1 IN THE MATTER OF A CLAIM UNDER THE NORTH AMERICAN FREE TRADE AGREEMENT And THE UNCITRAL ARBITRATION RULES B E T W E E N: METHANEX CORPORATION Claimant/Investor and THE UNITED STATES OF AMERICA as represented by the DEPARTMENT OF STATE Respondent/Party CLAIMANT’S REPLY TO THE STATEMENT OF DEFENSE Unless a fact is expressly admitted herein, the Claimant will require the Respondent to prove any fact relied on in its Statement of Defense under the provisions of Article 24.1 of the UNCITRAL Arbitration Rules. The headings set forth in this Reply follow the headings in the Respondent’s Statement of Defense (the “Defense”). THE FACTS I A. Nature of Methanex’ Business (i) Methanol Market 1. Methanol is a pure commodity. As a result pricing is determined b y the supply/demand balance. It is also a global commodity so that any regional pricing differences are quickly closed (subject to any transportation cost differentials). As a result, any measure to eliminate MTBE in California or the United States impac ts the global market for methanol. 2. It is misleading to state in paragraph 15 of the Defense that methanol is “primarily used to produce formaldehyde” without any reference to MTBE. While the largest single use of methanol is for the manufacture of forma ldehyde, representing 36% of global methanol consumption for the past three years, MTBE manufacture represents the second largest single use for methanol globally, and

2 2 the largest use for methanol in the United States. In 1999 MTBE consumed 29% of methanol globally, and 30% in both 1998 and 1997. In North America, 42% of methanol use in 1999 was for the manufacture of MTBE, and of that methanol, approximately 95% was consumed in the United States. Following MTBE, the third largest use for methanol is the m anufacture of acetic acid, which only consumed somewhere between seven and eight percent of the global supply over the past three years. The methanol prices quoted in the Defense are also misleading. Methanol pricing 3. $200 per tonne. Structural pricing levels typically cycles between US$100 and US are influenced by United States Gulf Coast producers (and their natural gas raw material cost) at the bottom of the cycle and methanol (or methanol derivative) substitution economics at the top of the cycle. hanex (ii) Met 4. To date, Methanex has not sold any of its methanol plants. While the Fortier plant has been temporarily idled, during this time, Methanex has actually acquired the minority 30% ownership from its partner so as to now hold, indirectly, 100% of the shares in Methanex Fortier. The shut - in of the Kitimat facility is also temporary, but of undetermined duration, due to the current economic conditions. 5. Methanex’ share price has historically correlated with the price of methanol and revious several years, not steadily declined but rather, has been has thus, over the p cyclical in nature. 6. The Toronto Stock Exchange (“TSE”) is the principal market for Methanex shares. The Respondent refers to the NASDAQ in its Defense. NASDAQ is the secondary market for trading in Methanex shares, and in 1999 represented only 12% of the total volume of shares traded. The day following the issuance of the Governor of California’s Executive Order (the “Executive Order”), the trading volume in Methanex shares on the TSE was nine times the average of the preceding four days and the closing price was C$0.55 lower than the closing price the preceding evening. With 173 million shares outstanding, this decline alone represented almost US$70 million or 10% of the market capitaliz ation of the company. 7. Following a prolonged period of languishing since the Executive Order, the share price has improved in recent months due to a significant increase in the global methanol price and independent efforts of Methanex to improve its corpor ate position generally in the methanol industry.

