executive measures. Such
substantive constraints include, for example, the rule of compensation
for expropriation, which the NAFTA Parties specifically incorporated, as
modified, in Article 1110. Other substantive constraints are recognized
by those principles of customary international law governing State
responsibility for injury to aliens relevant to investment, which the
NAFTA Parties referenced in Article 1105(1). There is, however, no
customary international law standard that requires States to adopt only
"good" legislation or decrees, as Methanex suggests. Because Methanex
has not -- and cannot -- identify any substantive standard of customary
international law implicated by the measures here, its claim under
Article 1105(1) is inadmissible.

## B. There Is No Liability For The Acts Alleged

### 1. There Has Been No Expropriation Of Methanex's Investments

143 The actions challenged by Methanex have none of the traditional
indicia of an expropriation. California has not nationalized or
confiscated Methanex's investments in the United States. California has
not interfered with Methanex's use of its U.S. investments. Moreover,
the type of action at issue here -- one to protect public health -- is
not, absent extraordinary circumstances not present here, one that can
be deemed expropriatory. Finally, particularly in light of the fact that
the market for MTBE in gasoline was created by regulation, Methanex
could have no reasonable investment-backed expectation that MTBE in
gasoline would not be further regulated or banned.

144 To demonstrate a violation of Article 1110, Methanex must prove that
its *investment* in another NAFTA Party has been expropriated.
Methanex's Statement of Claim identifies only two relevant U.S.
subsidiaries; the only purported investments alleged to have been
expropriated are the "businesses" of those subsidiaries. Neither
Methanex US, Methanex Fortier nor their "businesses," however, have been
expropriated.

145 First, it is beyond dispute that there has been no direct
expropriation. Neither Methanex US nor Methanex Fortier has been
nationalized or confiscated.

146 Second, California has taken no action that has had the effect of
indirectly expropriating Methanex US's or Methanex Fortier's
"businesses," even assuming that those could be construed as
"investments" within Chapter 11. The alleged expropriatory actions have
not interfered with Methanex's right to use, enjoy or dispose of its
investments. In other words, Methanex has suffered no deprivation of its
property rights.

147 Methanex's control over both subsidiaries remains intact. None of
the investments' physical assets have been taken away. The management of
Methanex US and Methanex Fortier has not been disturbed. Methanex US and
Methanex Fortier retain the ability to manufacture and market methanol.
And California has not transferred any of Methanex US's or Methanex
Fortier's property to itself or any other entity.

148 Methanex Fortier's sole business is manufacturing methanol at its
Fortier, Louisiana plant. The Fortier plant, however, has been idle
since *before* the announcement of the Executive Order and never
supplied customers in California in any event. Methanex idled the plant
due to the global oversupply of methanol, resulting low prices and
Methanex's opening of a new, lower cost facility in Chile. The
California actions did not interfere with Methanex Fortier's business
and could in no way constitute an indirect expropriation of Methanex
Fortier.

149 Similarly, Methanex US's business is marketing methanol in the
United States. Methanex US remains in control of all of its assets, and
its right to market methanol throughout the United States -- including
California -- has not been disturbed by any of California's actions.

150 Indeed, the only circumstance alleged by Methanex to constitute an
interference with its property is Methanex's subsidiaries' anticipated
reduced sales of methanol to MTBE producers due to the future
elimination of the market for MTBE in gasoline in California. Methanex,
however, has no property interest in being assured a market for methanol
as a feedstock for MTBE to be used in California's gasoline. Neither
municipal law nor international law recognizes a loss of the continued
existence of a particular market segment as a permissible basis for an
expropriation claim. Nor has Methanex identified any other property
interest that could be the subject of an expropriation claim under
Article 1110.

151 Methanex manufactures and markets methanol, not MTBE. The uses of
methanol are much more diversified than MTBE's use in gasoline. Methanol
is used to produce formaldehyde and acetic acid, among other things,
which are used, in turn, to produce a wide variety of items, including
fabrics, plastic bottles and laminated wood products. Only a fraction of
Methanex's production of methanol is sold to MTBE producers, and only a
fraction of that is used to produce MTBE for the California market. The
actions challenged by Methanex do not, in any way, restrict the ability
of Methanex US or Methanex Fortier to manufacture and market methanol
for use in the United States or anywhere else in the world, nor do they
deprive Methanex US or Methanex Fortier of their ability to sell
methanol to producers of MTBE for use in any place other than in
California.

152 Moreover, the challenged actions were environmental measures taken
to protect the public health by safeguarding the public's drinking water
supply. Customary international law recognizes that, absent
extraordinary circumstances, States are not liable to compensate aliens
for economic loss incurred as a result of a nondiscriminatory action to
protect the public health. This rule of customary international law
encompasses environmental measures, such as those at issue here, that
are taken to protect the public health.

