News Article

The State of Legal Certainty in Mexico's Energy Contracts

By Cas Biekmann | Fri, 06/26/2020 - 12:08

This article is based on a webinar focused on legal certainty in Mexico's energy contracts hosted by Mexico Business on July 25, 2020. This was the first in a series of webinars leading up to Mexico Energy Law Summit in 2021. Find more information on our next webinar here

While recent measures by CENACE and SENER have grabbed the spotlight in the energy sector, a variety of actions over the past 18 months precede them, which need to be understood to properly contextualize what is happening in Mexico’s energy sector. “The first notable action from the López Obrador administration was the cancellation of a notable high-voltage transmission line going from Ixtepec, Oaxaca to Yautepec, Morelos,” said Ruth Guevara, Partner at Zumma Energy Consulting and moderator during Mexico Energy Law Summit’s first webinar: Legal Certainty in Mexico’s Energy Contracts, held on June 25.

In an effort to backtrack the Energy Reform, the government cancelled long-term energy auctions. Other actions included an attempt to alter the administration’s relation with CRE and SENER, an effort to open CELs to CFE plants and a petition by CFE to solidify its position in the energy market. The government’s actions seemed to intensify when the pandemic became a reality. Recent measures include CENACE’s halt to renewable energy power plant tests needed for interconnection to the grid, a SENER policy favoring CFE over private renewable energy producers and a transmission hike for energy self-supply projects on so-called legacy contracts. “It seems like every month, the government issues a new measure to add to the fold,” said Guevara.

Sean McCoy, Partner at Mc. Abogados and one of the webinar’s panelists, added to this argument, stressing that the need for legal certainty in energy contracts is absolute. “If the government truly wants to strengthen CFE, it could actually benefit from generating a level playing field in the market. After all, to meet future energy demand, CFE would need much more investment than what it can afford,” he said. McCoy added that Mexico needs flexibility in its energy supply, as well as competitive prices to boost its industry. The only way to achieve this is through a free-market mechanism, by allowing many players to enter the playing field and collectively lower prices through competition. “For Mexico to truly take advantage of the newest developments in the market, it would need both foreign investment and private companies,” said McCoy.

Eduardo García Travesí, Partner at Galicia Abogados, elaborated on the impact uncertainty creates for financing in renewable projects. This impact is divided in two parts. First, projects that already had been financed by development and commercial banks do not stay without issues. Garcia noted that banks were often requesting impact studies and wanted to know how their investment would fare. “The next two years will likely be defined by litigations of private companies against new measures and restructuring and renegotiation of finance schemes,” said García. He noted that definite suspensions give more certainty if and when they are achieved, as was the case earlier this week when a provisional suspension was backed up by a federal court.

The second impact, according to García, is a deceleration in project financing, which was almost unavoidable as banks are openly showing their concern regarding sector developments. “For financing to go ahead, new requirements will arise, such as strict demand for storage capabilities and further guarantees on the side of the developer,” he says. While investors with a high-risk appetite will always be interested, more needs to be done to attract the conventional financing needed to meet energy demand.

Cynthia Bouchot, Director General of Energía CB Consultores, gave particular attention to power plants on legacy contracts signed before 2013. These plants enjoyed favorable transmission costs as part of a scheme to incentivize clean energy production. While these costs might not be the same if CFE could establish them nowadays, contracts signed had a validity of 15 to 20 years. “Hiking the costs, therefore, is problematic for both judicial certainty and energy prices,” Bouchot said. “Whatever the legacy contracts say ought to be respected. as changing them could affect the economic viability of the power plants.” One major point Bouchot raised about this threat to legal certainty is that energy prices will likely rise because of it. The final consumer stands to lose a lot as well, as prices for Mexico’s produced goods will go up when the bill eventually and inevitable trickles down. The problem, in the end, is not the change in the industry’s structure; if legal certainty remains unaffected, this should be no problem in itself.

Regarding viability, Bouchot also addressed the issue of storage and its impact on costs. While some years ago projects had to pay US$6 million for 1MW of storage, costs had decreased significantly. “Storage is now a viable option and utility scale projects incorporate them to the point that renewable energy is more than viable,” she said. What is missing, however, is investment from the government in the area of transmission and distribution.

Herfried Wöss, Partner at Wöss & Partners, shifted the attention to legal arbitration to protect investment. “Amparos are a good option, but they can be either won or lost. Even if they are won, regulatory changes can simply move forward in other areas. State responsibility laws are quite limited as well,” he said. Wöss argued that the state has certain rights to expropriate projects but needs to pay fairly according to international public law. All of these options, however, are too far out, according to him. Instead, he focused on the contract model from CENACE, stipulating the relationship between energy generator and qualified supplier. The model established by previous auctions has imperfections but is used as a basis for judicial litigation today. The London International Arbitration Court plays an important role here, as the international sphere is indispensable for the Mexican private sector in this issue. Commitments such as to the Paris Agreement add further strength in this area.

Israel Hurtado, President at the Mexican Academy for Energy Law, considered that the government’s measures should be analyzed according to the country’s and the international context. “With COVID-19 affecting the outlook of state production companies, the government was unfortunately pushed to making the wrong decisions,” he said. If CFE would indeed be focused on fulfilling the role of energy supplier, Hurtado said it could actually be purchasing some of the cheapest energy imaginable coming from renewable sources. However, the current government sees CFE in a more central role in terms of energy production. The question, then, is how the private sector can coexist with CFE and how both can develop together. What helps this effort is that the private sector, its associations and even final users are currently uniting, projecting a stronger voice to the government.

Cas Biekmann Cas Biekmann Journalist and Industry Analyst