Changes To The Mexican Energy Regulations And Protective Measures For The Private Sector

The election of Claudia Sheinbaum as Mexico's new president, succeeding Andrés Manuel López Obrador (AMLO), suggests the continuation of significant changes to the electricity and renewable energy sectors. The recent landslide victory of Morena (ruling party) and its allies PT (Partido del Trabajo) and PVEM (Partido Verde Ecologísta de México) in the June 2 election gives the coalition a relative majority in the Senate (3 seats away from supermajority) and supermajority (two-thirds majority) in the House of Representatives, almost sufficient to pass constitutional amendments affecting investments in natural resources in Mexico. This significant federal legislative power, coupled with control over 26 of the 30 state legislatures, give the ruling party-led coalition a majority unattainable under AMLO's administration.

AMLO's administration sought to implement major changes to the regulatory framework set by the 2013 Energy Reform. In 2021, the proposed reforms to the Electricity Industry Law (LIE)¹ aimed to change the regime applicable to renewable power generation. In addition, proposed constitutional reforms seeking to consolidate the electricity sector under the state-owned Federal Electricity Commission (Comisión Federal de Electricidad, CFE) have stirred considerable debate and uncertainty. Under Claudia Sheinbaum's presidency these reforms are likely to be approved, with significant impact in private investment and lead to disputes.

I. MEXICAN POWER SECTOR UNDER MORENA'S ADMINISTRATION

A. PROPOSED CHANGES TO THE POWER SECTOR UNDER AMLO'S ADMINISTRATION

1. CHANGES AFFECTING RENEWABLES

On March 2, 2021, the Mexican Congress approved a bill tabled by the Mexican president to amend the LIE, which was published on the Official Gazette on March 9, 2021². This reform implied broad repercussions on the energy sector, given that it modified the rules applicable to: (i) new power generation projects, (ii) renewable energy, (iii) power generation projects under the LSPEE³ (legacy projects), and (iv) dispatch rules.

On January 31, 2024, after a series of court injunctive proceedings were commenced by some of the companies affected by the modification of the electricity reform, the Supreme Court rejected the reform to the LIE. The Second Chamber of Mexico's highest court held that the reform "violated the principles of competition, free concurrence and sustainable development" of the industry established in the 2013 Energy Reform.

2. CHANGES BENEFITING STATE-OWNED COMPANIES OVER THE PRIVATE SECTOR

On September 30, 2021, AMLO tabled a Constitutional Reform aimed to reorganize the electricity sector in Mexico⁴. The President proposed to strengthen CFE, which would assume regulatory authority functions, controlling and supervising the National Electricity System, which functions are currently performed by CRE (Comisión Reguladora de Energía) and CENACE (Centro Nacional de Control de Energía) (e.g. wheeling tariffs would have been determined by CFE as opposed to the wheeling tariffs issued by CRE today). Additionally, the proposed Constitutional Reform would have limited the participation of the private sector in the generation of power to no more than 46% of the total generation in the national electricity market. The initiative was voted and rejected by the Congress on April 17, 2022, due to the lack of supermajority, with 275 votes in favor, 223 against and 0 abstentions.

B. EXPECTED CHANGES TO THE POWER SECTOR UNDER SHEINBAUM'S ADMINISTRATION

On February 5, 2024, AMLO presented a second initiative to reform the Constitution regarding the electricity sector. Under the Sheinbaum administration, the supermajority in Congress will be in place to potentially pass this reform. The key proposed changes in this second initiative are, among others are:

