Guadalupe Esparza Sánchez Diego Álvarez Ampudia Rodrigo Acuña Gorozpe February 22 2021 Power market war and outlook for 2021 Ramos, Ripoll & Schuster | Energy & Natural Resources - Mexico Guadalupe Esparza Sánchez, Diego Álvarez Ampudia, Rodrigo Acuña Gorozpe Energy & Natural Resources IntroductionPrevious actions against marketNew menaces – disappearance of CRE and legal reformElectricity Industry Law reform initiative and its implicationsDefence mechanismsInternational influenceMid-term electionsOutlook for 2021IntroductionThe year 2020 was one of conflict for the Mexican power sector. The federal government carried out numerous actions to prioritise the Federal Commission of Electricity (CFE) over private participants in the electricity market, which was fully opened to private participation through the 2013 and 2014 energy reforms. In so doing, the government attempted to return the CFE to a monopoly to the furthest extent possible; however, private entities fought back and some have obtained overwhelming victories in the domestic courts (for further details please see "Counter-reform: latest developments in battle that has become war"). Many of these disputes are still pending, but the government is expected to lose most if not all of them. Nonetheless, the government has showed no intention of changing the way in which it handles the energy sector; instead, it has intensified its attacks and now intends to reform the law (but not the Constitution (yet)). In any case, the 6 June 2021 mid-term elections may still turn the tide.This article summarises:the government's main attempts to undermine the electricity market's competitiveness in favour of the CFE;the status of said actions;the new law reform initiative; andexpectations for the Mexican electricity market in 2021.Previous actions against marketNew power auctions and construction of transmission linesNew power auctions and the construction of essential power transmission lines were cancelled when the current administration took power. There are no plans to resume the auctions (which were remarkably successful and generated some of the cheapest power prices in the world) and there have been no concrete announcements of new transmission infrastructure. The current infrastructure is insufficient and an unexplained failure caused a massive electricity outage on 28 December 2020, exposing the negligence in this regard.(1)Cessation of issuing permits for new power generation projectsThe Energy Regulatory Commission (CRE) and the Ministry of Energy (SENER) have deliberately slowed the passing of permits required for new power generation projects using diverse excuses such as the COVID-19 pandemic to deny receipt of any new documentation, delaying numerous projects.(2) On 18 January 2021 the CRE announced a new indefinite period of limited activities and the suspension of deadlines and terms until the situation caused by the pandemic improves. This provides the CRE with justification to stop issuing permits and deny the receipt of new applications.Clean energy certificates In October 2019 SENER modified the rules for obtaining clean energy certificates (CELs), which incentivise the growth of renewable energy capacity, to allow the CFE to comply with its CEL obligations more easily by granting CELs to renewable energy plants which started operation before the energy reform. This would have flooded the market with CELs, substantially reducing their price. However, dozens of judicial challenges were submitted against this modification and the domestic courts have granted injunctions suspending its application. This injunction will last until the final resolutions of the corresponding judicial procedures are passed, which is expected in 2021.Pre-operative tests of intermittent power generation In April 2020 the National Centre for Energy Control (CENACE) issued a regulation to stop pre-operative tests of intermittent power-generation (solar and wind) projects – allegedly to protect the grid from the demand variations caused by the COVID-19 pandemic. Companies and civil organisations challenged this, and the domestic courts granted injunctions with general effects suspending said regulation.Power transport feesIn June 2020 the CRE issued a resolution which increased the power transport fees applicable to grandfathered projects of self-supply by up to 811%. This affected numerous projects which entered into operation before the energy reform, endangering their operations. More than 50 judicial challenges were submitted, and the domestic courts granted injunctions suspending the resolution's application.Reliability, Security, Continuity and Quality of the National Electric System Policy In May 2020 SENER issued the Reliability, Security, Continuity and Quality of the National Electric System Policy, a regulation intended to modify:diverse market rules which, among other things, impose competition barriers on private and renewable energy power plants; andthe rules on dispatching CFE plants with priority (instead of dispatching based on the cheapest price (the economic dispatch rule)).This regulation was challenged not only by companies and civil organisations, but also by governmental entities like the Federal Commission of Economic Competence (COFECE) and the states of Jalisco, Tamaulipas and Colima, which submitted special complaints before the Supreme