I. Introduction

Since taking office in 2018, the president of Mexico (Andrés Manuel López Obrador or “AMLO”) has encouraged and developed policies that have given more control to the government over different markets and industries. His leftist ideology has gained so much power that his proposals and decisions have changed foreign investment in crucial ways.

AMLO has targeted specific economic sectors, one of them being electricity. He has continuously stated that Mexico will no longer protect foreign investors because the industry and activities that surround investments belong to the State. In most of his daily conferences, he repeats that his main priority is Mexico’s sovereignty and independence from the outside world.

This article analyzes (1) the current legal developments on the electricity sector in Mexico that restrict the participation of private foreign companies, and (2) the potential claims that foreign investors may have  under the United States-Mexico-Canada Agreement (“USMCA”).

II. Material Changes in Mexico that have affected Foreign Investment in the Electricity Sector

    A. Amendment to the Federal Energy Law

On March 9, 2021, the Mexican Congress enacted an amendment to the Federal Energy Law (“the Amendment”) to give the State more control over the distribution and commerce of electricity.

Under Articles 27 and 28 of the Federal Constitution, the State controls the transmission and distribution of electricity, exercises complete ownership and control over the agencies and corporations that interact with those markets, and has the power to plan and control the National Electricity System. However, the generating, buying and selling of electricity are not covered by the Constitution, and many foreign and domestic private parties are involved in such activities. Rules of fair competition regulate these activities to prevent the creation of monopolies.

The 2021 Amendment modified the electricity sector as follows:

A. It changed the way that electricity is dispatched by prioritizing the energy produced in assets owned by ‘Comision Federal de Electricidad’ (“CFE”) which would be included in newly-created electricity hedging agreements with physical delivery commitment. Consequently, energy produced by CFE’s power plants must be dispatched first, regardless of cost-efficiency and sustainability implications, at the expense of private power companies.^[2]

B. It mandated the Federal Regulating Commission of Energy (“CRE”) to revoke private companies’ permits of self-sufficiency in those cases that the Commission considers that they were obtained “in violation of the law.”^[3]

C. It granted CRE the power to review power purchase agreements entered into with independent power producers in order to confirm that they are still “profitable” for the State, which may lead to renegotiation or termination.

D. It also introduced the concept of contracts of electric coverage with physical delivery and limited the participation of private parties in such contracts.^[4]

E. It required that a power generator, in order to retain permits for electricity generation issued prior to the Amendment, must comply with the planning criteria of the National Electric System created by the Federal Energy Agency. It further provided that the granting of new power generation permits is also subject to those same planning criteria.[5]

F. It provided that Clean Energy Certificates (“CELs”) will now be given without taking into consideration the private companies’ starting date of commercial operations.^[6]

G. Finally, it permitted the elimination of a fair competition scheme that allowed the purchase of electric energy by private sector companies through public auctions.^[7]

    B. Supreme Court Decisions

In April 2022, the Mexican Supreme Court decided a lawsuit (acción de inconstitucionalidad 64/2021) that had been filed by a group of senators to determine the constitutionality of the Amendment and whether it violated Mexico`s obligations under the USMCA and the Trans-Pacific Strategic Economic Partnership Agreement. While a majority of the justices determined that several provisions were unconstitutional, their position did not receive the supermajority (8 of 11) required under Article 105, Section II of the Federal Constitution.  As a result, the Amendment is now in force.

The Court also did not decide whether the foreign investors’ rights under the USMCA were affected. As a result, the Court dismissed the constitutional challenges.

    C. Amparo Challenges

The 2021 Amendment is also the subject of “amparo” proceedings.  In Mexican law, amparo is an action for the protection of constitutional rights. The amparo trial is governed by a set of principles and rules found in Article 107 of the Federal Constitution and Law of Amparo, the essential ones being: (i) an act or omission from the public or private authority must exist; (ii) the injury in violation of constitutional rights caused by that act or omission must be real and imminent; (iii) the amparo action has relative effects (the judgment will only benefit or affect the claimant); and (iv) previous and ordinary remedies must be exhausted, unless an exception applies.

Two types of amparo exist: the direct and the indirect. The former is appropriate against final judgments and resolutions that end a trial, and will be heard by Courts of Appeals. The latter can be filed against laws, acts or omissions from the authority that affect the private party’s constitutional rights, and will be heard by District Courts.

In this case, multiple private parties filed indirect amparo actions last year before District Courts against the Amendment, alleging that the new Electricity Industry Law violated the Federal Constitution.  Most of those proceedings ended in judgments in favor of the claimants. Consequently, multiple appeals were filed in the Federal Courts of Appeals by the counterparty, in all these cases being the authorities responsible for amending the Electricity Industry Law.

In parallel, senators filed the action mentioned above before the Mexican Supreme Court to determine the constitutionality of the Amendment. As opposed to the amparo actions, the unconstitutionality action has general effects, which means that the Supreme Court can strike down a law.