• The amendment of Article 25 of the Constitution will eliminate the concept of "state-owned productive company". Currently, state utilities are considered "state-owned productive companies", which have to compete in the market as if they were private companies. Before the 2013 Energy Reform, the state utility had a monopoly over the electricity market in Mexico. After such Reform, limitations were imposed to the state utility to allow free competition in the market and to avoid prevalence of CFE as the main market participant. If this initiative is approved, it is possible that CFE will have a preferential legal framework to perform activities in the electricity market vis-à-vis private companies;
• The amendment of Article 27 of the Constitution will establish that "[the laws shall determine] that in no case shall [private parties] have prevalence over the state-owned public company" in the generation or supply of electricity. This would considerably curtail the participation of private companies in the electricity sector and would give a preference to companies owned by the State (CFE); and
• The amendment of Article 28 of the Constitution will allow a new "state-owned public company" to control the National Electricity System. Before the 2013 Energy Reform, CFE controlled the National Electricity System. Nowadays, the National Electricity System is controlled by CENACE, an independent body which operates the system without being a market participant. If this Reform is approved, CFE would have advantages over all private companies given that, in addition to being a market participant, CFE would become the system operator.

1. CHANGES AFFECTING RENEWABLES

If the Constitutional Reform⁵ is implemented, President-elect Claudia Sheinbaum will be responsible for driving these new policies. Some of the expected impacts to the private sector are:

• Further regulations for renewables owned by the private sector: It is expected that solar and wind projects will be required to install batteries to secure reliability of the grid. This will be applicable to new and existing power projects which may significantly rise the costs of the projects and affect the investors rate of return.
• Dispatch: Change the dispatch rules in the Wholesale Electricity Market to favor CFE projects, instead of renewable projects. As of today, renewable projects have a dispatch priority over polluting and inefficient conventional projects. This negatively affects CFE, as many of its power plants are not dispatched as they still use fuel oil and are not efficient. If the dispatch rules change and dispatch priority is given to CFE power plants, the number of renewable projects that would be dispatched, would be reduced.
• Tariff Adjustments: Rise tariffs for the interconnection of renewables into the national grid.

2. CHANGES BENEFITING STATE-OWNED COMPANIES OVER THE PRIVATE SECTOR

The proposed Constitutional Reform would also impose the following measures, favoring CFE over private players:

• Prioritization of CFE: Ensuring CFE is and remains the major player in the electricity sector by giving advantages and priority over private parties in all activities within the Wholesale Electricity Market.
• Contract Renegotiations: Renegotiating existing contracts with private energy producers to secure more favorable terms for the state. Similar to what happened at the beginning of AMLO's administration with gas transportation agreements between private parties and CFE, it is expected that tariffs and step-in rights in legacy contracts (independent power producers) will be renegotiated.
• CFE as main generator: Recently, the Mexican State managed to expand its ownership of generation infrastructure in Mexico after the acquisition by the State of thirteen power plants from Iberdrola⁶. It is expected that new legislation will be enacted in order to establish that a minimum of 54% of power projects in Mexico must be controlled by the State (CFE). This limitation could affect projects that are in development and not yet interconnected to the grid.

II. IMPACT TO PRIVATE INVESTMENT IN THE POWER SECTOR UNDER MORENA'S ADMINISTRATION

A. IMPACT ON INVESTORS AND PROJECTS

The proposed changes in the energy sector could create an uncertain climate for foreign investors, leading to a wait-and-see approach. These reforms could lead to significant regulatory and operational challenges, thereby increasing the risk of investment disputes.

1. POWER PROJECTS POTENTIALLY AFFECTED:

• Renewable Energy Projects: Solar, wind, and hydroelectric projects may face regulatory and contractual challenges due to policy shifts;
• Energy Infrastructure: Investments in grid modernization and expansion, required for new private projects to comply with interconnection agreements required to connect into the grid, may be impacted by changes in state priorities and regulatory frameworks;
• Legacy Power Generation: Legacy projects that have permits granted before the 2013 Energy Reform, owned by private parties, may face increased scrutiny and potential renegotiation of contracts; and
• Projects that participate in the Wholesale Electricity Market: Rules applicable to dispatch, requirements to become a Market Participant, and price calculations in the Wholesale Electricity Market may change.