Court. The Supreme Court declared most of this policy invalid on 3 February 2021.Energy sector development programmeIn July 2020 SENER issued an energy sector development programme which expressly indicated the objectives of:prioritising the CFE over other market participants;using more fuel oil and coal for power generation; andmodifying the power market rules.This programme was also challenged and has been suspended until the final resolutions of the diverse procedures have been issued, which is expected to begin in 2021.With some of these challenges having already been resolved against the government, it is expected that the rest will have a similar outcome, especially unconstitutionality claims being heard by the Supreme Court. However, the government has not indicated an intention to change its handling of the energy sector and has instead announced further attacks on the market.New menaces – disappearance of CRE and legal reformIn January 2021 the president announced that he was considering taking action to dissolve autonomous organisations (decentralised and independent from the executive branch) such as the National Transparency Institute, COFECE and the CRE and assign their functions to centralised government departments. This announcement has been heavily criticised for the severe regression which it would trigger by reducing the checks and balances of the government. However, a constitutional reform must be passed to effectively dissolve the CRE, the disappearance of which would give the executive more control over which permits are granted or denied, the determination of fees and tariffs and the issuance of new rules to modify the current conditions. The president's party does not hold the qualified majority required to pass a constitutional reform (three-quarters of Congress) and since mid-term elections are scheduled for June 2021, it is unlikely that any constitutional reform will be proposed and voted on before then.In this regard, and despite the president recently reaffirming that no constitutional changes would occur until at least 2022, on 29 January 2021 the executive power proposed a bill to amend the Electricity Industry Law. This is not a constitutional reform per se but rather a legal reform; thus, it requires only a simple majority in Congress (50% of the votes plus one) to be passed. This bill has preferential status, which means that it must be discussed and voted on by the Deputy Chamber within 30 days. If the initiative is not voted on within such time, it must be the first matter to be discussed and voted on at the next plenary session of the Chamber. If approved or modified by the Chamber, the bill will go to the Senate for voting and discussion, also within 30 days. Considering that the president's party has a majority in both chambers of Congress, there is a good chance that this amendment will be approved.Electricity Industry Law reform initiative and its implicationsThe Electricity Industry Law reform initiative has five main objectives.Replacement of economic dispatch ruleThe economic dispatch rule provides that the power plants that produce cheaper energy must be dispatched first in order to ensure that the best prices are offered to the final user. The reform intends to change this so that it favours the CFE by establishing a new rule under which plants would be dispatched in the following order:hydroelectric plants;other CFE power plants (of any technology, including the most expensive and highly contaminating ones, such as thermoelectric plants);combined cycle power generation plants of independent energy generators;wind and solar farms of private companies; andcombined cycle plants of private companies.Although the explanatory statement of the initiative specifies that this modification intends to ensure the reliability of the system and reduce costs, it is self-contradictory as the lowest prices are guaranteed by dispatching the cheapest energy first, and the reform does not indicate that dispatch based on security criteria is preferred. Instead, it simply grants priority dispatch to the CFE (regardless of the price or the security of the supply).Conditioning of granting of new permits on SENER's planningThis change would entitle the CRE to consider, at its own discretion, SENER's planning objectives when deciding whether to grant generation permits, as well as their:modification;revocation;assignment;extension; ortermination.This contradicts the market principle of free access and ignores the responsibility of:CFE Distribución and CFE Transmisión (subsidiaries of the CFE which still have a monopoly over transmission and distribution activities) to extend these networks;the SENER to plan this extension accordingly; andthe CENACE to ensure reliability and security despite the free access principle (which is the mechanism most countries use to balance their power systems).Modification of rules for granting CELsThis change was made to grant CELs to power plants which commenced operation before the energy reform so that old CFE plants may receive them and thus appear to comply with the CFE's clean energy obligations and Mexico's energy transition objectives.This goes against the original objective of the CELs, which is to encourage the installation of new clean power plants, and affects their value by flooding the market with new CELs. As discussed above, SENER tried