3 3 MTBE B. 8. MTBE was not "born" of regulation in that federal law has never mandated its specific use. Research and development activities of refiners spurred the introduction of alternate gasoline formulati ons, some containing MTBE from about the late 1970s, during the phase out of lead from gasoline. MTBE was thus widely used for over a decade prior to the passing of the Clean Air Act Amendments of 1990, which saw the introduction of reformulated gasoline (“RFG”) in 1995. The United States Environmental Protection Agency (“EPA”) has repeatedly emphasized that MTBE was not required in RFG, in so far as Clean Air Act neither the nor EPA requires the use of specific oxygenates, but rather an oxygen content by weight. Refiners have the choice as to which oxygenate to use. Both ethanol and MTBE are used in the current RFG program, with fuel providers choosing to use MTBE in about 87% of the RFG mainly due ics and ease of transport. to reasons of lower cost, superior blending characterist C. CALIFORNIA MARKET FOR MTBE 9. 70% of MTBE consumed in California is produced by sources external to the United States, 20% comes from the United States Gulf Coast area and 10% is manufactured in California. Methanex suppli es methanol to offshore MTBE producers, to United States Gulf Coast MTBE producers and to California MTBE producers. 10. It is not relevant that foreign MTBE producers are the principal suppliers for the California market. D. NMENT MTBE EFFECTS ON HEALTH & ENVIRO (i) Drinking Water & Health 11. The measure as reflected in the Executive Order was not based on any concern regarding health. In fact, the Executive Order specifically excluded health as a justification for the measure. 12. There is not a shred of clinical or epidemiological evidence to support the notion that MTBE has caused or will cause any human cancer. Moreover, there is no meaningful evidence that MTBE is causally related to any definitive human disease. There is no evidence of systemic pathology as sociated with MTBE and in fact MTBE may be a chemopreventative agent. In this regard, animal studies have demonstrated a reduction in specific types of benign tumors or cancers in rats.

4 4 There are marked inconsistencies in the animal data which vitiates 13. any meaningful conclusions about carcinogenesis in animals. The studies have been very limited in nature and have no relevance to human carcinogenesis. There is no known causal association of MTBE with any type of human cancer and no ects for MTBE in humans after inhalation or oral exposure. known genotoxic eff 14. MTBE has been administered as a therapeutic agent for the treatment of gallstones. Despite single doses of up to 20ml, and significantly larger doses being administered over a period of days via catheter for direct infusion into the gall bladder, no consistent acute or chronic toxic sequelae have been reported, other than varying intensity of nausea and the detection of a breath odour. iences, the 15. The EPA, the National Institute for Environmental Health Sc International Agency for Research on Cancer, the California Office of Environmental Health Hazard Assessment’s Proposition 65 Committee and the U.S. National Toxicology Panel’s Board of Scientific Counselors have all cancer causing agent, a carcinogen or an agent likely declined to list MTBE as a to cause cancer. 16. Paragraph 50 of the Defense is misleading. The reference to 5.0 ppb references the taste and odour thresholds for MTBE. The threshold established for health purposes in California is 13 ppb, the lowest threshold for any State. Much has been made of MTBE’s extremely low taste and odour thresholds, so clearly no one could unwittingly drink water with concentrations of MTBE that would pose d taste of MTBE at concentrations any health risk. One would detect the smell an far below that established by the State of California for health purposes. The Respondent fails to identify the other components of gasoline - benzene, 17. to as toluene, ethylbenzene and xylene (commonly and collectively referred “BTEX”) - as having greater toxicity than MTBE. While it may be somewhat easier to clean up, BTEX is far more dangerous than MTBE. 18. It is presently not known if MTBE travels through soil rapidly. There is a limited database on the subject of the tr ansport of MTBE through soils. It is admitted that MTBE in dissolved form does travel through aquifers. 19. It is inaccurate for the Respondent to state that MTBE is highly resistant to biodegradation. Evidence discloses MTBE is degradable under both aerobi c and anaerobic conditions. MTBE will naturally degrade in aquifers once the source of MTBE has been identified and remedied. It is admitted that the current scientific research indicates MTBE generally takes longer to biodegrade than the more toxic BTEX components of gasoline.

