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A TEACHING CASE

MTBE AND NAFTA  

Teaching Note Available upon request from ITCD

 

Why doesn't the state of California sue Methanex for the remediation of MTBE contamination, as well as direct, indirect and anticipated human health costs??    

                                                                Margaret Schneider, former MIIS student 

Abstract:

          When Governor Gray Davis took steps toward banning MTBE from gasoline, he intended to protect California groundwater basins from further contamination. However, that decision also triggered a major international dispute under NAFTA. Canadian-based Methanex Corporation, the largest manufacturer of methanol (the primary ingredient of MTBE) in the world, filed a claim against the United States government in order to recover lost stock market value and anticipated profits. At least half a dozen similar cases are pending which challenge domestic regulatory decisions under NAFTA's Chapter 11, seeking both compensation and regulatory reversals. This pattern highlights unresolved conflict between domestic environmental regulation and international free trade and foreign investment protections. 

 

The Environmental Problem

      Early one August morning in 1995, while performing a routine inspection of water supply operations in the Charnock Wellfield, City of Santa Monica employee Andy Garcia* smelled turpentine in the water. Not a good thing, he thought. It turned out to be MTBE (methyl tertiary butyl ether) contamination from a nearby gas station's leaking underground storage tanks. The city had to shut down these water wells, pending cleanup actions expected to take several years. Then the Arcadia Wellfield tested way too high for MTBE. By 1996, the affluent and trendy City of Santa Monica had lost 50-80 percent of its local water supply wells to the turpentine stench, incurring an estimated cost of $150 million to remediate; and $3.3 million per year to buy replacement water. Then other cities began to complain. A pattern of groundwater pollution was emerging throughout California. Definitely not a good thing.

 

The MTBE Story

Added to some gasoline by the late 1970s as an octane booster, MTBE was originally hailed as one solution to air pollution. A substitute for the lead in old- fashioned "regular" gasoline (an environmental and public health disaster), MTBE is an oxygenate that helps gasoline burn more completely, thus reducing carbon monoxide and other tailpipe emissions. MTBE is generally preferred over another oxygenate, ethanol, because of its lower cost, ease of production (it is a byproduct of the oil refining process), and favorable blending characteristics with gasoline. 

MTBE content in gasoline increased dramatically when the federal Clean Air Act amendments of 1990 required reformulated gasoline (RFG: oxygenated fuel) in the smoggiest locations. For California, this meant MTBE was added to all gasoline sold in the Los Angeles area, Sacramento, and several other major metropolitan areas. The State Air Resources Board credits MTBE with a reduction in emissions of about 15 percent over the last 10 years, a considerable improvement in air quality. 

Unfortunately, gasoline escapes into the environment through various pathways: through leaking underground storage tanks (LUSTS), pipelines and spills, vaporizing at refueling operations, at manufacturing and industrial user sites, even from recreational watercraft. MTBE's physicochemical properties allow it to contaminate surface and groundwaters quickly. It is highly soluble, volatile, mobile and persistent, spreading faster and farther than other gasoline components. Even at extremely small percentages, MTBE is detectable in water by its distasteful turpentine smell. Called a "recalcitrant compound", MTBE is resistant to conventional water treatment techniques, and cleanup is very difficult and costly. 

In a pattern all too familiar, the environmental savior had become the environmental despoiler. There are no completed studies of long-term effects to humans from exposure to MTBE. Governor Gray Davis and the state legislature commissioned the University of California to do a study of MTBE, and to recommend regulatory action. That report, issued in November 1998 , after a thorough review of all the scientific literature available, found that MTBE caused: 1) objectionable taste and odor in water at concentrations as low as 5 ppm; 2) acute exposure effects of headache, nausea, vomiting, cough, dizziness, disorientation, or eye irritation; 3) cancer in rats, with the potential to cause cancer in humans. The research was inconclusive on whether or not MTBE exacerbated asthma, was neurotoxic, or affected reproductive or developmental processes. These university scientists urged the governor to ban the use of MTBE from his jurisdiction, the State of California. 

After consideration and consultation, on March 25, 1999, Governor Davis ordered state agencies to take the initial steps towards the elimination of MTBE from any gasoline sold or used in the state. To allow time for necessary industry adjustments, the ban would be accomplished in a phase-out fashion by the end of 2002. 