this in October 2019, but its administrative regulation was suspended by the courts.Elimination of CFE Basic Services Supplier's obligation to buy energy through auctions The CFE Basic Services Supplier is the CFE's subsidiary which sells energy to basic users (low-power consumers such as households and small businesses). At present, this must be done through auctions to secure the lowest possible price for users.This change gives CFE Basic Services Supplier the right to discretionally acquire energy from other CFE subsidiaries, independent of the conditions or prices which they offer. This would result in an increase in price (or an increase in subsidy or losses for the CFE to artificially sustain low prices) and will eliminate the incentives for CFE's subsidiaries to offer more competitive prices.CRE to revoke self-supply permits and review contracts with independent power producersThis initiative states that permits obtained through fraud should be revoked and that contracts which prove to be unprofitable for the federal government will be renegotiated or terminated.This objective is expressly set out in the initiative's explanatory statement and seeks to be implemented through the third and fourth transitionary articles. If implemented, it would be a harmful retroactive application of the law, which would be a violation of Article 14 of the Constitution.Defence mechanismsThe Mexican Institute for Competitivity, the Business Coordination Council, the International Chamber of Commerce, the US Chamber of Commerce and many other national and international organisations have already issued official statements opposing this latest reform initiative, and warned of the negative effects it could have for the economy, environment and rule of law in Mexico.If passed, this bill will likely create numerous violations of:constitutional provisions, including those regarding:free competition in the commercialisation and generation of electricity;the prohibition on a harmful and retroactive application of the law; andthe right to a healthy environment.constitutional principles of progressivity and legal certainty;international investment protection agreements, both multilateral (eg, the US-Mexico-Canada Agreement) and bilateral (eg, bilateral investment treaties), as it would constitute an indirect expropriation of investments (by depriving them of their original value through regulatory action) and a breach of the fair and equitable treatment obligations;the anti-monopoly chapters of international trade agreements;international agreements on climate change (eg, the Kyoto Protocol and the Paris Agreement), as well as national legislation on climate change and energy transition objectives; anddomestic antitrust legislation.Considering this and the latest judicial decisions discussed above (especially the Supreme Court decision), if the bill is passed, it will certainly be challenged through diverse mechanisms, including even more amparo actions (ie, a constitutional procedure before the federal courts to dispute acts of public authorities and protect human rights recognised in the Constitution) by affected entities and groups and unconstitutionality challenges (which may be submitted by organisations such as COFECE, state governments or even a minority percentage of Congress). It would also increase the risk of Mexico being subject to investment arbitration claims by foreign investors covered by multilateral and bilateral investment protection treaties and trade sanctions of other countries.All of these challenges would also have high chances of success, so the bill will likely be nullified. However, considering that the administration is determined to strengthen the CFE by any means, even if this happens, it is expected to continue trying to modify the rules, this time through a constitutional energy reform. Therefore, both the short and mid-term future of power sector policies in Mexico depend mainly on two aspects: international influence and the result of the mid-term elections.International influence A relevant factor for the direction which Mexico's energy policy will take in the coming years is the influence of its international partners – mainly, the United States. In this regard, President Joe Biden has clearly expressed his intention to implement a more aggressive policy regarding energy transition, and US investors and politicians have expressed discontent over the actions that the Mexican federal government has implemented in the energy sector. This was shown in an 11 January 2021 letter from officials of the former Trump administration to the Mexican secretaries of foreign affairs, energy and economy which expressed concerns for the "significant uncertainty about Mexico's regulatory processes" caused by government actions which "have damaged Mexico's overall investment climate" and which "raise concerns regarding Mexico's commitments under the USMCA" harming US-backed projects. This letter also stated that these issues had been "discussed with you previously".Even though the Mexican president, after receiving this letter, expressed that no change in policy was going to happen, the fact that the Biden administration is looking to regain leadership in the international sphere, that climate change is one of its priorities and that US investors are reaching more critical levels of economic damage means