End of electricity market? Constitutional energy counter-reform forecast

Introduction
Proposed initiative
Implications
Will the reform pass?
Comment

Introduction

There is an ongoing battle between the current federal administration and private participants of the electricity market (for further details please see "Power market war and outlook for 2021"). This battle has consisted of numerous attempts by the government to reverse the 2013 energy reform by undermining and limiting the participation of private entities in the power supply chain, favouring the Federal Electricity Commission (CFE) instead. As virtually all of the government's previous attempts have been stopped by domestic courts for going against the Constitution, the administration declared that it would seek a constitutional reform.

On 1 October 2021, sticking to its declaration, the administration launched its most ambitious attack against the current energy legal framework by means of a constitutional reform initiative that seeks to dismantle the electricity market, returning it to a CFE monopoly by reforming articles 25, 27 and 28 of the Constitution. The initiative not only affects the electricity sector, but also the hydrocarbons and mining industries.

Proposed initiative

The initiative can be summarised as follows:

• The CFE's subsidiaries, which are currently separated, would be reincorporated back into a single CFE entity.
• The National Centre for the Control of Energy, which is the operator of the national electricity system, would disappear and its functions would be assumed by the CFE.
• All activities relating to electricity generation, conduction, transformation, distribution and supply would be redefined as "strategic activities", reserved for public entities (as regards electricity, the current regulations classify only the control and planning of the national electric system, transmission and distribution as strategic activities).
• It would be mandated that the CFE generate at least 54% of the overall energy in Mexico, while private entities would be allowed to generate up to only 46% and would be forced to generate and sell it under the conditions that the CFE would determine.
• Power generation permits and electricity power purchase agreements executed with private entities would be cancelled (along with all pending permit requests).
• The CFE would be put in charge of dispatching its power plants by economic merit, complying with the criteria of reliability, continuity and stability.
• The National Hydrocarbons Commission (CNH) and the Energy Regulatory Commission (CRE) would dissolve and their responsibilities would be returned to the Ministry of Energy.
• The CFE and Pemex would stop being state-owned companies.
• Private entities would no longer be able to obtain concessions to exploit lithium and other minerals of strategic importance to the energy transition (without specifying what is meant by "energy transition").

Implications

The initiative is aggressive and, if passed, would essentially destroy the electricity market in its current form and radically change the whole energy industry. The CFE would not only become a monopoly, but it would also be more powerful than before the 2013 energy reform. The disappearance of the CNH and the CRE would create serious uncertainty. The ban on exploiting lithium and other currently undetermined minerals would have a negative effect on the mining industry. There is also a consensus that the initiative's enactment would violate a large number of international treaties, which would instigate:

• costly and lengthy litigation for the state;
• a high probability of arbitral awards against Mexico; and
• the imposition of penalties and tariffs under said treaties, not to mention the reduction of foreign investment and trust in the country (with all the predictable negative consequences).

Experts have predicted that the reform would:

• lead to an increase in energy prices;
• make it impossible to comply with clean-energy goals; and
• have harmful effects for the health of citizens who live near the CFE's oldest and more polluting plants, which would operate almost non-stop and take longer to be replaced (as there would be no incentive to replace them).

Will the reform pass?

In order to successfully reform the Constitution, two-thirds of Congress members (both in the Chamber of Representatives and the Senate) must approve the proposal in a vote. There must also be a majority approval from state congresses. Currently, Morena (the president's political party) and its allies do not control two-thirds of either chambers (ie, the Chamber of Deputies and the Senate), so it would need to reach agreements with opposing parties to get the sufficient votes (approximately 55 votes in the Chamber of Deputies and seven votes in the Senate).

In the immediate aftermath of the initiative's submission, the main opposing parties expressed their determination to reject the reform, except for the Institutional Revolutionary Party, which has an important number of seats in Congress. This led to the belief that there was a considerable chance that a number of its members would vote in favour of the reform. However, since then, the party and its members have expressed disapproval of the reform. As there is also a lot of opposition among civil organisations, it is now unlikely that the necessary number of members outside Morena and its allies will vote in favour of the reform (at least, in its current drafted form).

Morena saw this reaction and promptly communicated that, if rejected, it would propose a second "softer" version of the initiative which would not include the cancellation of contracts and permits. Such a statement would suggest that the party also believes that it is unlikely that the reform will be passed in its current form. There has also been discussion about whether to delay the vote until 2022, which also shows that the conditions are not yet ideal for the plan's approval. If the initiative is changed, there would be a higher chance of approval, but it can be argued that the changes would have to be substantial to achieve the desired change of opinion.

Comment

Although it will be important to follow the discussions in Congress in the following weeks to have more certainty about this initiative's destiny, there is evidence to suggest that it is much more likely that it will be modified or completely rejected than passed, at least in the short term.

However, it is almost certain that a second version of the initiative will follow, and that the governments' efforts to prioritise the CFE over other market participants will continue. So, it will remain essential for civil organisations, experts, companies and other industry players to continue voicing and evidencing their objections to inform the relevant discussions in the media and Congress.

It is important to share informative material to reduce misinformation and to elevate the level of discussion. There are also items in the current legislation that can be improved in order to treat all industry players equally. So, affected parties should also be conscientious about this and use this opportunity to improve the current legal framework, without destroying what has been achieved in the industry.

For further information on this topic please contact Diego Álvarez Ampudia or Rodrigo Acuña Gorozpe at Ramos, Ripoll & Schuster ​by telephone (+52 55 1518 0445) or email ([email protected] or [email protected]). The Ramos, Ripoll & Schuster website can be accessed at www.rrs.com.mx.