The Constitutional Electricity Reform Fallout

At the end of 2021, the president of Mexico, Andrés Manuel López Obrador, sent an initiative to the Mexican Congress to reform the Constitution’s articles 25, 27 and 28. These are the same articles that established the initial rules for the Mexican energy sector and the relationship between the state and individuals. This reform has been popularly called the "Electricity Reform;" however, the scope is even greater, affecting the oil and gas industry.

Originally, this reform initiative was known as the Electricity Reform because the main intention was to carry out a political movement to create an autarchy within the electricity industry in Mexico, proposing generally to eliminate all kinds of competition in electricity generation and favor the Federal Electricity Commission (CFE), a Mexican state company.

However, the Constitutional reform of President López Obrador also proposes the elimination of the Coordinated Regulatory Bureaus in energy, better known as the National Hydrocarbons Commission (CNH) and the Energy Regulatory Commission (CRE), which are Constitutional institutions and part of the federal administration, but with certain degrees of autonomy to provide fair competition between the companies of the Mexican state and the private participants in the energy market.

Thus, each bureau has a specific purpose within the energy industry. CNH is the authority in charge of the administration, surveillance and regulation of activities that encompass the upstream segment of the oil and gas industry; however, in 2019, it suffered a severe blow when it was forced by the Ministry of Energy (SENER) to suspend the bidding rounds for Mexico's oil fields, thus eliminating the possibility of increasing the country's oil and gas production capacities.

In the case of CRE, which is the office in charge of the surveillance, regulation and supervision of downstream activities, in addition to sharing the same functions within the electricity market, the action of regulatory capture was even more notorious than that for CNH, due to the restrictions of President López's energy policy. At the beginning of 2019, a relentless war was launched from the office of the presidency. Commissioners were pressured in order to provoke their resignation. Thus, in October of the same year, new commissioners were appointed who held the president's views. Since 2020, a new war has been fought against the participants in the energy market, especially in the electricity and fuel sectors.

However, the legal and constitutional scaffolding prevented the president from achieving energy statism. As a result, at the end of 2020 he promoted initiatives to reform the Hydrocarbons Law and the Electricity Industry Law, which were approved by Congress, but their legal effects were stopped by the intervention of the Mexican Supreme Court, after legal injunctions filed by private members of the industry. This is the main reason for the Constitutional Reform that is being discussed in the Mexican Congress and which, today, is in the process of being debated in an open parliament.

In this context, the obligatory question is asked:

How does the Electricity Constitutional Reform affect the Mexican oil and gas industry?

The answer is found in what I mentioned above and, which can be seen in the elimination of the eighth paragraph of article 28 of the Constitution within the initiative of the president, as well as in the Third Transitory article of the same initiative, which indicates that the functions of the regulatory bodies will be absorbed by SENER, an eminently political federal department.

To explain the negative effects of the elimination of the Constitutional energy regulatory bodies, we must remember that they are in charge of providing security and legal certainty to the companies that participate in the energy industry in Mexico by generating the minimum conditions of competitiveness. This action proposed by the president violates various chapters of the USMCA related to obstacles to trade, economic competition and advantages to companies of the Mexican state. It is a situation that, without a doubt, in the face of an eventual but unlikely approval of the reform by Congress, will lead to various panels of experts and international arbitrations for the protection of the interests and investments of foreign companies in Mexico.

The foregoing — since when all the surveillance and regulatory actions maintained by CNH and CRE within the hydrocarbons market are adopted by SENER, impartiality is lost (and it was already seriously undermined prior to the reform initiative) — makes it totally necessary to have an arbitrator that observes the principles of legality and legal certainty required by the international treaties ratified by Mexico; thus, weakening the industry and making it unattractive for investment.

But the problem is not exclusive to foreign companies or entrepreneurs. It is also important to the interests of national companies and entrepreneurs that operate with financial resources from abroad or that, as the case may be, operate as partners and strategic allies of peers on the outside. Those who, initially, by being governed by Mexican laws and not having the support of the protection provided by international legal systems, are left completely defenseless, since a Constitutional reform is not susceptible (by design) to injunctions in the Mexican courts.

Likewise, the president's Constitutional Reform aims to eliminate the Hydrocarbons Laws, in addition to the Electricity Law, without having in view any additional proposal or that provides a projection of legal certainty, rather than the good faith of the Ministry of Energy.

This will obviously have an impact on the development of new businesses, especially in the area of exploration and production of gas and oil, but even more so in midstream, specifically in hydrocarbon storage activity, in which Mexico has a very dangerous weakness, given that the oil and refined storage infrastructure has been null since the 1980s.

Finally, the disappearance of regulatory bureaus places consumers, both domestic and industrial, at a clear disadvantage by putting in place a systematic mechanism for the elimination of competition and, therefore, removing energy options, which would be a severe blow to national productivity and economy.

In short, the panorama looks unfavorable, except for companies owned by the Mexican government and the political-union groups that accompany them.