New Energy Policy Has Slowed Sector’s Development

Q: How has regulatory uncertainty in the energy sector transformed the legal advisory services provided by CMS Woodhouse Lorente Ludlow (CMS WLL)?

A: Unfortunately, the energy sector changed dramatically from one moment to the next. Four years ago, we were known as one of the best Mexican law firms regarding regulatory issues. We were advisers to the last administration and were involved in the creation of the new electricity market, the restructuring of CFE and the design of the long-term auctions. CMS WLL had the opportunity to collaborate with a significant number of companies in the electricity sector, both domestic and foreign.

The uncertainty generated by the government’s measures changed the type of services CMS WLL offered. The disinvestment generated by this uncertainty led to a drought of new projects, putting a stop to market demand for our advisory services for launching new projects. Instead, we helped clients to defend existing projects through amparos and other legal instruments to protect them from the different government measures. This is not as satisfying as being part of new projects that contribute to Mexico’s economic development.

Q: What recommendations are you giving your clients to adapt to the constant regulatory changes?

A: There are cases where the most viable recommendation is to exit the market, while others are looking to ride it out. Some clients need to generate value in the short term; they cannot wait for the market situation to change. Then again, some other clients have long-term visions; they are betting that the current situation is transitory. Their financial capacity allows them to invest today and expect returns in a few years. The industry generally agrees that the environment for the electricity market will not change during this administration.

Other clients see the current situation as an opportunity. They are aware that the market’s conditions, which led to less investment in CFE’s transmission, distribution and new plants, will generate a lack of capacity in the electricity system and cause dangerously higher energy prices. This could create an energy crisis that by 2024 will be one of the most serious problems Mexico will face. These actors are convinced that, regardless if MORENA remains in power, the next administration will be forced to change the current electricity policy. The sector is betting on a pendulum effect: in 2024, the sector will swing from the impossibility of mobilizing private projects to an urgent need to interconnect as many generation plants as possible to overcome the electricity crisis we are running toward.

Q: Where do you identify room to improve the 2014 Energy Reform?

A: This regulatory framework was complete. Modifying it was not and is still not necessary. Rather, the government should have completed the structural reform. Normally, countries take from five to seven years to fully implement structural electricity reforms but Mexico achieved it in three years. The problem began with the lack of completion of the required manuals and other regulations. When the administration changed in 2018, the required manuals and regulations remained pending. However, the new administration did not know the subject in depth and was against the sector’s liberalization that started in 1992. All the issues that the current administration wanted to see resolved, such as the issue of renewable energy intermittency, were already contemplated in the reform but they did not understand how the new market actually worked.

Misinformation led to misdiagnoses and wrong decisions that have left the electricity sector in limbo. Understanding the sector takes decades of study and experience, as it is a highly complex market. The new government's team could not become experts in such a short time. Unfortunately, they were also not open to receiving advice from experts, as the past administration did, and chose to return to the scheme of 30 years ago.

Q: What did the Supreme Court's reactivation of the Electricity Industry Law of 2021 (LIE) mean for the electricity sector?

A: The government wanted to reverse the 2014 Energy Reform. It began by stopping the reform through poorly-designed administrative actions. This allowed private companies to easily defend themselves through amparos that were entirely granted in favor of the companies. Every administrative government action regarding electricity between 2019 and 2020 was lost in court, so the proposal to change the law arose as an alternative.

The reform to the LIE was fast-tracked. Since LIE is a secondary law, its approval required a simple majority vote by Congress, which MORENA had at the time. When the law went into effect, companies proceeded to file for legal protection, as the LIE contradicted constitutional principles. Today, there are more than 284 amparos against the LIE’s reform and the effects of the reform are still suspended.

Meanwhile, governmental entities also communicated the new LIE’s unconstitutionality. Unconstitutionality actions were filed by the Senate's parliamentary minority, the Federal Commission for Economic Competition (COFECE) and the government of Colima. The Supreme Court (SCJN) reviewed these issues. When it does so, amparo resolution processes get suspended at federal courts. A qualified majority of eight SCJN ministers must agree on the resolution to consider the reform unconstitutional. During the discussion about the LIE, the SCJN achieved only simple majorities in favor of unconstitutionality, leaving the matter to be resolved case by case by federal courts, leading to the current situation.

Q: What effect does the Supreme Court's vote on the LIE have on the resolution of the amparos?

A: Contrary to the narrative promoted by the government, its reforms did not gain a judicial victory. Despite the failure to obtain a declaration of unconstitutionality, the precedent set by the simple majority vote in favor of the LIE’s reform unconstitutionality impacts the future resolution of amparos. When amparos reach their final instance, which could reach the SCJN, a simple majority will be required to grant the amparo. The simple majority of ministers are in favor of the LIE’s reform unconstitutionality, so we can predict that the resolution of amparos will be favorable for the private sector. Judges in federal courts must consider the precedent set by this simple majority vote.

Q: Why do large companies pay a cheaper electricity fare than basic supply consumers?

A: One of the pending issues left from the 2014 Energy Reform was to lower electricity prices. The Reform left CRE to set the tariffs required to recover all electricity generation costs. This task was previously performed by the Ministry of Finance, which remained responsible for setting the subsidies for each electricity tariff.

Basic supply tariffs were not on the rise. The government should have subsidized the tariffs for the most vulnerable. The new model did not lower tariffs but established real tariffs that reflected the full cost of generation, transmission and distribution of electricity.

The current government never triggered this mechanism and argued that basic supply tariffs kept rising while large companies paid less. The data was interpreted incorrectly: certain off-takers pay less because they have the option to purchase electricity from other generators that have lower tariffs than CFE but basic supply consumers do not have this option. The solution is to make CFE's generation more competitive to lower the cost of electricity while also using the existing subsidy scheme to protect the most vulnerable consumers.

Q: What are the risks that Mexico's current energy policy poses concerning the country's international commitments agreed in international treaties?

A: The current government has mistakenly read what the USMCA stipulates on electricity matters. The trade agreement is very clear: Article 8.1 allows Mexico, as an exception, to make choices on how it handles fossil fuels but this does not extend to electricity and energy issues. Therefore, the government’s reforms breach the USMCA, as well as a further 30 international treaties for the protection of investment.

If the government had won the LIE’s reform or managed to pass the electricity reform, this would have had serious consequences, since all those who invested in Mexico would have a valid argument for their respective country to sue Mexico to pay them back all the money invested and potentially earnings. Moderate calculations of these payments estimate this would have been 14 times the amount paid for the cancellation of Texcoco’s airport. More logical calculations indicated 40 times this amount.

However, the risk of ending up in international arbitration for violations of international treaties, including the USMCA, is no longer as latent now that the reforms are off the table. The possibility remains, as the sector’s paralysis also violates some of these other 30 treaties but international arbitration takes several years. Companies always prefer to exhaust all available options before activating this mechanism. Today, at least 21 international arbitrations related to the electricity issue are already in process.

CMS Woodhouse Lorente Ludlow is a law firm focused on energy, infrastructure, real estate development, banking, finance, corporate law, administrative law and climate change. The firm was founded in 2009 and began its formal association with CMS in 2013, formally joining the CMS network in 2018.