153 The NAFTA also recognizes a State's sovereign right to protect
public health and the environment. The preamble of the NAFTA notes the
Parties' resolve to "PRESERVE their flexibility to safeguard the public
welfare; . . . \[and\] STRENGTHEN the development and enforcement of
environmental laws and regulations." Article 1101(4) requires that
Chapter 11 be construed so as not "to prevent a Party from providing a
service or performing a function such as . . . social welfare . . .
\[or\] health . . . in a manner that is not inconsistent with this
Chapter." *See also* NAFTA art. 1114(1)-(2) & the North American
Agreement on Environmental Cooperation.

154 California's actions were taken to protect the public's drinking
water and are not discriminatory. Nor can they be viewed as bearing any
of the other hallmarks of expropriation recognized by international law.

155 Finally, Methanex could have no reasonable investment-backed
expectation that MTBE would neither be further regulated nor banned
anywhere in the United States in the future. MTBE producers operate in a
highly regulated environment. They necessarily operate under the risk
that their product may be regulated in the future. Indeed, insofar as it
relates to the sale of methanol to producers that manufacture MTBE,
Methanex's business was born of regulation: the use of MTBE as an octane
enhancer and an oxygenate arose in direct response to the adoption in
1973 of regulations limiting lead in gasoline and the 1990 amendments to
the Clean Air Act. Methanex, as a producer of a feedstock for MTBE, was
necessarily aware of the origins of the market for MTBE in gasoline and
operated under the risk that the regulations that gave rise to that
market segment could change and eliminate the market segment those
regulations created.

156 In sum, Methanex's Article 1110 claim bears none of the indicia of
an expropriation under international law. Its claim is without merit.

### 2. The Measures Do Not Breach Any Applicable Standard of Treatment

157 As noted above, customary international law imposes no constraints
on the process by which States adopt executive or legislative measures
and the measures at issue implicate no substantive customary
international law standard. Methanex's Article 1105(1) claim fails
because there is no standard of customary international law incorporated
into that Article that is applicable to actions such as those at issue
here.

Nonetheless, even if the acts that Methanex challenges were subject to
Article 1105(1), Methanex's claim would fail on the merits.

158 *First*, the actions taken by California with respect to the Bill
and the Executive Order were amply justified. MTBE is a hazardous
substance that renders water unpotable at very low concentrations. It is
undisputed that MTBE has contaminated ground and surface water in
California.

159 The Bill -- which provided money for a study of the effects of MTBE
on public health and the environment -- was an appropriate response to
the growing body of reports of MTBE contamination of drinking water in
California and elsewhere. The Executive Order -- which was based on the
UC Report, its peer-reviewed findings, written comments and three days
of public hearings -- was likewise amply justified. Moreover, the
administrative actions taken since the Executive Order was signed,
including the CaRFG3 regulations, were taken only after further study,
review, numerous public hearings and workshops and consideration of
written comments by government agencies and members of the public.

160 Methanex's assertion that the Executive Order is "arbitrary" because
of alleged deficiencies in the UC Report is baseless. That report is
based on accepted scientific principles properly applied. Moreover, any
alleged deficiencies were fully aired and addressed in the peer-review
and public-comment process that led to the adoption of the Executive
Order and the CaRFG3 regulations.

161 *Second*, the process by which the measure was adopted did not lack
"substantive fairness." As noted above, the Executive Order was based on
extensive oral and written comments on the UC Report submitted by the
public and several California agencies. Several authors of the UC Report
and representatives from various California agencies made presentations
regarding the UC Report during three days of public hearings. Oral
and/or written comments were submitted by numerous industry
representatives including Methanex, the Oxygenated Fuels Association,
the American Methanol Institute, individual MTBE producers (such as the
Huntsman Corporation) and other individual methanol manufacturers (such
as Neste Oil and the Atlantic Richfield Company). Thus, Methanex had
ample, meaningful opportunities to comment on the proposed ban of MTBE
in California's gasoline and the process by which the Executive Order
was issued was fair.

162 *Third*, Methanex's assertion that the Executive Order focused on
only one harmful component of gasoline adds nothing to its Article 1105
claim. As an initial matter, there is not, as Methanex suggests, any
customary international law standard that requires a State to adopt
comprehensive legislative or executive measures rather than regulate
specific components of a broader problem. In any event, the Executive
Order directed various California agencies to prepare peer-reviewed
reports on the public health and environmental effects of alternative
oxygenates and to pursue legislation to ensure that additional financial
resources of up to \$1 billion were available to remedy MTBE
contamination. And the CaRFG3 regulations would ban the use in gasoline
of *any* oxygenate other than ethanol, which is the only oxygenate for
which a full environmental assessment has been completed, unless the
California Environmental Policy Council determines that the subject
oxygenate will not present a significant risk to public health or the
environment.

