October 08, 2021

Regulatory Developments in the Mexican Power Sector—Chapter 5: The Disputes Options Arising From Mexico’s Efforts to Amend the Constitution

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REGULATORY DEVELOPMENTS IN THE MEXICAN POWER SECTOR—CHAPTER 5: THE DISPUTES OPTIONS ARISING FROM MEXICO’S EFFORTS TO AMEND THE CONSTITUTION

In Chapter 4 of our series regarding regulatory developments in the Mexican power sector during 2020 and 2021, we examined the bill introduced by President Andrés Manuel López Obrador (hereinafter, “AMLO,” and his administration, the “AMLO Administration”) on September 30, 2021 to amend the Mexican Constitution and unwind Mexico’s 2013 Energy Reform (hereinafter, the “Presidential Bill”). The Presidential Bill appears to be in furtherance of AMLO’s stated objective of pursuing any legislative and legal actions necessary to bring the entire power generation value chain into State ownership and control.

In this Chapter, we examine the extent to which AMLO’s proposed Presidential Bill could give rise to arbitration and other disputes against Mexico.

Key Aspects of the Proposed Constitutional Amendment

As discussed in Chapter 4 of our series, key aspects of the bill include:

  • Reorganizing the Power Industry: All activities in the Mexican power industry would be designated as “strategic” and would fall under the exclusive control of the State, acting through CFE. The power industry would become vertically and horizontally integrated in CFE. The National Center for Energy Control of Mexico (CENACE) would be subsumed as a business unit under CFE’s full control and the concept of a “productive state enterprise,” as established in the 2013 Energy Reform, would be eliminated. In addition, the Energy Regulatory Commission (CRE) would be dissolved and its activities and authority would be transferred to the Ministry of Energy (SENER).
  • Private Power Generation: By designating the power sector as a “strategic” State activity, most, if not all, power generation permits in effect on the date that the Presidential Bill is approved would be terminated, along with any associated power purchase agreements. While the Presidential Bill leaves open the possibility of private participation in the power sector, the scope of that participation is undefined beyond a specified hard-wired percentage and the rules applicable to private actors operating in the sector are unclear. To the extent that any power generation permits remain in effect, the Presidential Bill would require that all power be sold to CFE as the only authorized offtaker. The Presidential Bill does not provide guidance on the rules applicable to any power purchase agreement between CFE and private parties under this regime.
  • Clean Energy: The Presidential Bill provides that all clean energy goals in Mexico will be unilaterally determined by CFE, without establishing any objective parameters or principles governing CFE’s determinations. At the same time, the Presidential Bill eliminates clean energy certificates, which means that consumers would no longer be required to obtain any of their energy from clean sources.

If the Presidential Bill is enacted, existing energy projects would be subject to grave uncertainty. Valid power generation permits would be terminated. Existing projects that are not completed would be subject to substantial changes in the regulatory environment. Indeed, the regulations governing any such projects have not been defined, thereby raising questions as to how such projects will operate and whether the projects would be able to meet their payment obligations or generate a return on their investment. Likewise, the process and timing for issuing new permits for existing facilities and the pricing conditions offered by CFE for new power purchase agreements are not settled, nor are parameters described in the Presidential Bill. In addition, the conditions under which self-supply legacy permits would operate are even more uncertain. It is unclear if self-supply legacy permit holders would even be able to apply for a new permit, or if the rationale behind the Presidential Bill was to decommission—or even seize—those facilities. The Presidential Bill paints an incomplete and fractured picture of the power industry beyond its enactment.

Potential Disputes Arising Out of the Presidential Bill

The 2013 Energy Reform created a stable and transparent legal regime over the Mexican power sector. Permits were issued for fixed terms and could not be arbitrarily terminated by the Mexican government. As a result, significant private investments into the Mexican power sector were made by local and foreign investors following the 2013 Energy Reform.

If enacted, the Presidential Bill will abrogate investors’ contractual rights, undermine the regulatory regime that investors have relied upon for years, substantially impair the economic value of investments, and fundamentally deprive investors of ownership rights in their investments. Together, these consequences are likely to give rise to a significant number of commercial and investor-state disputes. The nature of any commercial disputes will depend on the specific terms of an investor’s commercial contracts, but almost certainly would include claims for breach of contract, force majeure, material adverse change, and changes to local laws and regulations. Investors should analyze their contracts to identify potential claims and liabilities that could arise if the Presidential Bill is enacted, with particular care given to any applicable notice requirements to ensure that claims are protected.