Another scientific body, the USEPA's Blue Ribbon Panel on Oxygenates in Gasoline, confirmed the UC findings, and recommended on July 27, 1999, a discontinuation of MTBE use. An occurrence survey found MTBE in the groundwaters of 49 states, many of which are developing their own regulations. The federal government is also considering action against MTBE, although currently the EPA has classified it as a "potential carcinogen" and issued only an "advisory" warning to municipal water purveyors. EPA set their advisory limit level based on kidney and liver effects observed in laboratory animal experiments. 

The controversy has spawned new research on the health effects of MTBE exposure, air quality impacts, actual occurrence, fate, and transport in the environment, and site remediation and water treatment techniques. 

In response to California's actions, the Shell Corporation began research into the microbial cleanup treatment of MTBE; the Tosco Corporation (76 & Circle K gasoline brands) and BP Amoco declared cooperation with government through rapid elimination of MTBE from their products. However, the Canadian Methanex Corporation, the major methanol manufacturer, with their market most severely threatened, took a very different action. 

 

NAFTA's Chapter 11 and the Methanex Law Suit

Methanex brought a claim against the United States government under NAFTA's Chapter 11, seeking compensation of US$970 million for business lost due to "indirect expropriation."  They claimed that the California measure cost them the loss of anticipated profits, of their customer base and of a substantial portion of the market for methanol. It caused a drop in both the global commodity price and stock market value, reduced return on their capital investments in methanol production facilities, and diminished their "goodwill reputation." 

NAFTA's Chapter 11 (see specific text in Annex 1) provides the basic protections of non-discriminatory, fair and equitable treatment for foreign investors, and payment of compensation in cases of expropriation. Its scope and definitions are very broad, and its objectives are to establish a secure investment climate, to remove barriers to investment, and to provide an effective dispute resolution process for disagreements between investors and host governments. Methanex primarily cites Article 1110 on Expropriation and Compensation as the legal basis for their claim, among other pertinent sections of the chapter. 

All three parties to NAFTA (Canada, Mexico, and the United States) strongly supported the particular investor protection regime embodied in NAFTA's Chapter 11, under which Methanex brought its claim. Through Chapter 11's unprecedented grant of standing to private companies to directly pursue complaints against sovereign governments, the parties hoped to restore investor confidence. The United States leads the trend toward lifting traditional constraints on standing in international law, going beyond government-to-government legal relations. Chapter 11 allows corporations access to international tribunal arbitration directly, without consulting their home or host governments, and by-passing all domestic legal court systems. 

Mexico in particular needed to dispel the persistent corporate memories of its sudden take-over (nationalization) of all the foreign oil industry assets in 1938, and indeed the general historic reputation of capricious and unfair treatment of foreign investors. Mexico is very clear today that direct foreign investment is an essential component of the country's development, offering new jobs and training, increased capital flows, current technologies, infrastructure, and sometimes even environmental leadership. Attracting such vital investment depends upon a stable "investment-friendly" climate, with no hint of market access restrictions, fear of expropriation, or business operations interference. Reasonable certainty and predictability inspire investor confidence. 

NAFTA's Chapter 11 seeks to offer redress for any arbitrary or discriminatory government acts against foreign investors or investments. It presents a very broad scope in defining "expropriation," going beyond the seizure of property or deprivation of full use of the investment to include "creeping expropriation" or "disguised, de facto, or indirect expropriation", or measures "tantamount to expropriation."  Both established and future investments are covered. Some U.S. government negotiators have reportedly argued that this legal threat encourages legislators to refrain from passing laws that violate their own international agreements. 

This is not the first Chapter 11 case involving gasoline additives. A year earlier in 1998, an apparently similar case had been settled in advance of any arbitration covering the merits of the case. Its cast of characters were reversed from the MTBE case: an American company, Ethyl Corporation, sued the Canadian government, under NAFTA Chapter 11, for regulating Ethyl's gasoline octane booster product MMT (methylcyclopentadienyl manganese tricarbonyl). Canada finally paid Ethyl Corporation about US$13 million dollars and revoked the MMT regulation. 

 

The MMT Story

Virginia-based Ethyl Corporation is the sole North American producer of MMT, known commercially as HiTec 3000, which it distributes through its subsidiary, Ethyl Canada, Inc., located in Ontario. Also a fuel additive which boosts octane in gasoline and thus reduces engine "knocking", increases the efficiency of gasoline production, and cuts nitrogen oxide emissions, MMT replaced lead in some gasolines as early as 1977. Ethyl was also the primary producer of lead gasoline additive, which was finally completely banned from United States gasoline in 1995, after the damaging effects of lead exposure on children's brain development was proven. 

