Mexican President Andrés Manuel López Obrador (AMLO), on Sept. 30, 2021, sent to Congress a constitutional reform proposal relating to Mexico's energy sector (the Proposal). For now, the Proposal consists of a few modifications to the broad concepts that govern the Mexican energy sector, included in Articles 25, 27 and 28 of the Mexican Constitution, along with a number of transitory articles. However, the Proposal represents a significant change of direction from the legal framework and institutional design established since the previous energy reform in 2013. This Holland & Knight alert provides a brief summary of the key provisions of the Proposal and includes commentary regarding its overall significance in connection with the Mexican energy industry.
Although the Proposal has been presented as a reform of Mexico's power and renewables sector, the proposed changes have direct impact on the entire hydrocarbon sector value chain as well.
At its core, the Proposal focuses on consolidating control over all power sector activities. The Federal Electricity Commission (Comisión Federal de Electricidad or CFE), the state-owned electric utility of Mexico, and Mexican Oil (Petróleos Mexicanos or PEMEX), the state-owned oil and gas company, would now be considered government entities, rather than productive state companies. Additionally, under the Proposal, the energy sector regulating agencies — National Center for Energy Control (El Centro Nacional de Control de Energía or CENACE), in charge of operating the electric grid and the wholesale market, would be integrated into CFE; and the Energy Regulatory Commission (Comisión Reguladora de Energía or CRE), in charge of regulating power and mid-downstream oil and gas activities along with the National Hydrocarbons Commission (Comisión Nacional de Hidrocarburos or CNH), in charge of regulating upstream oil and gas activities — would be extinguished and their authorities assumed by the Energy Ministry (Secretaría de Energía or SENER).
Moreover, and of particular concern, are the terms of the Proposal cancelling all power generation permits (including all pending permit requests) and power purchase agreements currently in place, as well as the non-recognition (deemed as illegal) of amended self-supply and independent power producer permits in effect before the 2013 energy reform. Furthermore, CFE would have a constitutional right to generate at least 54 percent of Mexico's energy (leaving the remaining 46 percent open to private participation). The Proposal also grants CFE the authority to determine transmission and distribution tariffs and effectively cancels the clean energy certificate program.
Financing and Investment Protection Considerations
Investors and operators in Mexico's energy sector should closely monitor the Proposal's discussion and approval process in Congress. In particular, they should monitor the Proposal as it relates to existing financing agreements in place for ongoing power and renewables projects, as well as with investment protection and defense strategies. If approved, the Proposal could potentially trigger change of law, default and step-in-rights provisions, among others, typically included in existing project finance arrangements with commercial and development financing entities.
Likewise, investors and operators could begin considering the local and international investment protection and defense strategies that would become available upon the approval of the Proposal and any implementing legislation. Given the constitutional nature of the Proposal, local defense strategies for investors and operators may be somewhat limited to specific implementation acts or regulations. However, remedies may be more readily available through one of multiple free trade or investment protection treaties entered into by Mexico. In particular, the Proposal could potentially trigger violations by Mexico of its obligations under Chapter 14 (Investment), Chapter 15 (Cross-Border Trade in Services) and/or Chapter 22 (State-Owned Enterprises) of the United States-Mexico-Canada Agreement (USMCA).
As with any other constitutional reform proposal, two-thirds of the Mexican Congress (both Congress and Senate) and the majority of the state legislatures must approve the Proposal for it to become law. In addition, the constitutional changes must be regulated and implemented by numerous implementing legislation. Even though the governing party, National Regeneration Movement (Movimiento Regeneración Nacional or MORENA), and other allied parties have a majority both in Congress and the Senate, they will need to find additional votes in opposing parties such as the Institutional Revolutionary Party (Partido Revolucionario Institucional or PRI), National Action Party (Partido Acción Nacional or PAN) and Party of the Democratic Revolution (Partido de la Revolución Democrática or PRD) to complete the two-thirds threshold. The legislative process to discuss the Proposal is scheduled to begin this month and is estimated to be voted on by December 2021. If the Proposal is approved, the state legislature approval and implementing legislation process will need to follow, most likely to be completed during 2022.
Although limited, the Proposal carries significant risk for investors and operators in the Mexican energy market and should be evaluated by investors and operators (both in the power and renewables sector as well as in the oil and gas sector) in connection with previous government action such as the SENER energy policy, the limitations on export and import permits and authorized points of entry and the changes to the Hydrocarbons Law, among others.
In their discussion of the Proposal, the Mexican Congress will need to address issues such as the terms to indemnify holders of power generation permits and power purchase agreements that will suffer their cancellation, how CFE will fulfill the role of operator and market regulator at the same time, what the future of the power wholesale market is without an independent regulating agency, to what extent existing financing arrangements will be affected and what will be the future of all permits and contracts currently in effect for all oil and gas activities, among many others.