In a bid to leave his mark on Mexico’s energy sector, Mexican President Andres Manuel López Obrador (AMLO) is rolling back reforms by his predecessor Enrique Peña Nieto that were designed to increase competition in the energy market. For years, Mexico’s energy market was in decline due to a lack of foreign investment and competitive pricing, governance challenges, capital constraints, and a drop in crude oil production. Peña Nieto sought to reverse this trend with ambitious reforms that required amending Mexico’s Constitution to allow for much needed foreign direct investment (FDI). But in his populist push, AMLO has railed against this market opening, and sought to increase the role of state intervention in Mexico’s energy markets.

Through a recent bill, which passed comfortably through Mexico’s Congress on March 2, 2021, AMLO is fulfilling his promise to make changes to Mexico’s Law of the Electric Power Industry (LIE) by putting more power in the hands of state regulators. The changes are significant enough to have generated broad opposition from energy experts, environmental activists, investors, and business associations. While the law was supposed to go into effect within six months, a temporary reprieve has been handed down by Mexican district courts, suspending implementation until they rule on the law’s constitutionality. AMLO is confident that, if the dispute escalates, the Supreme Court of Mexico will rule in his favor, but if it does, it is likely to lead to further discord between Mexico and its foreign investors, and add to an already strained U.S.-Mexico relationship. With U.S. Trade Representative Katherine Tai putting emphasis on enforcing existing trade rules, and pressure from Congress likely to build, the electricity bill could trigger international litigation if it is not resolved in Mexico’s courts.

Why doesn’t the electricity bill add up to “reform”?

AMLO’s “reform” of the Law of the Electric Power Industry represents the first instance of his administration pushing for major legislative changes in energy. But what does AMLO’s bill do, exactly? The bill undercuts competition and the protections to private investors established through Mexico’s energy reforms (passed in 2014), as well as efforts to combat climate change and transition to clean sources of energy. It’s not so much “reform” as an energy policy “regression” for Mexico. There are a number of concerns with the law, but it’s the potential impact on foreign investors that could undo much of the gains in the energy sector since the energy reforms went into place. We address some of these issues below.

First, the law mandates that Mexico’s independent system operator for the electricity market, Centro Nacional de Control de Energía (CENACE), which manages the national electricity system, change the order in which electricity is dispatched to the grid to serve large consumers. Currently, these consumers acquire energy through a wholesale market made up of private firms and the state-owned power utility, the Federal Electricity Commission (CFE). CFE is involved in electricity generation, transmission, distribution and retail, though generation “is by far its least profitable activity,” according to a report by the Wilson Center. CENACE then authorizes the dispatch of the cheapest energy available from these producers. Excluding hydroelectric, geothermal, and nuclear plants – which do not have the combined capacity to satisfy demand – private solar and wind generators and natural gas-powered plants represent the cheapest available sources.

Challenging the independence of the country’s electricity management, AMLO’s new law requires electricity to be dispatched by CENACE according to a fixed order: 1) Hydroelectric plants; 2) CFE-owned nuclear and geothermal plants; 3) CFE-owned natural gas-powered plants; 4) CFE-owned carbon- and fuel-powered plants; 5) Privately-operated natural gas-powered plants under contract with CFE; 6) Wind and solar electric generation systems; 7) Private natural gas-powered plants not contracted by CFE.

This order appears to discriminate against most private electricity generators in favor of the state-owned CFE. If implemented, this aspect of the legislation could be challenged in international tribunals for giving preference to a state-owned enterprise (it is already being challenged in domestic courts).

While AMLO has defended Mexico’s sovereignty on energy issues on the basis of the United States-Canada-Mexico Agreement (USMCA), which recognizes Mexico’s “sovereign right to reform its Constitution and its domestic legislation,” the reality may be a little more complicated. Depending on how the law is implemented, it is possible that it could violate a number of provisions of the USMCA, and both state-to-state and investor-state dispute procedures are available. Notably, legacy investments are still covered under the scaled back investor-state dispute settlement rules for three years after entry into force; and for new investments, the oil and gas and power generation sectors are still covered for investor-state disputes related to covered government contracts. While Canada does not have recourse to ISDS against Mexico under USMCA, it could pursue a claim under the Comprehensive and Progressive Trans Pacific Partnership (CP-TPP), to which Mexico is also a party.