In addition to commercial disputes, investors may be able to assert claims under one or more of the over 40 bilateral and multilateral investment treaties (hereafter, “Investment Treaty” or “Investment Treaties”) to which Mexico is a party. These include bilateral treaties with Spain, France, the Netherlands, China, Germany, Korea and the United Kingdom, as well as multilateral treaties with the United States and Canada, such as NAFTA and the USMCA.

Investment Treaties protect “investors” from one treaty country that make “investments” in another treaty country from certain adverse government actions. Such investments include physical assets owned in Mexico, equity shares held in a company, debt instruments, property interests, certain contractual rights, and other tangible and intangible interests arising out of capital investments made in Mexico. Subject to the nationality of the investor and the terms of the specific treaty, investments in the Mexican power sector likely to be affected by the Presidential Bill should be covered.

Investment Treaties serve two principal purposes. First, they define the types of protections accorded to foreign investors and investments. These protections include:

  • Expropriation: Expropriation occurs when a government seizes private property for a public use. Such property includes physical assets (e.g., a power generation plant), as well as contractual rights. An expropriation can occur directly, where a government formally seizes title and possession to an investor’s property, or indirectly, where the investor retains title and possession of its property, but the value of that property is materially diminished through a government’s action (including the passage of laws and regulations). While a government may lawfully expropriate private property, it must compensate the owner for the value of the expropriated asset. Investment treaties permit investors to bring claims against a government where their property is expropriated and either no compensation or inadequate compensation is provided.
  • Discriminatory Treatment: Investment treaties prohibit treaty parties from discriminating against investors or investments from other treaty partners. Specifically, a host government must treat a qualifying investment from a treaty party as well or better than it treats similar investments made by either local investors (National Treatment) or other foreign investors (Most Favored Nation Treatment). For example, Mexico would have difficulty enacting measures that prefer domestic power generators over foreign power generators operating in the same sectors. Likewise, it would be problematic if Mexico enacted a measure that preferred power generators from one foreign country over power generators from other foreign countries. Overall, the anti-discrimination provisions in investment treaties are intended to ensure that similarly situated parties are treated equally, regardless of nationality. The Presidential Bill appears to give CFE preferential treatment on commercially significant matters such as the electric grid dispatch order rules in a manner that will disadvantage and discriminate against foreign investors. It also creates the potential for discriminatory treatment by granting CFE broad discretion in awarding new power generation permits and setting the commercial terms for such permits. The improper exercise of this discretion could create a situation in which foreign investors are treated materially worse than domestic investors, which could violate Mexico’s National Treatment obligations.
  • Unfair and Inequitable Treatment: Foreign investors are protected against unfair and inequitable treatment and are entitled to the full protection and security of the law. These provisions require a host state to ensure a certain level of transparency and stability within the law and may hold a state responsible where its actions undermine a foreign investor’s reasonable expectations regarding the investment climate in which it is operating. If enacted, the Presidential Bill will materially affect foreign investors’ expectations regarding the operating environment for power generation facilities. The full scope of how such expectations may be affected will not be known unless and until the Presidential Bill and the corresponding regulations are enacted. It is clear, however, that the nationalization of the power sector and the creation of a monopoly under CFE will fundamentally undermine the existing regulatory regime and investment environment.

Second, investment treaties provide private investors a direct right of action against a host government for violations of international law. Most investment treaties—and all investment treaties to which Mexico is a party—give investors the right to bring claims either in the local courts of the host country or before an international arbitral institution.

Each investment treaty will contain its own dispute resolution provision that sets out the options and requirements for bringing claims against a host state. Investors wishing to bring investment treaty claims against the Mexican government would need to do so in accordance with the procedures set out in the various treaties. For example, certain of the Investment Treaties to which Mexico is a party require investors to wait six months after a dispute has arisen to initiate arbitration. Other treaties require investors to pursue claims in the local courts (either through a final decision or for a defined period of time) before a claim may be submitted to arbitration. Investors, therefore, will need to ensure they have complied with the necessary preconditions to initiating arbitration so as not to put their claims in jeopardy.

Autoren und Mitwirkende

Christopher M. Ryan

Partner

International Arbitration

+1 202 508 8098

+1 202 508 8098

+1 212 848 4000

+1 212 848 4000

Washington DC