On February 17, 2022, the Supreme Court gave notice^[8] to Courts of Appeals to stop amparo reviews proceedings^[9] until the Supreme Court rendered an award on the mentioned unconstitutionality action 64/2021, and the constitutional controversies 44/2021 and 45/2021. The Plenary of the Court ruled on the unconstitutionality action on April 7, 2022, deciding to dismiss the action for some sections of the Amendment to the Federal Electricity Law, while declaring other portions of it valid.  The Court dismissed both constitutional controversies.

Consequently, the Court gave notice on October 10, 2022^[10] to all the Courts of Appeals that heard amparo reviews on the Amendment to resume their activities and deliberate on these cases. Given that the notice is recent, no final decisions have been rendered on these appeals yet.^[11]

    D. Consultations under the USMCA

The USMCA permits each Party to initiate state-to-state disputes against another Party.  If a dispute settlement panel finds the responding Party to be in breach, and if the responding Party does not come into compliance, the panel can authorize the complaining Party to suspend benefits under the USMCA. This remedy can provide leverage to compel compliance with USMCA rules.

On July 20, 2022, the United States and Canada requested dispute settlement consultations with Mexico under the USMCA. The consultations relate to measures taken by Mexico, including the Amendment and the Supreme Court decision, that undermine American and Canadian companies and U.S.-produced energy in favor of CFE.

At the heart of the complaint are (i) delays in granting permits, (ii) a Mexican electricity law that prioritizes state-owned enterprises and agencies, and (iii) other rules that are disadvantageous to foreign investors.  Mexico’s economy ministry has stated that dialogue had been “productive” with U.S. and Canadian counterparts, and that they want to keep talking to reach a “mutually satisfactory” solution. As of the date of this article, the consultations period has ended; now it remains to be seen if a settlement can be reached.

III. Potential Claims of Foreign Investors under the USMCA

For investments made by U.S. investors in Mexico in power generation projects and other electricity businesses, investor-state dispute settlement (“ISDS”) is available between the United States and Mexico pursuant to Annex 14-D of the USMCA, but its scope is substantially limited. The USMCA significantly rewrote the basic guarantees so that investor-state arbitration is only permitted in cases of denial of post-establishment national treatment and “Most Favored Nation” violations, or in the case of direct expropriation.

In a departure from the North American Free Trade Agreement (“NAFTA”), investors under the USMCA are required to seek recourse before a competent court or administrative tribunal of the respondent state, for a minimum of 30 months, before commencing investor-state arbitration. They will also have to give 90 days’ notice of their arbitration claims. These rules significantly delay any access to ISDS remedies.

However, U.S. and Mexican investors enjoy broader access to investor-state arbitration, including the right to bring claims for violation of minimum standard of treatment and indirect expropriation, for investments that qualify as “covered government contracts” in sectors such as oil and natural gas production, power generation, telecommunication, transportation, and certain infrastructure investments that are not for the exclusive use of either Mexico or the United States.^[12]

The Free Trade Commission of the USMCA has not provided an interpretation of the scope and meaning of the covered government contracts. The same is true of investment arbitration tribunals; no tribunal has yet had the opportunity to explore and interpret this section. In accordance with the treaty, if an investment dispute arises from a covered government contract, the investor will have access to an arbitration remedy similar to NAFTA, without the requirement of exhausting local remedies. Power generation is considered part of covered government contracts. However, no interpretation has been made as to the extent of these provisions.

Mexico has taken measures that have delayed, denied, and revoked the ability of private companies to operate in Mexico’s energy sector. Therefore, foreign investors who are nationals of the US, may be able to claim violations of the following USMCA provisions:

A. Article 14.4, because an arbitral tribunal could find that the host State is favoring national investors and their investments over US investors and their investments.

The USMCA recognizes the national treatment standard to protect foreign investors from being treated discriminatorily in comparison with other national investors. The electric reform could result in violation of Article 14.4 of the Treaty because it is not giving foreign investors the same treatment as CFE and it would primarily affect enterprises that are owned by foreign investors. National private enterprises have also been affected because they are not receiving the same treatment as the mentioned state-owned company CFE.

The access to the energy network generators is in the process of changing the electricity dispatch system, giving priority to the CFE. Hydroelectric plants will have top priority, followed by CFE energy plants, wind and solar plants owned and operated by private parties and lastly, private companies with other characteristics. Additionally, the CRE now has the power to revoke private companies’ permits of self-sufficiency in those cases that the Commission considers that they were obtained “in violation of the law.”

The cancellation of the Long-Term Auctions also eliminates the possibility of competing to sell electricity, which makes it difficult to finance new clean generation products and could increase the final rates of electricity. Therefore, clean energy enterprises are also affected because they will not have the same access to the network generators or electricity dispatch as CFE. Consequently, US investors will most likely allege that they are not receiving the same treatment as nationals of Mexico, in this case CFE.

B. Article 22.5.2, because the relevant administrative body is not “exercising its regulatory discretion in an impartial manner with respect to enterprises that it regulates, including enterprises that are not state-owned enterprises”.[13]

As mentioned before, the amendment gives the CRE the power to revoke private companies’ permits of self-sufficiency in those cases that the Commission considers that they were obtained “in violation of the law.” Moreover, the contracts of electricity generation entered into by private parties must now be revised by the government to determine if they comply with the Law.

