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Mexico Energy Update: Renewable Energy Foreign Investment Under Threat; Protracted Legal Fight Looms Ahead

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Late last week, Mexico’s President A.M. Lopez-Obrador doubled-down on his vow to reestablish the state’s dominance in electricity generation and promised to fight back against successful legal challenges that temporarily halted his administration’s recent regulations that jeopardized 44 projects with approximately US$6.4 billion in renewable energy investments (28 of these projects are nearing commercial operation and 16 remain under construction).  Although President Lopez-Obrador expressed an openness to a dialogue with industry, the renewable energy sector in Mexico likely faces a protracted legal and political fight for safeguarding its investments.

Background

The most recent threat to renewable energy generators began on April 29, 2020 when Mexico’s independent system operator (“CENACE”) notified generators of its decision to indefinitely suspend all legally mandated pre-operational tests for solar and wind projects in light of the COVID-19 pandemic. CENACE justified its action on the basis of safeguarding the national grid against the system interruptions that such intermittent renewable energy projects allegedly could cause during the pandemic. The link between CENACE’s measure and the COVID-19 pandemic is tenuous at best.

On May 15, 2020, Mexico’s Ministry of Energy (“SENER”) took the additional step of publishing a new general reliability policy, the Policy on Reliability, Safety, Continuity and Quality of the National Electricity System, resulting in significant modifications to the regulatory regime originally established by Mexico’s 2014 energy reforms (the “Policy”).  Chief among the changes brought about by the Policy are revised criteria in the procedure to determine the dispatch priority for Mexican power-generation facilities. In addition, however, substantial new rules have been imposed on privately-owned renewable projects increasing regulatory compliance costs across the board.  In general, the Policy serves to advantage public-sector involvement in Mexican renewable generation by the Comisión Federal de Electricidad (the “CFE) and affects the development and operation (and ultimately the economics) of projects by investors who entered a reformed and competitive energy market in Mexico. The international impact of the Policy is likely to implicate legal protections of investment under the 1992 North American Free Trade Agreement (NAFTA), the 2018 Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and other trade and investment treaties binding on Mexico.  Mexico’s adoption of the ICSID Convention in 2018 provides an additional avenue for foreign investors to obtain redress.

Highlights of the Policy include:

  • Prioritization of “security” in dispatch procedures over selecting the next-lowest-cost generator, including special designations for “reliable generators” within the discretion of SENER.

  • Newly created “Ancillary Services” for renewable projects which must be provided by the CFE (at project developers’ cost).

  • Suspension of ongoing solar and wind applications, and virtual suspension of the interconnection of private solar and wind applications with Mexico’s energy grid.

Yet by the middle of last week, at least 23 of the 44 current wind and solar projects were able to obtain constitutionally protected relief (amparos) against the CENACE’s suspension of commissioning and interconnection tests.  Although CENACE lifted such suspensions, it also signaled its intent to appeal such rulings and President Lopez-Obrador reaffirmed his support for such actions in a regularly scheduled May 21 press conference.

Implications

While the Policy was issued under the guise of a response to the COVID-19 global crisis, it has immediately drawn widespread criticism for what appears to be more favorable economic treatment for the CFE.  The Policy will no doubt be subject to legal scrutiny in Mexico, including constitutional challenges, as power-generation stakeholders digest the changes to the energy regime and adjust accordingly.  These challenges will take time, but imminent price hikes and environmental degradation might prove to be pivotal factors in the durability of the move by SENER.

The CFE’s legacy assets that will be pressed into service by the Policy at the expense of private generation are largely fossil-fuel generation facilities that will produce electricity at both a higher economic and environmental cost than the new-build renewable generation displaced by the new regulations. Foreign investors, particularly those from North America and Europe, will likely be disproportionately impacted as the bulk of new renewable investment in Mexico following the reforms of 2014 included environmentally-conscious stakeholders from abroad.

Foreign investors in Mexico may invoke the legal protections of applicable treaties, including NAFTA, the CPTPP and bilateral treaties between Mexico and Austria, Belgium, Finland, France, Germany, Italy, Korea, Spain, Sweden, Switzerland, and the United Kingdom.  Although the exact terms may be different in each of these treaties, they typically offer national treatment to covered investors and their investments, that is, treatment at least as favorable as investors and investments of the host country.  They also offer “fair and equitable treatment” and an international minimum standard of treatment.  These standards have been applied to provide relief against state measures that are held to be arbitrary or that have destroyed the legitimate expectations on which investors have relied when making their investments.  These treaties typically allow covered investors to enforce their legal protections through international arbitration with the host country, without the need of further approval, but sometimes subject to stringent procedural conditions (including the waiver of recourse to local procedures).  The ICSID Convention, to which Mexico is now a party, provides an arbitration forum administered by one of the component organizations of the World Bank Group in Washington, D.C.

It will be crucial, therefore, for investors to undertake careful consideration of their rights and remedies under applicable treaties and of other options available to them, as Mexico’s power sector suffers radical change and enters menacing territory.

For further information or questions related to this client update, please contact your regular Partner at Baker Botts or one of the attorneys featured below.

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