5 5 Groundwater Contamination (ii) 20. It is inaccurate for the Respondent to imply in paragraph 56 that MTBE presents a significant risk to all of the drinking water supplies in California. MTBE and other gasoline components pose a ris k to drinking water supplies only where those drinking water supplies are adjacent to leaking underground storage tanks (“UST”) or other sources of gasoline contamination, a situation that not only creates an MTBE risk, but also creates a risk of BTEX cont amination of the water. While detectable amounts of MTBE may move farther or more rapidly in an aquifer, its taste and odour are quickly identified and disclose the fact of a leaking UST or other source of gasoline contamination. It is more accurate to tate that leaking UST and other sources of gasoline contamination present a s significant risk to drinking water supplies in their vicinity. 21. Contrary to the position adopted by the Respondent, the Claimant does not regard inevitable in substantial quantity. To accept gasoline leaks or other releases as leaking UST or other gasoline releases as “inevitable” completely disregards the initiatives of the California, United States and other countries who have taken the position that it is not acceptable to simpl y presume that substantial gasoline leaks are bound to occur. 22. Two - stroke watercraft engines emit up to 30% of their gasoline fuel unburnt in their exhaust as part of their normal operation, discharging not only MTBE but also BTEX. This is a recognized so urce of environmental contamination. While there are documented cases of surface water contamination by gasoline components, the Claimant is unaware of any California drinking water with raft being MTBE levels in excess of the State’s threshold as a result of waterc permitted on recreational use reservoirs. 23. Leaking UST have caused virtually all contamination of drinking water in California. In the examples cited by the Respondent, the City of Santa Monica problem was caused by leaking UST, as was the situ ation in Glennville, California. Leaking UST also caused the problems in the South Lake Tahoe Public Utility District. In each of these cases, all components of gasoline were leaked into the environment, not just MTBE. While MTBE may have led the plume and been the initial marker for the leak, BTEX was also inevitably present. The references to contaminations of MTBE in the Lake Donnor and Shasta Lake 24. regions do not evidence any problem with drinking water. The examples quoted are not necessarily rep resentative of MTBE concentrations in these or other lakes, reservoirs or drinking water. 25. The cost estimates referred to in paragraph 70 of the Defense are for the costs to clean up the gasoline spills not an MTBE spill.

6 6 CALIFORNIA’S ACTIONS E. Bill 521 (i) Senate 26. Paragraph 71 of the Defense suggests that the US$500,000.00 provided by Senate Bill 521 (the “Bill”) was adequate to carry out the study required by the Bill. In fact, the Bill required a comparative study of the human health and environmental risks and benefits, if any, associated with the use of MTBE as compared to ETBE, TAME and ethanol. Such a study was not done and could not have been done for the amount of money provided. Rather than advise the government that it was out such a study, the University of California, taking its cue impossible to carry from the tenor of the Bill, proceeded to work up a case detailing the purported risks of MTBE. (ii) University of California Report Paragraph 72 of the Defense states that the University of Cali 27. fornia issued a “competitive peer review request for proposals.” In fact, the call for proposals was only open to University of California staff, without regard to the availability of others, regardless of experience or stature in the field. The Bill res tricted the use of the funds to the University of California. 28. The failings of the University of California Report (the “UC Report”) have been outlined in the Statement of Claim. (iii) Public Testimony and Peer Review Although public hearings were held a nd the UC Report debated, no significant 29. changes were made in the UC Report when delivered to the Governor. In particular, the EPA had serious concerns respecting the UC Report, but their comments were ignored. It is interesting to note in paragraph 82 o f the Defense that the Respondent, in listing various agencies, makes no mention of the EPA comments on the UC Report. (iv) Executive Order The Executive Order clearly requires MTBE to be removed from gasoline no later 30. than December 31, 2002. This requ irement in turn triggered the application of Section 4 of the Bill which provides: “(a) If the sale and use of MTBE in gasoline is discontinued pursuant to subsection (f) of section 3 of this act [the Executive Order], the State shall not thereafter adopt or implement any rule or regulation that permits or requires the use of MTBE in gasoline.