MMT is not approved for use in reformulated gasolines in the United States, is banned totally in the state of California, and is very little used by any other industrialized countries. Automobile manufacturers in North America complained that MMT damaged modern emissions diagnostics and pollution control equipment in cars, just as lead did. 

Scientific evidence identifies inhaled air-borne manganese in acute doses as a neurotoxin, marked by symptoms like Parkinson's disease and premature aging of the brain. Workers suffering moderate exposure showed impaired hand-eye coordination, reaction time, and lung function. However, in 1994 Health Canada acknowledged significant data gaps when it recommended that further studies were needed to measure long-term, low-dose, chronic exposure effects on people, especially on those vulnerable groups such as the elderly, pregnant women, and children. A study by the Research Triangle Institute concluded that the risks of MMT exposure were acceptable. With the scientific uncertainty about the health risks, the CEPA (Canadian Environmental Protection Agency) did not have the authority to ban the use of MMT directly. 

The Canadian Minister of the Environment in 1995, Sheila Copps, (and later her successor, Sergio Marchi) introduced bills to ban the import and interprovincial trade of MMT in response to public concerns. On June 24, 1997, the MMT bill became law, and Canada banned the import or interprovincial transfer of the substance. 

Anticipating this outcome, Ethyl Corporation sued the Canadian Government under NAFTA Chapter 11 on April 14, 1997, commencing the international proceedings before the Canadian Parliament had completed its legislative process. Ethyl sought US$200 million in compensation for losses resulting from "expropriation" of assets, and for loss of its good reputation. Specifically, it brought a claim under Article 1102 National Treatment, Article 1106 Performance requirements and Article 1110 Expropriation and Compensation. 

In general, trade policy officials reject the use of trade tools as environmental policy instruments. They emphasize that domestic environmental protection goals should be achieved through normal environmental regulation, or the use of the new market tools (targeted taxation, tradable permits, etc.), not the manipulation of import/export policies. A healthy segregation of trade and environment is best, according to the trade community. 

Canada defended itself by insisting the Act was part of a comprehensive air pollution control effort which fulfilled the governmental responsibility to public health protection, that the ban applied to everyone, and that there were no domestic manufacturers of MMT to be covertly protected. It grants no special privileges to Canadian goods or services. The government confiscated no property or investment, but only exercised normal sovereign regulatory powers. 

A year later (24 June 1998) the three-person tribunal officially awarded itself (and NAFTA) jurisdiction over the case. Less than a month after that, the parties settled the case between themselves, prior to full substantive arbitration. The Canadian government agreed to pay US$13 million in compensation to Ethyl Corporation. In addition, on July 20, 1998, the Government of Canada announced that it lifted the ban on importation or interprovincial transfer of MMT. The government's statement that morning:

Current scientific information fails to demonstrate that MMT impairs the proper functioning of automobile on-board diagnostic systems. Furthermore, there is no new scientific evidence to modify the conclusions drawn by Health Canada in 1994 that MMT poses no health risk.                                                                (Ethyl Corporation Website) 

       Although legally binding precedent does not exist in international law, this apparently comparable case cast a long shadow over the MTBE case in the minds of public activists. Reactions from non-governmental organizations (NGOs) were immediate and extremely harsh, as this example from the Environmental Defense Fund indicates:

The rollback of the Canadian MMT ban is bad politics and bad public health policy. The Canadian government has gotten the critical issue backwards. The key point is not that there are scientific uncertainties about whether MMT is toxic, it's that there's not enough information to show that MMT is safe.                                               Karen Florini, EDF 

 

 

The U.S. Department of State: Legal Defense

      The Methanex claim came into the legal affairs office of the U.S. State Department, where Dan Lewis* and his team had the task of crafting the defense. He needed to neutralize Methanex' demand, yet at the same time preserve the general principles of investment protection and of environmental protection. Both the U.S. Environmental Protection Agency (USEPA) and the U.S. Trade Representative's (USTR's) office were already expressing specific concerns to him at the interagency meetings. 