163 *Fourth*, California considered the effectiveness of existing and
alternative methods for dealing with MTBE contamination. Contrary to
Methanex's suggestion, both the federal government and California have
enacted and enforced legislation to prevent contamination from leaking
USTs. In fact, California enhanced its laws dealing with gasoline
releases as contemplated by the Executive Order. Notwithstanding these
efforts, releases and spills are inevitable given the vast amount of
gasoline with MTBE that is stored, transported and handled, and the
myriad opportunities for leaks, spills and emissions as a result of
accidents, natural disasters and the lawful operation of watercraft.
Moreover, unlike releases of conventional gasoline, releases of gasoline
containing MTBE are more likely to reach and contaminate water sources,
are generally not subject to bioremediation and are extremely costly to
clean up. California's actions were amply justified by chemical
characteristics and public-health and environmental threats unique to
MTBE.

164 *Finally*, the Executive Order was issued after consideration of the
interests of Methanex and Methanex US. The public, including Methanex
and its U.S. subsidiaries, had ample notice of, and opportunity to
comment in writing and orally on, the phase out of MTBE before the
Executive Order was issued.

165 Thus, Methanex's Article 1105(1) claim fails on the merits: the Bill
and the Executive Order suffer from none of the defects on which
Methanex relies to support its assertion that their adoption breached
the United States' obligation to provide Methanex US treatment in
accordance with international law.

## C. Methanex's Damages Claims Are Without Merit 

166 Methanex's claims for \$970 million in damages are without merit.
Although the Statement of Claim provides no information concerning how
this amount was calculated, Methanex stated, in public announcements
accompanying the filing of its claim, that the amount was broadly based
on the long decline in its share price.

167 Methanex's claim of loss based on a decline in its share price is
without support. The financial markets effectively shrugged at the
announcements of the Bill and the Executive Order: neither announcement
provoked the sudden surge in trading volume and substantial change in
share price that mark an event that materially affects market valuation
of equity shares. The long-term decline in Methanex's share price
reflected overcapacity in the methanol industry and other factors, not
the measures complained of here.

168 Methanex's claim of loss based on the decline in the global price of
methanol is similarly without merit. The global price of methanol
remained relatively low until recently because of the construction of a
number of new, low-cost plants in a cyclical industry in which capacity
already exceeded demand -- not because of the California measures at
issue here. Indeed, Methanex's suggestion to the contrary is belied by
the fact that the global price of methanol has *increased* substantially
since the announcement of the Executive Order in March 1999.

169 The other losses claimed by Methanex are not admissible under the
principles of international law that inform the interpretation of
Chapter 11. There is no recognized property right to a "customer base,"
a "market for methanol in California and elsewhere," or any specific
rate of "return . . . on capital investments." Injuries to such
non-existent "rights" cannot form the basis of a Chapter 11 claim. Nor
is the "good will" of a business a property right that by itself is
capable of being expropriated under customary international law.

170 Finally, neither Methanex's Statement of Claim nor its Notice of
Intent to Submit a Claim to Arbitration provides any information
concerning its vague claimed loss "of a substantial amount of its
investment in Methanex US and Fortier." This claim, to the extent that
it purports to be based on a loss independent of those already
addressed, has been pleaded with insufficient particularity to satisfy
the requirements of Chapter 11 for a claim to be submitted to
arbitration.

171 For the avoidance of doubt, the United States denies each and every
allegation of the Statement of Claim not specifically and unambiguously
admitted in this Statement of Defense.

# IV. Relief Sought

172 For the foregoing reasons, the United States respectfully requests
that this Tribunal render an award: (*a*) in favor of the United States
and against Methanex, rejecting Methanex's claims in their entirety and
with prejudice; and (*b*) pursuant to paragraphs 1 and 2 of Article 40
of the UNCITRAL Arbitration Rules, ordering that Methanex bear the costs
of this arbitration, including the United States' costs for legal
representation and assistance.

> *Respectfully submitted,*
>
> Mark A. Clodfelter
>
> *Assistant Legal Adviser for International*
>
> *Claims and Investment Disputes*
>
> Barton Legum
>
> *Chief, NAFTA Arbitration Division, Office*
>
> *of International Claims and Investment*
>
> *Disputes*
>
> Alan J. Birnbaum
>
> Andrea J. Menaker
>
> *Attorney-Advisers, Office of International*
>
> *Claims and Investment Disputes*
>
> [United States Department of State]{.smallcaps}
>
> Washington, D.C. 20520
>
> August 10, 2000

[^1]: *Azinian v. United Mexican States*, ICSID Case No. ARB(AF)/97/2,
    14 Foreign Inv. L.J. 538, 562 ¶ 83 (1999) (Nov. 1, 1999) (Award).

[^2]: Statement of Claim ¶ 35 (emphasis supplied). Methanex also alleges
    that "\[t\]he measure constitutes a substantial taking of . . .
    Methanex's investment in Methanex US and Fortier." *Id*. The
    Statement of Claim provides no information concerning this alleged
    investment or how it could conceivably be viewed as having been
    expropriated. To the extent this claim differs from others pleaded,
    it is stated with insufficient particularity to engage the
    Tribunal's jurisdiction.

[^3]: *Barcelona Traction Light & Power Co., Ltd.*, (Belg. v. Spain),
    1970 I.C.J. ¶ 44 (Judgment of Feb. 5, 1970).