Talos vs. Mexico: a dispute in the energy sector that could end up in international arbitration

México - 
Gabriela Cosío, senior associate in the Corporate Law and Commercial Contracts, Litigation and Arbitration.

Mexico faces potential arbitration as a result of strategic decisions taken by the Mexican Government’s Energy Secretariat (SENER) regarding the Zama field.

Talos Energy Inc. (NYSE: TALO) and Talos International Holdings SCS  have submitted Notices of Dispute to the Government of Mexico under the Agreement between the United States of America, the United Mexican States and Canada (USMCA) and the Bilateral Investment Treaty between the United Mexican States and the Belgo-Luxembourg Economic Union (BLEU-BIT) over decisions taken by SENER, including the recent designation of Petróleos Mexicanos (PEMEX) as the operator of the Zama oilfield.

The Zama oilfield has a production potential of up to one billion barrels of oil and was discovered by Talos and notified to the National Hydrocarbons Commission (CNH) on 11 July 2017. After three months, the CNH notified Talos of the plausible existence of shared oilfield, since from the information provided by Talos it was possible to infer that the oilfield extended to an areas assigned to Pemex Exploración y Producción (PEP).

On 9 December 2017, after an evaluation was performed, Talos confirmed the existence of a shared oilfield located in between the area operated by Talos as per the Shared Production Exploration and Extraction Contract CNH-R01-L01-A7/2015 (the Talos Contract).

Since then, Talos has been operating the shared field as per the agreements reached between PEP and Talos in the respective the Pre-Unitization Agreement in force until the asset is confirmed and a final Unitization Agreement is entered into by PEP and Talos and approved by SENER.  However, recently, SENER has designated PEP as operator of the Zama oilfield, a decision which allegedly causes loss or damage to Talos as an investor and as the operator under the Talos Contract (the Zama Dispute).

There is no question as to the complexity that a dispute of this nature poses, especially considering the background around the Talos Contract and the available dispute resolution variants that bring us back to the clauses of the model exploration and extraction contracts arising from the 2013 Energy Reform (E&E Contracts).

The Hydrocarbons Act contains a provision regarding the dispute resolution methods included in E&E Contracts. The referred provision states that, while E&E Contracts can contain alternative dispute resolution clauses, the parties must select Mexican Federal Laws as the applicable law, and specify that the proceedings shall be held in Spanish (article 21). Article 22 of the Act further states that any dispute related to government termination of E&E Contracts cannot be subject to arbitration.

As the first, second, third and fourth public bids of Round 1 developed, the CNH made several modifications to the terms and conditions of the contracts. The final versions included an experimental arbitration clause providing for any dispute arising from or relating to this Contract that has not been resolved within three (3) Months after the commencement of the conciliation period or that it would have been rejected by any Party in terms of Article 26.2, it shall be resolved by arbitration pursuant to the UNCITRAL Regulations. The Parties agree that President of the International Court of Justice shall be the nominating authority for the arbitration proceeding. The applicable substantive law shall be as provided in Article 26.1 [“This Contract shall be governed by and construed in accordance with the laws of Mexico.”], and disputes shall be resolved strictly according to law. The arbitral tribunal shall consist of three members, one named by CNH, another named jointly by the Operator and the Participating Companies and the third (who shall be the president of the tribunal) named in accordance with the UNCITRAL Regulations. The arbitration proceeding will be conducted in Spanish and the seat of the arbitration shall be the City of The Hague in the Kingdom of the Netherlands.

In this context, at least preliminarily, three different dispute resolution variants may be envisaged regarding the Zama Dispute:

  1. Investment arbitration under the USMCA or the BLEU-BIT;
  2. Commercial arbitration subject to an experimental arbitration clause under the Talos Contract and
  3. Appeal before Mexican courts against the SENER’s resolution to designate PEP as the Operator of the Zama oilfield.

As the anecdotal COMMISA case showed us, both Talos and the Mexican Government shall clearly determine their strategies, prior to initiating the different resolution proceedings in order to consider any potential overlapping that may in the end compromise their position.