The CP-TPP adds an additional layer of complexity because Mexico “locked in” some aspects of its energy reforms in that agreement. This is important because the USMCA grants Mexico the right to adopt additional non-conforming measures on investment and trade in services, as long as these do not accord USMCA parties treatment less favorable than that accorded to parties from any other trade agreement that Mexico has ratified – a clear reference to CP-TPP. Thus, insofar as Mexico cannot restrict investments in the areas covered under CP-TPP, it also cannot do so under USMCA.

The order in which electricity is dispatched also has potential environmental implications, as carbon- and fuel-powered plants would be relied upon more heavily for electric power generation than cleaner wind and solar electric generation systems, which will now sit near the bottom of the queue. Not only could this undermine Mexico’s transition to cleaner energy sources, it could also violate Mexico’s commitments under the eight multilateral environmental agreements covered by the USMCA’s environmental chapter.

In addition, the legislation undercuts protections for private firms that entered the industry prior to the enactment of the energy reforms. Beginning in 1992, these firms were able to generate electricity for their associates, including large industrial firms such as Ford, Continental, and Hershey’s, and as contractors for CFE on a limited basis. When the LIE overhauled the legal framework governing the industry in 2014, the permits and contracts obtained by these firms were grandfathered up until their original expiration date. But AMLO’s reform now provides for their potential cancellation within a span of 6 months, should a revision by the Energy Regulatory Commission (CRE) and CFE find these permits and contracts to be “fraudulent” or not “cost-effective.”

What’s at stake?

Mexico’s electric power sector received more than $11 billion USD in net foreign direct investment between 2014 and 2020. Most of this FDI comes from EU countries, Canada, and the United States. Since the energy reforms, opportunities for U.S. investments in the energy sector have grown, and a vibrant cross-border electricity trade has developed, as electricity prices in Mexico became more competitive. As can be seen in Figure 1, U.S.-Mexico electricity trade has witnessed pronounced growth in recent years. AMLO’s actions could therefore threaten to undo some of the gains of integration in our energy markets.

In fact, since AMLO took office, there have been a number of alarms raised over his actions in the energy sector that have concerned foreign investors. Former Secretary of State Mike Pompeo sent a letter to Mexico’s cabinet officials warning that “recent regulatory actions by the Mexican government have created significant uncertainty about Mexico’s regulatory process, especially regarding the energy sector, and have damaged Mexico’s overall investment climate.” He went on to say that these actions also “raise concerns regarding Mexico’s commitments under the USMCA.” Other trading partners have put forward similar concerns. For example, an attempt last year by CENACE to effectively restrict access to the electrical grid for renewable energy, under the guise of safeguarding its “reliability” and “security,” prompted Canada and the EU to send formal letters to the Secretary of Energy, stating that this and other actions from the administration undermined Canadian and European investments in the sector.

But Mexican consumers may pay the heaviest price. In 2020, CFE’s average generation costs were 252 percent higher than those of private firms employing renewable sources. Experts further estimate that the fixed order for electricity dispatch mandated by AMLO’s bill would lead to the average cost of electricity increasing by more than 180 percent – an impact that would not only be reflected directly on utility bills, but also in higher prices for other goods and services.

In cementing his legacy, AMLO may turn off the lights

With his presidential term coming to an end in 2024, López Obrador has a few years left to leave his mark on Mexican politics and cement his legacy against what he claims to be Mexico’s “long neoliberal nightmare.” A key part of this is his crusade against the energy reforms. The fact that AMLO’s party, Morena, remains highly popular and may clinch another majority in Mexico’s Congress in June’s mid-term elections, gives AMLO little reason to back away from his controversial policies.

AMLO is not likely to easily give in to international pressure to change his approach, so the best outcome we may be able to hope for is a domestic resolution whereby Mexican courts declare the law unconstitutional. But in case this does not happen, Canada and the United States, as Mexico’s neighbors and closest trade partners, will have to raise the issue with AMLO directly to ensure that his actions do not jeopardize the hard gains of the energy reforms and the future of North American trade and cooperation on energy-related issues.