7 7 If the sale and use of MTBE is to be discontinued pursuant to (b) subdivision (f) of section 3 of this act, the State Air Resources Board nvironmental Protection Agency that the shall immediately notify the E use of MTBE in gasoline in this State will be discontinued.” 31. The Governor used no data from the public hearings or the peer review in coming to his decision to remove MTBE from commerce, but relied solely on the UC Report. Once the Governor held that there was a significant risk to the environment, he 32. had the authority under the Bill to take any “appropriate action”. He failed to do so. Appropriate action would have involved an analysis similar to that carried ou t 33. Toxic Substance Control Act under the TSCA ”). The TSCA , as written and (“ interpreted by the courts, is a guide as to how California ought to have conducted its risk management actions on the MTBE in water issue. The ’s overall TSCA approach is particula rly well suited to the MTBE situation in which it is not the per se , “manufacture, distribution in commerce, use, or disposal of MTBE”, which poses a risk, but rather the release into the environment of gasoline that the TSCA is that the regulator’s actions presents a risk. The basic premise of should be limited to only the type and degree of regulation necessary to address an unreasonable risk posed by a substance. 34. Under the TSCA , if such an unreasonable risk is found, the EPA is required to apply “one o r more ...requirements ... to the extent necessary to protect adequately against such risk using the least burdensome requirements...” (15 U.S.C. § 2605(a)). In addition, EPA may not promulgate a rule under the if TSCA the risk of injury to health or the environment can be “eliminated or reduced” by actions taken under another federal law, unless EPA finds that regulation under TSCA is in the “public interest” (15 U.S.C. § 2605(c)). the 35. In selecting the least burdensome alternative, the proper course for the Governor to have followed was to consider each regulatory option, beginning with the least burdensome, and the costs and benefits of regulation under each alternative. Under this “least - to - most - burdensome hierarchy,” the Governor’s selection of th e most burdensome alternative a total ban of MTBE - cannot be justified if there - was any other regulation that could have achieved an acceptable level of risk. 36. Methanex agrees that MTBE (or BTEX), once in the environment , poses some degree of risk. How ever, the severity of any risk to human health or the environment had not been thoroughly established; nor had it been properly compared to the benefits provided by MTBE or the costs of eliminating the use of MTBE. Likewise, there was no objective evaluat ion of the efficacy of actions to prevent MTBE from getting into the environment, nor of any alternative means of managing the risk presented when MTBE is in the environment.

8 8 37. The Governor failed to proceed with an examination of a descending hierarchy of options in which risk reduction is measured against the action, and in which a ban or removal from commerce is the last resort, being taken only where, after examining all other measures, the risk remains unacceptable. As such, the d both procedural and substantive fairness. Governor’s action lacke Subsequent California Legislative Action (v) The subsequent legislative action taken by the Senate clearly demonstrates that 38. new requirements designed to prevent unauthorized UST releases were politically possi ble and could be effective in reducing, if not eliminating, any unacceptable risk to contamination of ground or surface waters by gasoline components including MTBE. (vi) Actions Taken by Regulatory Agencies The numerous public meetings on proposed regul ations that would eliminate the 39. use of MTBE in gasoline in California referred to in the Defense paragraph 92 are irrelevant given that the Executive Order has a deadline date of December 31, 2002, by which MTBE must be removed. 40. The reference in paragraph 99 of the Defense stating that the proposed CaRFG3 regulations are based on a “comprehensive set of scientific studies” is misleading. An analysis of the “comprehensive studies” reveals a limited selection of studies from and by those whose findings coul d be anticipated. OTHER STATE AND FEDERAL ACTIONS F. Paragraph 105 of the Defense suggests that one of the recommendations of the 41. Blue Ribbon Panel could be taken in isolation. In fact, the Blue Ribbon Panel Report (the “BRP Report”) states: “The foll owing recommendations are intended to be implemented as a single package of actions ...” (emphasis in original)(Executive Summary, p.3). 42. The BRP Report then proceeds to list the recommended actions to “enhance, improve protection of drinking water accelerate, and expand existing programs to supplies from contamination.” The recommendations included: • “accelerate enforcement of the replacement of existing tank systems ..., including, at a minimum, moving to have all states prohibit fuel deliveries to non - upgraded tanks...” “evaluate the field performance of current system design requirements and • technology...”