          USTR reminded State of their abiding concern for maintaining a healthy NAFTA agreement, and of the history and concepts supporting the investor protection chapter. Its fundamental intent has always been to encourage good governance, that is, government which is neither arbitrary nor discriminatory against foreigners. The goal of the Chapter 11 language is to provide accountability for governmental actions, seeking even-handed decisions even in the face of typical political dynamics which all too often shift cost burdens to outsiders. 

Environmental policy is not immune to expedient political responses to pressure from vested-interests. If environmental goals can be accomplished through one of several methods, the natural tendency of countries is to choose the way which would also benefit domestic industry over foreign competition. Multilateral, collective, agreed-upon oversight of local political vagaries can reinforce good domestic governance. It is very important to have a neutral venue where regulatory actions can be scrutinized for disguised protectionism. Otherwise clever specialized interests can successfully undermine the free trading system for their own private gain, costing domestic consumers and international investors unfairly. 

      Environmental officials' first major concern about the Chapter 11 cases, and the Methanex case in particular, is the challenge those cases make to the sovereign right to govern and regulate in the public interest. International law recognizes the permanent sovereign right of nations over their domestic natural resources and environment. If the government had to pay compensation every time an environmental regulation affected an industry, the potential crushing liability would paralyze public agencies. So far the public has not had to pay for the right to clean air, water, and soils. Private industry's right to make a profit has until now always been circumscribed by the collective need to protect environmental quality. This public/private balance has never been easy, but the universally accepted Polluter Pays Principle clearly identifies who should pay the costs of environmental compliance. 

     In the United States, a convoluted and politically-charged controversy over "regulatory takings" spawned many new state laws which favor compensation to private property owners when environmental regulations significantly reduce the value of property. The property no longer has to be physically taken, nor full use of the property denied, as in classic expropriation situations. This potential liability has chilled many land-use environmental regulatory actions. USEPA worries that NAFTA Chapter 11 claims reflect an international version of the domestic controversy, which has already gone too far in the wrong direction. Of course, Chapter 11 goes far beyond physical property value. 

      Environmentalists both inside and outside USEPA have another serious complaint about this tribunal arbitration process: the lack of transparency and citizen access. The Investor-State Dispute Mechanism (ISDM), as it is legally called, is built upon the traditional commercial arbitration model, which values business confidentiality. Typically, all three tribunal members are lawyers familiar with trade policy and law, without environmental expertise whatsoever. They need not consult experts, allow observers, nor accept information from anyone not directly involved in the case. Release of any information in the case is voluntary, at the discretion of the parties and the principles of the case. One environmental thinktank criticized the process as "closed, secretive, non-transparent, and one-sided," which amounted to "a significant loss of democratic legitimacy." 

Arbitration under Chapter 11 completely bypasses domestic courts, and thus tribunals operate in a legal atmosphere defined by NAFTA alone, without any constitutional safeguards; no standing roster of neutral judges; no appeals procedures; no defined due process; no public access or review; no body of case law with which decisions must be consistent. In international law, binding precedent based on previous case decisions does not exist as a legal construct. 

Several other cases under NAFTA's Chapter 11 are proceeding towards arbitration, asking for both compensation and regulatory reversals. Like the MTBE case, they raise serious questions about how to balance important protections for investors and the environment alike. Any work on these claims also illuminates larger political and legal issues such as jurisdiction, sovereignty, standing, transparency, and democracy. The State Department team needed to integrate these trade and environmental values while at the same time presenting a solid defense against the Methanex lawsuit. 

Dan Lewis personally sympathized with environmentalists' demands about process and participation. In a commitment to transparency, he made many finished documents available by email to anyone who asked for them. Precious few people asked. 

 

The Tribunal:

This case has now gone into arbitration before the NAFTA tribunal selected specifically for the purpose. The United States Department of State, the defendant, bestowed their one choice upon Warren Christopher, a well-known statesman and lawyer, once the Secretary of State himself, and most recently a major player in sorting out the confusing U.S. Gore-Bush presidential election of 2000. Methanex, the claimant, selected William Rowley, an important Canadian corporate lawyer; and together they appointed V. Veeder, an English lawyer, as the third member of the tribunal, and its presiding arbitrator. 

The tribunal is charged to decide this case under NAFTA's Chapter 11, using that agreement's specific language and general international law as their guide. Some legal opinions suggest that they may only consider the effect of the California measures upon the investor, rather that the intent.  Any appeal to their decision is extremely limited. They have received the original claim from Methanex, the State Department's statement of defense against the claim, responses and counter-responses, and other documents. 