These provisions may give rise to arbitrary practices by the government because the law itself permits arbitrary conducts. “In violation of the law” is an open-end provision, which can be filled with any justification that the government creates. Additionally, the power to revise current contracts that do not comply with the law permits unpredictable actions by the government to freely consider which contracts must be revised, and to what extent.

C. Article 29.3, because Mexico “is not administering its laws in a consistent, impartial, and reasonable manner.”

The Electricity Law permits the cancellation of CEL permits and permits of self-sufficiency plants, as well as the revision of existing contracts with private parties, leaving to the side the application of proceedings and laws that require certain requisites so that the authorities may exercise those powers; a circumstance that may cause the violation to Article 29.3 of the treaty.

To cancel a permit or review an existing contract, the competent authorities need to follow certain guidelines, contained in multiple laws that are in force, like the Federal Constitution[14], the Administrative Proceedings Law[15] and case law. However, the Amendment goes beyond the applicable legal framework and gives the government the power to initiate these types of proceedings on grounds that could be considered arbitrary because they are not legally or factually supported. Moreover, the competent authority has the discretion to choose which contracts or permits to cancel and which to leave in force as they are. Under the Federal Constitution, the competent authorities need to justify their actions, stating what power is the one in exercise and the factual background that permits such exercise.

If those elements are not present, the authority may be in violation of the fundamental right of foreign investors` legal security.

IV. Conclusion

These developments in Mexico reflect a political trend in Latin America: nationalism in strategic sectors of the economy. Honduras is in the process of revising multiple energy producers’ contracts, similar to Guatemala.  Political changes in Chile, Colombia and Peru also suggest that potential difficulties may arise in those countries for foreign investors in the energy sector.

Mexico is in the process of negotiating the enforcement of energy policies that have undermined U.S. and Canadian nationals through consultations under the USMCA. However, the repercussions are difficult to predict. The Mexican Ministry of Economy has experienced significant changes in their official personnel, beginning with the resignation of Tathiana Clouthier, former Secretary of Economy with AMLO’s administration. Clouthier has been trying to convince the Secretary of Energy, Rocío Nahle García, to take a flexible approach to avoid reaching the panels stage under the USMCA. However, Rocío Nahle García has mentioned on multiple occasions that she will take a strong stand supporting AMLO’s policies.

As a consequence, the outcome of the USMCA’s consultation process is unpredictable. AMLO’s administration is currently taking a strong and rigid stand to protect the new electricity regime. Commentators and lawyers are unsure as to the outcome of this situation.
Mexico’s current governmental authorities have proven to be inconsistent, erratic, and deeply unstable. Therefore, foreign investment in Mexico will likely face harsh challenges in the years to come, rooted in a left-wing policy focused on giving more power to the State.

[1]CFE is a state-owned electricity company. The government is responsible for the control and development of the national electricity industry, and CFE carries out that mission.

[2] See Amendment at Article 3, Section XII, XII bis, Article 4, Section VI, Article 26, Article 4, Section I, Article 35, Article 12, Section I, Article 53, Article 108

[3] See Amendment at Article Fourth.

[4] Íbidem at Articles 3, 4 and 26.

[5] On March 2022, the CRE issued new requirements to obtain power generation permits. The new regulation sets out further requirements and establishes new obligations in connection with generation permits, including legal, technical, and financial aspects.

[6] All clean power generation facilities will be eligible to obtain CELs regardless of their ownership and the time when the power facilities began operating. This change will notably result in CFE’s clean energy facilities receiving CELs, and will eliminate the need to acquire new CELs through the CEL market. The resulting oversupply of CELs will likely cause a drop in the value of the CELs, discouraging investments in new clean energy projects and negatively affecting the return on investment of the existing clean energy investments installed after 2014.

[7] The cancellation of the Long-Term Auctions (“SLP”) eliminates the possibility of competing to sell electricity and CEL mainly to CFE, which makes it difficult to finance new clean generation products and could increase the final rates of electricity.

[8]General Agreement 3/2022 of the Supreme Court of Mexico.

[9]This Supreme Court action does not suspend the effects of the Amendment. It was focused on the tribunals’ activities. The court’s power to suspend other proceedings is governed by Article 366 of the Federal Code of Civil Proceedings.

[10]General Agreement 7/2022 of the Supreme Court of Mexico.

[11] The amparo appeals that were suspended and now resumed were AR 459/2021, 462/2021, 486/2021, 433/2021, 497/2021, 522/2021, 452/2021, 457/2021, 437/2021, 495/2021, 519/2021, 496/2021, 521/2021, 292/2021, 22/2022 and 32/2022. Courts of Appeals can modify, affirm, or deny the district court amparo awards.

[12] See USMCA, Annex 14-E, art. 6(b).

[13] Id at Article 22.5.2

[14] Article 16 of the Federal Constitution sets forth that every government act that affects an individual must be justified by the applicable law that gives that governmental authority to act and by a certain set of factual conditions that justify the exercise of that power.

[15] See Mexico’s Administrative Proceedings Law at Article 3, Section V.