9 9 • “strengthen release detection requirements to enhance early detection...” • “require monitoring and reporting of MTBE and other ethers ...” “encour age states to require that the proximity to drinking water supplies, • use - and the potential to impact those supplies, be considered in land planning and permitting decisions for siting new UST facilities...” “implement and/or expand programs to train and l • icense UST system installers and maintenance personnel...” • “work with Congress to examine, and, if needed, expand the universe of regulated tanks...” In addition, the BRP Report presents several recommended actions (still as part of 43. relating to implementation of federal and state Safe the “single package”) Drinking Water Act programs, protection of private wells and surface water sources of drinking water, and funding and implementation of remediation and treatment programs. 44. The BRP Report then recomme nded actions relating to reducing the amount of MTBE being used, an option which was clearly open to California. 45. A specific recommendation of the Blue Ribbon Panel was that federal law be amended to clarify the authority of EPA and the States to “regulate and/or eliminate the use of gasoline additives that pose a threat to drinking water supplies.” With respect to States, the BRP Report recommends that States should be given the authority to regulate and/or eliminate a gasoline additive only if they: “ demonstrate that their water resources are at risk from MTBE use, 1) above and beyond the risk posed by other gasoline components at levels of MTBE use present at the time of the request.” 2) “...have taken necessary measures to restrict/eliminate the presenc e of gasoline in the water resources.” California did not and could not meet this test. 46. The several Blue Ribbon Panel members who concluded that the use of MTBE in gasoline should be completely eliminated had an apparent bias for that result. 47. The state ment in paragraph 107 of the Defense that in late 1998 the State of Maine withdrew from the federal oxygenated fuels program “after discovering” that approximately 16% of wells in the State were contaminated with MTBE is inaccurate and misleading. In fact , Maine did not withdraw from the federal

10 10 oxygenated fuels program as it was never in it. It did withdraw from the RFG program, which it had entered as part of its State Implementation Plan to meet the The State had already indicated it int ended to opt out prior to any Clean Air Act . surveys being conducted. The Respondent states in paragraph 107 of the Defense that approximately 16% 48. the 16% of wells in the State of Maine were contaminated with MTBE. In fact, ater systems" and not "wells in the reference is to a study of "public drinking w state". Sources for these systems include reservoirs, surface water and wells. The same study detected toluene in 13% of the samples. The study covered virtually - 900 systems. It did not in all of the State’s some 800 clude private wells. A separate telephone survey of private wells determined that many with unacceptable levels of gasoline components were due to deliberate or accidental dumping of gasoline in the subject’s yard. 49. MTBE was not banned or removed from commerce in Maine. It continues to be used as a source of octane in the gasoline pool. 50. In paragraph 108 of the Defense, there is reference to joint statements by the EPA Administrator and the U.S. Secretary of Agriculture. Such statements demonstrate th at the political considerations in this debate are driven by the agricultural lobby to secure a ban of MTBE in favour of ethanol. II POINTS AT ISSUE A. Jurisdiction and Admissibility The Arbitral Tribunal has the power to rule on objections that it has no 51. jurisdiction by reason of Article 21 of the UNCITRAL Arbitration Rules, however, the Respondent appears to have confused the issue of liability with the issue of jurisdiction. 52. Under Article 1116 of NAFTA, an investor may submit to arbitration “a cla im that another Party has breached an obligation under ... Section A ... and that the investor has incurred loss or damage by reason of, or arising out of, that breach”. The Arbitral Tribunal has jurisdiction to determine if the investor’s claim alleges a bre ach of an obligation under Section A and, in so doing, determine whether that claim has been made out. Issues such as whether the Bill and Executive Order are measures, whether Methanex fits within the wording of Article 1116, whether Methanex has incurre d loss or damage, whether the claims are or are not too remote and whether the measures pleaded in the claim fail to accord a minimum standard of treatment required under Article 1105 are all issues of liability, not jurisdiction.