In addition to these documents from the principles in the case, the tribunal has also been asked to accept an amicus curiae (friend of the court) brief from a Canadian thinktank called the International Institute for Sustainable Development (IISD), headquartered in Winnipeg. The brief would describe some legal and political options for modifying or interpreting NAFTA's Chapter 11 intentions and language. IISD had also asked for observer status, a role quite often granted by the United Nations and other international negotiators. 

The tribunal in turn inquired of the NAFTA parties whether or not they should accept such input to the case from non-principles, to which both Canada and the United States responded affirmatively, but Mexico rejected. 

Should the tribunal accept the IISD brief and grant them observer status? 

How should the tribunal decide the case before them?

 

Relevant Websites: 

International

NAFTA Free Trade Commission ; US, Canada, Mexico http://www.nafta-sec-alena.org/
Commission for Environmental Cooperation http://www.cec.org/

 

 

Government

U.S. State Department   http://www.state.gov/
U.S. Environmental Protection Agency   http://www.epa.gov/
U.S. Trade Representative   http://www.ustr.gov/
California Governor's Office http://www.governor.ca.gov/
State Water Resources Control Board http://www.swrcb.ca.gov/
Cal/EPA (California Environmental Protection Agency) http://www.calepa.ca.gov/
California Air Resources Board http://www.arb.ca.gov/homepage.htm
Department of Health Services http://www.dhs.ca.gov/
Association of California Water Agencies http://www.acwanet.com/

   

Private Industry

Methanex http://www.methanex.com
Ethyl http://www.ethyl.com/
Archer Daniels Midland http://www.admworld.com/
Appleton and Associates: International Lawyers   http://www.appletonlaw.com/
Oxygenated Fuels Association http://www.cleanfuels.net/
California MTBE Research Partnership http://www.ocwd.com/nwri/mtbe.htm
Western States Petroleum Association http://www.wspa.org/
American Corn Growers Association http://www.acga.org/
National Corn Growers Association http://www.ncga.com/
Renewable Fuels Association http://www.ethanolrfa.org/
U.S. Council for International Business  http://www.uscib.org

  

NGOs
International Commercial Diplomacy Project http://commercialdiplomacy.org
International Institute for Sustainable Development http://www.iisd.org/
Friends of the Earth International  http://www.foei.org/
Environmental Defense [Fund] http://www.edf.org/
National Wildlife Federation www.nwf.org/
Sierra Club (Canada) http://www.sierraclub.ca/
Greenpeace http://www.greenpeace.org/
Public Citizen http://www.citizen.org/
World Wide Fund for Nature http://www.wwfus.org/commerce

REFERENCES

Documents available from author at lstrohm@miis.edu:

§         Statement of Defense of Respondent United States of America, August 10, 2000, by United States Department of State, Office of International Claims and Investments Disputes

§         Claimant’s Reply To The Statement Of Defense by Methanex

§         Rejoinder of the Respondent of the United States of America, Sept 14, 2000

§         Statement of Defence: Ethyl Corporation v. Gov't of Canada, Nov 27, 1997

§         See also www.naftaclaims.com

 

Analytical Articles:

Dhooge, Lucien J. (2001). The Revenge of the Trail Smelter: Environmental Regulation as Expropriation Pursuant to the North American Free Trade Agreement. American Business Law Journal, Spring (forthcoming), 48 pages.

Ganguly, Samrat (1999). The Investor-State Dispute Mechanism (ISDM) and a Sovereign's Power to Protect Public Health. Columbia Journal of Transnational Law, 38:113, 49 pages.

International Institute for Sustainable Development and WWF (2001). Private Rights, Public Problems: A Guide to NAFTA's Controversial Chapter on Investor Rights. Canada: IISD. Available at http://iisd.ca.

Mann, Howard and Konrad von Moltke (1999). NAFTA's Chapter 11 and the Environment: Addressing the Impacts of the Investor-State Process on the Environment. Working Paper of the International Institute for Sustainable Development (http://iisd.ca), 80 pages.

Von Moltke, Konrad (2000). An International Investment Regime?: Issues of Sustainability. International Institute for Sustainable Development (http://iisd.ca), 76 pages.

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