2.PROTECTING INVESTORS RIGHTS

Investors should take several steps to prepare for potential arbitrations:

• Conduct a Thorough Review of Contracts: Assess the potential impact of regulatory changes on current investments.
• Develop a Comprehensive Legal Strategy: Address potential breaches of contract or expropriation claims proactively.
• Ensure Adequate Investment Treaty Protection: Ensure that current investments have adequate investment treaty protection.
• Gather and Preserve Evidence: Collect documentation to support claims related to fair and equitable treatment, expropriation, breach of contract, and other violations of the contract, law and applicable multilateral and bilateral investment treaties.
• Engage with Legal Advisors: Work with legal advisors experienced in international arbitration and investment protection to navigate potential disputes effectively.

B. REMEDIES AND RISK MANAGEMENT

1. TYPES OF INVESTMENT PROTECTION CLAIMS

Affected investors may invoke the following claims:

• Expropriation: Claims related to direct or indirect expropriation of investments without adequate compensation;
• Fair and Equitable Treatment: Claims based on violations of fair and equitable treatment principles, including arbitrary or discriminatory measures, and breaches of an investor's "legitimate expectations";
• Breach of Contract: Claims arising from breaches of contractual obligations by the state or state-owned entities; and
• Denial of Justice: Claims related to denial of justice in the host country's legal system, including lack of due process and judicial fairness.

Mexico has a history of compliance with arbitration awards under the New York Convention. However, parties sometimes use local Mexican courts to try to derail arbitration proceedings. Investors can expect that Mexico will generally adhere to international arbitration rulings, providing a measure of security for those seeking redress through arbitration.

2. RISK MANAGEMENT

As investors, it is crucial to recognize the potential risks and prepare for the regulatory challenges that may arise. The energy sector is vital to Mexico's economy, and it is imperative to protect investments in this area. By closely monitoring developments and engaging with legislators, investors, and industry stakeholders, our clients can position themselves to address the challenges and mitigate the risks associated with regulatory uncertainty.

At the same time, investors should understand the protections offered by investment treaties -whether bilateral or multilateral- as well as other dispute resolution mechanisms that seek to protect foreign private investments in Mexico. Our international arbitration practice can provide expert legal advice and strategic guidance.

At Mayer Brown, we remain committed to guiding our clients in the complexities of the Mexican energy sector. With our in-depth knowledge of energy laws and regulations, coupled with our extensive experience advising clients in the energy industry, we stand ready to help our clients achieve their business objectives and maximize value in this dynamic and changing landscape.

As President-elect Claudia Sheinbaum's administration takes office, we look forward to working closely with our clients to navigate the opportunities and challenges that lie ahead in the Mexican energy sector.

Footnotes

1. Electricity Industry Law (Ley de la Industria Eléctrica), Diario Oficial de la Federación, August 11, 2014.

2. Decree amending and adding several provisions of the Electricity Industry Law, Diario Oficial de la Federación, March 9, 2021.

3. Electricity Public Service Law (Ley del Servicio Público de Energía Eléctrica), published in 1975 and abrogated in 2014, when the new Electricity Industry Law was published.

4. Andrés Manuel López Obrador, Initiative with Draft Decree reforming Articles 25, 27 and 28 of the Political Constitution of the United Mexican States, on energy matters, October 1, 2021.

5. Hernández Ochoa, César Emilio, "Opinión técnica sobre la iniciativa presidencial de reforma energética del 5 de febrero de 2024", Instituto de Investigaciones Jurídicas de la UNAM, 2024, https://archivos.juridicas.unam.mx/www/bjv/libros/15/7483/12.pdf

6. Secretaría de Hacienda y Crédito Público, "Comunicado No. 41 Gobierno de México suscribe el acuerdo de compra-venta de 13 plantas de energía eléctrica de Iberdrola", June 12, 2023, https://www.gob.mx/shcp/prensa/comunicado-no-41-gobierno-de-mexico-suscribe-el-acuerdo-de-compra-venta-de-13-plantas-de-energia-electrica-de-iberdrola.

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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.