President of Mexico files constitutional reform bill on electricity

Energy

Energy Alert

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Since 2020 and throughout 2021, the Mexican Government has promoted a series of regulatory measures and legal reforms that have sought to ensure the Federal Electricity Commission (Comisión Federal de Electricidad or CFE) and Petróleos Mexicanos (Pemex) hold a dominant position in Mexico's energy sector, at the expense of private investors.

These measures have been considered contrary to the free market and have discouraged private investments in the sector. Until now, the Mexican Judiciary has declared them unconstitutional for being contrary to the legal and institutional framework derived from the 2013 Energy Reform.

Consequently, on September 30, 2021, the president of Mexico presented a constitutional reform bill before the Chamber of Deputies, which seeks to dismantle the electricity legal framework derived from the 2013 Energy Reform and grants the CFE a dominant role both at a regulatory and market level.

In this alert, we briefly describe said bill and its potential effects on investments made in the Mexican electricity sector.

The content of the bill

The bill begins by describing the points that the current government considers harmful from the constitutional framework of the 2013 Energy Reform, and thereafter, “proposes a new Mexican electricity system in which the State recovers the management of the national electricity system, through the CFE.” The CFE itself “becomes a State body, responsible for its planning and control, autonomous in the exercise of its functions and in its administration.”

To achieve this end, the bill proposes a reform to articles 25, 27 and 28 of the Mexican Constitution to establish inter alia the following:

  • The proposed reform establishes electricity as a strategic area in the charge of the State, incorporating the generation, wheeling, transformation, distribution and supply of electrical energy as “indivisible processes.” In consequence, the State, by means of the CFE, “will exclusively carry out the supply of electricity,” which “may acquire electricity from the private sector.”
  • The bill proposes to grant the CFE the status of a “State body” (in contrast to its current designation as a “State productive company”) and grants it regulatory powers over the market.

    In addition, the bill consolidates, under the CFE, the management of the Mexican electricity sector by (i) incorporating into it the National Energy Control Center (Centro Nacional de Control de Energía or CENACE, the independent operator of the Mexican electricity system since the 2013 Reform), (ii) granting the CFE the power to “dispatch its power plants on economic merit” and (iii) granting it the power to determine “the tariffs of the Transmission and Distribution networks, as well as the tariffs for end users.”

    In this context, the CFE would be integrated as a “single State body” vertically and horizontally, maintaining a reduced number of subsidiaries, and “its strict legal separation is canceled”, a change derived from the 2013 Reform.

  • Notably, the bill anticipates that “[t]he CFE will generate at least 54 percent of the national electricity consumption on a permanent basis” and fixes a maximum of 46 percent of the market share to private investors (the bill itself recognizes that, currently, private companies represent 62 percent of the market), and subjects them “to the planning and control of the national electricity system, through the CFE.”

    The aforementioned 46 percent, indicates the bill, “will be incorporated through an acquisition mechanism by the CFE, based on competition procedures” and, without further explanation, the bill provides for “the cancellation of all the electricity generation permits granted and the power purchase agreements, as well as the various figures of private generation and the requests pending resolution.”

  • Additionally, the bill establishes that only private projects that were developed under the following electricity generation schemes will be recognized: (i) generation plants of independent producers “without considering illegal surpluses”; (ii) long-term auction plants and plants built based on the legislation derived from the 2013 Energy Reform; and (iii) “Authentic Self-Supply (sic)” power plants.

    The bill provides that these power plants “will be able to continue generating electricity and compete to offer the lowest production costs, to be acquired by the Federal Electricity Commission through CENACE, in the short and long term, for the benefit of final users.” However, the bill states that the CFE “will establish the necessary contract modalities for the acquisition of electrical energy and capacity generated by the private sector, as a special regime different from that established in article 134 of the Constitution.”

    The “generation from the modifications to the Self-Supply permits that were granted in contravention of the provisions of the Electric Power Public Service Law (Ley del Servicio Público de Energía Eléctrica)” and the “surplus generation from independent Energy Producers, derived from permits superimposed on the original permit of the plant” will not be recognized or acquired by CFE.

  • Regarding renewable energies, the bill provides that “the State will establish the Energy Transition, using in a sustainable manner all the energy sources available to the Nation, gradually reducing greenhouse gas emissions and components.” In this regard, the CFE will be responsible for the execution of the Energy Transition in electricity matters, as well as any necessary activities. Likewise, the bill proposes to cancel the Clean Energy Certificates.