11 11 The Bill and Execut (i) ive Order are Measures “Relating to” Methanex’ Investments The words of Article 1101 of NAFTA with respect to measures “relating to” 53. investments of investors should, in conformity with international law, be given their ordinary meaning, which is broad. H ad the drafters of NAFTA wished to restrict the article to a direct or “legally significant” connection, the language of the treaty would have specifically so stated. A measure “relates to” the affects that investment in a materi al way. To afford the investment if it de facto words the interpretation requested by the Respondent would remove all measures which had the effect of expropriation, but which did not on their face have any legal connection with the investment. Bilateral investment treaties commo nly include not just expropriations but also measures generally recognized as de jure indirect, creeping, or expropriation. The definition pressed by the de facto Respondent is inconsistent with the interpretation used by other international arbitral trib unals and would render meaningless the references in Article 1110 to “indirect expropriation” or measures “tantamount to expropriation”. Under United States domestic law, the ordinary meaning of the words “relating 54. to” is a broad one to stand in some re lation; to have bearing or concern; to – pertain; refer; to bring into association with or connection with. 55. Previous NAFTA arbitration tribunals appear to have equated “relating to” with 1 “affecting”. 56. The Bill and the Executive Order collectively had a “ material effect” on the property rights of Methanex U.S., had “some relation to” those rights, had “significant bearing on” those rights and was an indirect expropriation of a material portion of Methanex U.S.’ business. (ii) Article 1116 Jurisdiction 57. A rticle 1116 provides relief to investors where a Party has breached an obligation under Section A of Chapter 11. Article 1116 permits an investor of a Party to make a claim on its own behalf where the investor has incurred loss or damage by reason of a br each of Section A (emphasis added). 58. Chapter 11, Section A of NAFTA contains two articles which the Claimant claims were breached by the Respondent, namely Articles 1105 and 1110. Article 1105 requires that each Party shall accord to investments of in vestors of 59. another Party, treatment in accordance with international law, including fair and equitable treatment and full protection and security. With the failure to accord Methanex U.S. fair and equitable treatment as detailed below, California 1 Pope & Talbot Inc. v. The Government of Canada, Interim Award dated June 26, 2000

12 12 d a breach of Section A. Methanex has a claim for this breach, provided committe it is able to show damages have been suffered as a result . 60. Article 1110 provides that no Party may indirectly expropriate an investment of an investor of another Party or take a meas ure tantamount to expropriation of such investment except on payment, without delay, of compensation equivalent to the fair market value of the expropriated investment. The measures detailed above ess, and the failure to are tantamount to an expropriation of Methanex U.S.’ busin compensate Methanex U.S. is a breach of Section A. As a result, Methanex has a claim for this breach, provided it is able to show damages have been suffered as a result . 61. Methanex U.S. Methanex claims significant losses distinct from any loss to Under Article 1116 of the NAFTA, once a breach of Section A is established, an investor may recover for loss or damages incurred by reason of, or arising out of, that breach. As detailed below, Methanex has suffered significant damages as a result of the breaches of Articles 1105 and 1110. Waiver by Methanex US and Methanex Fortier (iii) 62. Methanex, Methanex U.S. and Methanex Fortier have provided a proper waiver to their rights to initiate or continue any proceedings set out in Article 11 21(1)(b). 63. - recognized legal principles, the Respondent is entitled to rely on both Under well factual and apparent authority of the corporate counsel and assistant corporate secretary of Methanex, Mr. Randall Milner. Mr. Milner had authority to bind Met hanex U.S., Methanex Fortier and Methanex. 64. Should the Panel require evidence of his authority, it will be adduced. 65. The waiver is effective to preclude Methanex U.S., Methanex Fortier or Methanex from bringing action before any other administrative trib unal or court under the laws of the United States. It would be inconceivable for a court to rule in any attempted action brought by Methanex, Methanex U.S. or Methanex Fortier that the waiver is insufficient. The Expropriated Investment (iv) 66. Methanex’ clai m under Article 1110 alleges an indirect expropriation of the enterprise, Methanex U.S. 67. In order for there to be an expropriation, it is not necessary to nationalize the company or seize all of its assets. The deprivation of a part of its property is suf ficient.