that diplomatic pressure will likely increase substantially, which may lead the Mexican administration to reconsider. This would not be the first time that the current Mexican president has shown a willingness to cooperate with the United States on controversial matters which he previously opposed, as he implicitly agreed to become an immigration barrier for the United States by using the military to secure Mexican borders. The fact that other Mexican trade partners are also making competition or economy-related sacrifices to comply with energy transition obligations will also lead to increased pressure on Mexico to reconsider some of its energy policy convictions and make some concessions.Mid-term electionsThe most important factor for the future of Mexico's energy policy is the upcoming mid-term elections. They will determine the path that the power sector will take in the coming years. If the president's party, Morena, performs well and obtains a qualified majority (three-quarters in Congress), a constitutional counter-reform will likely be implemented. However, if it does not perform well and loses seats in Congress, said initiative will most likely not be presented. Similarly, a sufficiently meaningful defeat in the elections could lead the government to consider a new line of action in the power sector.Outlook for 2021Considering all of the above, the following predictions can reasonably be made for Mexico's power market in 2021:The domestic courts will continue to rule in favour of the current legal framework and final resolutions of the challenges discussed above will start to be issued (starting with those still pending by the Supreme Court), most likely in favour of the power market and against the government's actions.The granting of new permits and, in general, any procedures before the CRE and CENACE will continue to be slow and limited.It is unlikely that any discussion or voting on a constitutional reform will occur before the 2 June 2021 election. However, the bill reforming the Electricity Industry Law will likely be passed (but will be subject to legal challenges which will probably nullify it).Despite the current power industry war, the economy will start to recover in 2021(3) and energy demand will continue to grow, along with the need for more generation, distribution and transmission infrastructure, so the industry will not be halted.Big new energy projects will mostly be those carried out by the CFE, with the most abundant focusing on power generation (which has been allocated the biggest portion of the budget in CFE's business plan, which was made public on 22 January 2021) – mainly combined-cycle gas plants – followed by transmission and distribution infrastructure. The CFE will require both private financing and private participation to carry out these projects, so a considerable number of contracts with private parties are expected to be awarded by the CFE in 2021, most of them under the Pidiregas scheme.The government has also announced two packages of privately funded infrastructure and energy projects. Another package is expected to be announced in March 2021 and a fourth project is expected to be announced at the end of 2021, which will also include power-related infrastructure.Off-the-grid alternatives (eg, distributed energy, self-supply and isolated supply) will remain the main alternative for new fully private power generation projects because they require less formalities to be carried out before the CFE, the CRE and CENACE and have little or no impact on the grid (which is one of the government's main concerns). The number of projects under these schemes has been growing continuously and that trend is expected to continue steadily.If international political pressure continues to increase, gradual variations and small concessions in the energy sector may start to be seen – for instance, the release of determined permits and procedures required for key projects backed by foreign investment and an increase in CFE partnerships with private entities. This would be further boosted if the president's party suffers a defeat in the mid-term elections in June 2021.For further information on this topic please contact Guadalupe Esparza Sánchez, Diego Álvarez Ampudia or Rodrigo Acuña Gorozpe at Ramos, Ripoll & Schuster by telephone (+52 55 1518 0445) or email ([email protected], [email protected] or [email protected]). The Ramos, Ripoll & Schuster website can be accessed at www.rrs.com.mx.Endnotes(1) To divert attention away from their responsibility in this respect, CFE and National Energy Control Centre officials published documents explaining that the outage was supposedly caused by a grass fire. This was later revealed to be apocryphal. Analysts consider the failure to have been caused by a combination of old transmission infrastructure and a failure of the determined power generators (the CFE sustains that these were renewable energy generators but it is feasible that it was the CFE's old plants which failed).(2) These suspensions were clearly unfounded since both agencies may receive documents electronically or with little or no personal interaction and process requests remotely, so no violation of COVID-19 measures would occur if they continued their duties.(3) The International Monetary Fund has forecasted that Mexico's gross domestic product will increase by 4.3% in 2021.