    Due to its importance for the Energy Transition, the bill sets forth that “no concessions will be granted on lithium and other necessary strategic minerals.” However, to the mining concessions already granted by the Mexican State, which, to date, have records of lithium exploration duly endorsed by the Ministry of Economy, “the aforementioned restriction will not be applied.”

  • Lastly, the bill provides that the “coordinated regulatory bodies in energy matters” (órganos reguladores coordinados en materia energética), the National Hydrocarbons Commission (Comisión Nacional de Hidrocarburos or CNH) and the Energy Regulatory Commission (Comisión Reguladora de Energía or CRE), “are abolished” and their “structure and powers are incorporated into the Ministry of Energy (Secretaria de Energía).”

The potential effects of the bill

The bill not only proposes the dismantling of the current legal and institutional framework for electricity, but could also result in a series of highly harmful consequences for private investors in the energy sector in Mexico, by generating an unprecedented level of legal uncertainty:

  • On the one hand, it is noteworthy that the CFE, as a “State productive company” was structured under the 2013 Energy Reform in such a way that, by limiting its market power, it allowed the development of a free competition scheme in the Mexican energy market, which was opened to private investment and participation.

    Pursuant to the bill, the CFE, in its new role as a “State body,” would not only become a “market participant” with broad dominance over it, but, if the bill is approved, it would have regulatory powers that would allow it to eliminate the conditions of free market competition against its competitors by limiting the dispatch of energy generated by private power plants or manipulating distribution and transmission rates to its benefit.

  • On the other hand, the minimum percentage of market participation that the bill “grants” to the CFE (and its correlative limit for private companies) is arbitrary, since the bill does not offer an explanation of the criteria used for the selection of said figures. In addition, that 54 percent, which represents the figure the CFE will generate of the national electricity consumption, is even more serious if it is considered that, as we mentioned, the same bill recognizes that currently private investors have 62 percent of the market share.

    As stated by the Mexican Business Coordinating Council (Consejo Coordinador Empresarial or CCE), the Mexican Institute of Finance Executives (Instituto Mexicano de Ejecutivos de Finanzas or IMEF) and the Mexican Confederation of Industrial Chambers (Confederación de Cámaras Industriales or Concamin), the acquisition by the Mexican State of 8 percent of the electricity generation that is currently in private hands could lead to a true regulatory expropriation of the generation plants that are affected by the measures taken under said criteria. It should not be forgotten that this 8 percent represents multi-million dollar investments by national and foreign investors.

  • Likewise, the purported “cancellation of all the electricity generation permits granted and the electricity purchase and sale contracts, as well as the various private generation figures and the pending requests for resolution” would represent an unprecedented blow for private investors, since not only would they be thrown into total uncertainty regarding their rights, but they would also be obliged to contract under the “acquisition mechanism by the CFE” to be determined.

    In addition, it is contradictory that the CFE, whose power generation capacity is largely based on plants that use fossil fuels, is the body “responsible for the execution of the Energy Transition in terms of electricity, as well as the activities necessary thereto” and, in addition, has as direct competitors the private wind and solar power plants.

  • Additionally, the fact that the “mining concessions already granted by the Mexican State and in which to date there is a history of lithium exploration duly endorsed by the Ministry of Economy” is commendable; however, the ability of the Mexican State to establish a state-owned company capable of efficiently carrying out lithium exploration and extraction works is in question, considering the vital role that lithium will play in the energy transition.
  • Finally, the disappearance of the CNH and the CRE would cause enormous legal uncertainty for individuals at the regulatory and contractual level.

Conclusions

In the light of the foregoing, there is no doubt that, if the bill succeeds, private investors would be seriously affected as it creates a drastic change in the rules that allowed them to make their investments, in violation of the principles of legal security, free competition and stability in the regulatory regime.

As a result, within the framework of the more than 30 international agreements for the promotion and protection of investments signed by Mexico to date, it is recommended that investors who have participated in projects in this sector in Mexico consider their rights and potential resources under the applicable investment treaties or other international instruments, as investment arbitration is a potential and effective mechanism to protect such investments.

In this regard, please see our series of alerts on the potential for investment treaty claims arising out of measures taken by States in response to the COVID-19 pandemic:

If you have any questions regarding these new requirements and their implications, please contact the authors, any member of our Energy team or your DLA Piper relationship attorney.

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