13 13 Property includes both tangible and intangible property. Customers cultivated by 68. Methanex U.S. constitutes one of its most valuable assets and is known in law le under the general heading of goodwill. It is an intangible asset but it is a valuab component of the property of a business, every bit as much as the premises, machinery and equipment. 69. It is clear that NAFTA contemplates both tangible and intangible property being subject to expropriation. Article 1139 includes in the definition of i nvestment both tangible and intangible property acquired in the expectation, or used for the purpose of economic benefit or other business purposes. Article 1139 also contemplates the expropriation of “interests” and interests arising from the commitment of capital or other resources in the territory of a Party to economic activity in such territory. 70. Methanex U.S.’ access to the U.S. market is a property interest subject to protection under Article 1110. Where an investment’s business activities have b een interfered with in a material or substantial way, that is an expropriation under international law. The use of the words “tantamount to expropriation” are broad enough to include a 71. measure which removes an entire market otherwise available to Methanex U.S. Regulation can indeed be exercised in a way that constitutes a measure tantamount to expropriation. An action that prevents, unreasonably interferes with, or unduly delays effective enjoyment of Methanex U.S.’ property is an 2 expropriation. (v) Loss o r Damage Suffered by Reason of the Bill and Executive Order 72. It is alleged by the Respondent that “given the nature of the Bill and the Executive Order” Methanex has no compensible injury or damage. The Bill and the Executive Order together constitute a m easure under the NAFTA. “Measure” is including “any law, regulation, procedure, requirement or practice” . defined as The requirement of the Executive Order to establish a timetable for the removal of ure. MTBE no later than December 31, 2002 is clearly a meas 73. The effect of the measure is to cause the removal of MTBE from commerce in California. The result is the indirect expropriation of Methanex U.S.’ business of selling methanol to MTBE producers. Remoteness (vi) 74. NAFTA Chapter 11 sets out the circumstan ces under which a claimant may make a claim for loss or damages. If Methanex’ claim falls within the words of NAFTA, it is entitled to compensation. If it does not fall within the words, it is 2 Third Restatement of the Foreign Relations Law of the U.S., Chapter 712, Comment (g).

14 14 , to the extent they not so entitled. Principles of “customary international law” modify or otherwise limit the clear words of NAFTA, are not applicable. 75. Current bilateral investment treaties and NAFTA protect investors beyond that which is contemplated in the 1970 decision of Barcelona Traction , referred to by the Respondent. Article 1105 Claim (vii) 76. The Respondent has argued in paragraph 139 of the Defense that Methanex’ claim under Article 1105(1) “is inadmissible because it fails to identify because there – is none any customary international law standard of tre atment incorporated into – that Article that is applicable to the challenged actions.” (emphasis added) Article 1105(1) of NAFTA requires each Party to accord “investments of investors of international law , includ ing fair and another Party, treatment in accordance with equitable treatment and full protection and security.” (emphasis added) Article 1105(1) does not refer to customary international law, but to “international law” regardless of its source. Moreover, regardless of whether there is a principle of “fair and equitable treatment” under international law, the Parties to NAFTA, by making express reference to “fair and equitable treatment,” clearly intended that this standard apply to investments in one NAFTA country by an investor of another NAFTA c ountry. There is nothing in NAFTA to suggest that the “fair and equitable treatment” standard as incorporated into NAFTA is limited to substantive fairness as the Respondent suggests. 77. The Respondent asserts that “[c]ustomary international law imposes no constraints on the processes by which states adopt executive or legislative measures...” Methanex’ claims however, relate to how the Bill was applied and implemented. Regardless of whether there is an international law principle requiring procedural fairne ss in the adoption of executive or legislative measures, there is an international law principle requiring procedural, as well as substantive fairness, in the application and implementation of executive or legislative measures to the investments of foreign investors. B. Liability Expropriation of Investment (i) 78. The Respondent repeats the error of attempting to classify the measure as one to protect public health, which it is not. 79. The Respondent repeats the error of claiming that for expropriation to exist, it is necessary to have nationalized or confiscated Methanex’ investments in the United States.

