Since our May 20 blog post, the Energy Regulatory Commission (“CRE”) added its name to the list of agencies disturbing Mexico’s legal and regulatory certainty. Additionally, the López Obrador administration has spent time publicly defending recent Ministry of Energy (“SENER”) and independent system operator (“CENACE”) regulatory changes affecting renewable energy projects.
On the evening of May, 28, 2020, CRE, in extraordinary session, passed two resolutions modifying the tariffs applicable to the transmission services used by “legacy renewable and cogeneration energy contracts” (those contracts executed prior to the 2013 Energy Reforms, “Legacy Contracts”), to bring them to 2018 tariffs. In support of the new tariff structure, the head of the Federal Electricity Commission (“CFE”) publicly asserted that renewable energy engages in unfair competition because they do not pay for access to the grid and get paid even when they do not consistently produce energy. This assertion is incorrect. Although Legacy Contracts receive “preferential” treatment, such projects are required to pay interconnection tariffs, albeit low interconnection tariffs. Legacy Contracts receive preferential treatment because, at the time they were executed, the Mexican government sought to promote renewable energy project development in Mexico. Since renewable energy projects were more expensive to develop versus projects using conventional energy sources, Legacy Contracts enjoyed an economic incentive to development in the form of low interconnection tariffs. Legacy Contracts were also specifically carved-out of the Ley de Industria Electrica’s application, which means the they should continue to enjoy such treatment and be governed by the Ley del Servicio Público de Energía Eléctrica until the end of their term.
Comparatively, post energy reform contracts are governed by the Ley de Industria Electrica and pay CFE a monthly fee at the regulated rate set by CRE for the use of transmission lines. Since renewable energy projects do not produce base load power, they only receive payment for the energy they produce. As such, the statement relating to renewable energy projects “getting paid even when they do not consistently produce energy”, is incorrect or at the very least misleading if they relate to take or pay arrangements (an arrangement the administration is openly hostile towards).
While the López Obrador administration has reiterated that all the recent regulatory changes, including CRE’s, were necessary to, among other things, protect the grid, benefit end-users, level the current playing field, and put Mexico’s interests ahead of private, mostly foreign, companies, these actions have resulted in more uncertainty and strong negative reactions. Additionally, López Obrador’s main defenses fall apart with just a scratch at the surface: the grid is already at risk due to a lack of modernization; end-users will undoubtedly suffer from (i) private companies loss of investment appetite, (ii) increased costs of energy given dispatch rules no longer require the cheaper energy (usually renewable energy) be dispatched ahead of costlier energy, and (iii) increased pollution levels; and the playing field was tipped in favor of CFE by the Agreement setting forth the Policy of Reliability, Safety, Continuity, and Quality of the National Electric System. There is a lot to parse out here.
First, independent antitrust regulator (“COFECE”) issued a statement strongly condemning CENACE’s orders stating that they stifle competition and impede open, non-discriminatory, access to markets.
Second, the court specialized in economic competition granted injunctions to six companies accepting the argument that CENACE violated their fundamental rights. As a result, CENACE removed the preoperative testing restrictions for all those projects that filed for injunctive relief (23 in total) and granted provisional dispensations from application of the suspension order. However, CENACE has indicated its plans to appeal the judicial orders.
Third, the governors of Nuevo León, Coahuila, Tamaulipas, Durango, Michoacán, Jalisco, and Colima signed a declaration intending to pressure the administration into reversing its actions against renewable energy projects in their respective states given their economic and social impact. While these governors are opposition party members, they lead some of Mexico’s largest states in terms of size and economic importance, and are especially relevant to the United States, Mexico, Canada Agreement (“USMCA”).
Fourth, it is no secret that Latin America is plagued by aging infrastructure, in desperate need of modernization, especially with respect to interconnection and capacity absorption. Mexico is no exception. That said, most energy auctions and infrastructure projects actually developed focused on bringing more clean, cheap energy online and were not accompanied by any meaningful focus on the technical ability for the underlying infrastructure to absorb all this new capacity. The international bidding processes for two transmission line projects, Baja California to Sonora and Oaxaca to Morelos, were both cancelled months after López Obrador began his sexenio (presidential term). The purpose of these projects were specifically to interconnect the Baja California peninsula’s isolated grid to the national grid at Sonora and reduce the heavy energy losses caused by aging infrastructure. It is thus logical that Mexico now worry about overwhelming aged infrastructure during a pandemic that has seen record drops in energy usage. However, no other Latin American country appears to have taken similar actions against their renewable energy market.
Lastly, the COVID-19 pandemic is expected to have devastating impacts on the population and economy of Mexico, and López Obrador is betting heavily that the USMCA’s entry into force on July 1 will invite more private foreign investment. However, these latest regulatory changes and the resulting legal and regulatory uncertainty further frustrate the private sector López Obrador has already antagonized by cancelling certain projects and contracts. Moreover, these regulatory changes appear to violate the USMCA (in addition to the Paris Climate Agreement and Mexican law, which we do not discuss here) but, given it is not in force and still subject to “technical modifications” by the United States’ Congress, it is unclear how the current situation (i.e., apparent/active noncompliance with the USMCA) would be viewed by the United States government.
Once again, López Obrador publicly stated that his administration would defend its actions, but at the same time would be open to renegotiation with the affected parties. This generates various concerns not the least of which includes contract security and whether the private sector should expect to have the administration renegotiate without cause governmental contracts that were previously awarded through a public bidding process. López Obrador used similar tactics to renegotiate natural gas transportation contracts that were awarded through a public bidding process shortly after entering office.
The impact of the various regulatory changes will not be immediately known, especially since CRE has not released the applicable tariff structure and the COVID-19 pandemic continues to disrupt the world. Private companies operating or investing in Mexico would be wise to continue to monitor these developments and, in the very short term, determine whether, in addition to arguments based in Mexican law, the USMCA might be used as an avenue to drive private sector dialogue with the López Obrador administration.