15 15 The Respondent fails to appreciate that under Article 1116, if an investor has 80. incurred loss or damage by reason of or arising out of the breach by a Party of an obligation under Section A, the damages which may be claimed are at large. Accordingly, it is immaterial whether the Fortier plant ever sold methanol into California. The removal of the market for methanol as a feedstock for MTBE has resulted in a fu rther delay in bringing the Fortier plant back into production. This has caused damage. Paragraph 153 refers to some of the provisions of the preamble to NAFTA. Not 81. referred to by the Respondent is the provision in the preamble, which states: a predictable commercial framework for business planning and “ENSURE investment”. 82. The claim by Methanex is not an attack on the sovereignty of the Government of California or of the United States to develop or enforce environmental laws and regulations. It is an attack on a measure, which though wrapped in the rhetoric of health and the environment is, on close analysis, an unjustifiable measure. Article 1114 specifically deals with environmental measures. It provides that 83. nothing in Chapter 11 shall be const rued to prevent a Party from adopting, maintaining or enforcing any measure otherwise consistent with this Chapter that it considers appropriate to ensure that investment activity in its territory is undertaken in a manner sensitive to environmental concer ns. (emphasis added) (ii) Lack of Fair & Equitable Treatment As discussed above, Methanex is claiming that the manner in which a legislative 84. measure was applied and implemented violates Article 1105(1), not the process Bill required a comparative study of the by which that measure was adopted. The human health and environmental risks and benefits, if any, associated with the use of MTBE as compared with ETBE, TAME, and ethanol. No such study was ever carried out. 85. The Bill also required the Governor to ce rtify, after considering not only the UC Report, but also the peer review comments and public testimony, whether using MTBE in gasoline in California posed a significant risk to human health or environment and if so, to take “appropriate action”. The Gove rnor did not take into consideration the peer review comments or the public hearings in reaching his conclusion and therefore did not follow the requirements laid down in the Bill. Further, the Governor failed to take “appropriate action” as mandated by t he Bill, by ordering the removal of MTBE from commerce, rather than the measured approach required by the TSCA or that recommended by the Blue Ribbon Panel. C. Damages

16 16 86. Methanex’ damage claim is not based on a loss of share value. ages have been suffered and calculates its loss under three 87. Methanex asserts dam lost profits associated with the lost methanol sales to the MTBE separate heads – market; margin losses on the balance of methanol sales due to the negative red as a result of the measure taken by demand shock; and direct expenses incur California. 88. The particulars of the direct expenses incurred by Methanex are ongoing and will be provided prior to the commencement of the arbitration. 89. The damage assessment extends beyond a simple examination of t he loss of the California MTBE market for methanol. The California measure will have extenuating effects as other states move to follow the California example and remove MTBE from commerce. The damages claimed by Methanex also include the present value of anticipated losses to be suffered by Methanex from a loss of the national MTBE market for methanol. 90. Methanex has global investments and maximizes or optimizes the supply of methanol by effectively utilizing its global supply chain. There are costs to Me thanex in having to re - optimize its global supply chain due to the negative demand shock impact on sales volume with the elimination of a substantial portion of the methanol market. 91. The historical decline of the share price is the marketplace recognitio n of the damage sustained by Methanex. The potential damage to Methanex was acknowledged by the securities marketplace when the concerns of MTBE were - first raised by California and Methanex was then de valued via its share price. The recent improvement i n the share price is the marketplace’s response to Methanex’ efforts to improve its situation and better its corporate position in the methanol market generally. The damages claimed are not characterized as a loss to the market capitalization of the compa ny. The loss of the market capitalization was due to the securities market recognizing that the measure imposed by California would result in an over capacity in the global market for methanol. The margin losses are calculated by examining how the negati ve demand shock 92. impacts the price of methanol, as a global commodity. With the skewing of the supply/demand balance, the price of methanol will be depressed with the negative demand shock. It is projected to take six years for the methanol demand to reco ver to the pre - negative demand shock levels. The demand loss is permanent.

17 17 Respectfully submitted this 28th day of August, 2000. ____________________________________ BAKER & McKENZIE Barristers and Solicitors BCE Place, 181 Bay Street Suite 2100, P. O. Box 874 Toronto, Ontario M5J 2T3 J. Brian Casey (416) 865 - 6979 – telephone Janet E. Mills (416) 865 - 6967 – telephone (416) 863 - 6275 - facsimile Counsel for the Claimant

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