2024 Mexican Constitutional Reform Bill: Proposed Changes for Foreign Investors in the Electricity Sector

On February 5, 2024, President López Obrador sent the Reform Initiative to the Chamber of Deputies. This, in turn, was submitted to the United Commission of Constitutional and Energy Matters for review. 

As currently written, the Reform Initiative contains numerous provisions similar to those existing in Mexico's 2013 Energy Reform, with certain modifications that could mean considerable differences as they are regulated in secondary laws. (It is important to note that the Reform Initiative has not been approved by the Congressional members and was not included in the discussions of the constitutional reform to the judicial branch which has been already approved by the Congressional members on September 11, 2024.) The most problematic provisions consider:

• That although it is confirmed that the planning of the national electricity system and the areas of transmission and distribution of energy correspond exclusively to the nation—as currently established—it is provided that individuals may participate in the other activities of the electricity industry: "that in no case shall they prevail over the Public Company of the State";
• The objectives of planning and control of the national electricity system are defined as: "to preserve the security and energy self-sufficiency of the Nation and to provide the people with electricity at the lowest possible price, avoiding profit, to guarantee national security and sovereignty through the Public Company of the State";
• It is proposed to change the nature of CFE from being a Productive State Company to a "Public Company of the State"; and to eliminate the requirement that its performance shall be in accordance with "best practices" with the intention, as indicated in the explanatory statement of the Reform Initiative, that the objective of CFE is to fulfill a social function rather than merely being profit-making, and ceasing to be guided by the concept of "best practices" that are not considered applicable to a public company, but to a private company with corporate governance; and
• The transitional measures of the Reform Initiative provide that the same enters into force the day after its publication, also it gives the Congress a period of 180 calendar days from the approval and publication, to make the necessary adjustments to secondary laws, which indicates that the point described above, will be determined in the secondary laws.

In addition, it is important to note that there is another constitutional reform initiative that aims to eliminate various autonomous bodies, including the Energy Regulatory Commission, which is pending to be discussed in the Chamber of Deputies and the House of Senators.

What is the Importance of the Reform Initiative?

The Reform Initiative translates into a limitation to the Energy Reform of 2013, which can lead to a substantial increase in the State control and the participation of CFE in the activities of the electricity industry, as well as in the cost of electric energy by establishing that this shall be provided at the lowest possible price, avoiding profit-making. 

However, at this stage it cannot be said with certainty what will be the degree of increased control of the State and of the participation of CFE in the industry, nor how to calculate the price of electricity or how the above will be implemented, as such aspects will be regulated by secondary laws. Although, elected President Claudia Sheinbaum stated throughout her campaign, and once elected, she confirmed in several interviews, that she considers it appropriate for CFE to be in charge of the generation of 54% of the country's electricity generation, and the remaining 46% corresponds to private industry, as President Andres Manuel López Obrador had proposed in the first initiative of constitutional reform to the electricity sector on September 30, 2021 (the "First Reform Initiative"). 

Finally, we consider appropriate to mention that the Reform Initiative, subject to what the secondary laws indicate, represents a more "measured" change to Mexico's electricity industry, compared to the First Reform Initiative, because according to the latter, among other concepts: 

• The wholesale electricity market would disappear along with the participation of private individuals in the different links of the production chain of electricity industry, except for the generation of electricity for its exclusive sale to CFE;
• The generation permits granted so far and those that are in process would be canceled, giving these plants the possibility of participating for around the 46%; of the generation of energy that the country require, competing to offer CFE the lowest production costs for energy; and
• Clean energy certificates would be eliminated, providing that the State will stay in charge of the Energy Transition through the nation's available energy sources by establishing of scientific, technological, and industrial policies.

What Should Foreign Investors Know to Protect Their Rights if the Reform Initiative Is Approved and Implemented?

While the Reform Initiative contains several proposals that today may be considered incompatible with the principles provided for in the Mexican Constitution, such as the principle of progressivity and non-retroactivity, as well as the guarantee of a healthy environment and sustainable development, should the Reform Initiative be approved, domestic legal avenues for investors will be limited. This is so because the Reform Initiative is an amendment to the Constitution, and it is possible that the mentioned principles may not be enforceable by adjustments arising from the other 19 constitutional reform initiatives.

Foreign investors, however, may have recourse under international law. Several provisions of the Reform Initiative may violate the rights granted by Mexico to foreign investors in more than 40 investment treaties and free trade agreements. Therefore, while considering the legal options to challenge the Reform Initiative, foreign investors in the electricity industry should be sure to consider an international approach.

As a result of the Reform Initiative, while individuals may continue to participate in the same activities of the electricity industry, which they currently do (generation and qualified supply of energy), in no case shall they prevail over the Public Company of the State ("CFE").

In particular, and depending on the corporate structure of the investment, foreign investors may be able to initiate international legal proceedings through the investment protection clauses in international treaties. These treaties include the various bilateral Reciprocal Investment Promotion and Protection Treaties signed by Mexico and other nations (i.e., those with Spain, the Netherlands, Germany, and France), as well as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, or CPTPP, which is in force for Mexico, Australia, Canada, Japan, New Zealand, Peru, Singapore, and Vietnam. In addition, for some U.S. investors, Annexes 14-D and 14-E of the Agreement between Mexico, the United States, and Canada ("USMCA") are also a potential source of investment protection, as is Chapter Eleven of the North American Free Trade Agreement ("NAFTA") which, although superseded by USMCA, continues to apply to some investments until July 1, 2023. Notably, NAFTA's applicability may be limited as it contains broad exceptions for the energy sector. 

The availability of international law protections and the strength of these protections depends on the specific treaty, with some treaties providing more robust protections to international investors. It is therefore important for foreign companies to consider how their Mexican investments are structured, before a dispute arises, to ensure the strongest treaty protections possible. The most common treaty protections that potentially may be implicated by the Reform Initiative are the protection against expropriation without fair compensation and the guarantee of fair and equitable treatment. 

As a matter of international law, an expropriation takes place when an investor is substantially deprived of the use, benefit, or control of its investment. Importantly, investments generally include not only subsidiary companies or shares therein, but also contracts, permits, and other legal entitlements. An expropriation may be found even without a formal seizure of assets, where the investor retains paper title over the property. If the state's acts deprive an investor of the ability (but not necessarily the right) to exploit and enjoy its investment, a claim for expropriation may be possible. Most of Mexico's international treaties protect qualified investments from expropriation unless the governmental actions were taken for reasons of public interest, on a nondiscriminatory basis, in accordance with the rule of law or due process, and upon payment of compensation.

Fair and Equitable Treatment ("FET") is, at its core, a guarantee of good faith and due process, and is the most frequently invoked standard in investment disputes. Where available, it is likely to be the strongest claim in a dispute related to the Reform Initiative. Under the general FET standard, Mexico must not impair, by arbitrary, unjustifiable, or discriminatory measures, the operation, management, maintenance, use, enjoyment, or disposal of protected investments. Some of Mexico's treaties narrow the FET standard to treatment in accordance with international law or with customary international law. The FET standard is fact-specific and may be breached by a state's actions or omissions that: (i) are not transparent or consistent and create an unstable or unpredictable legal framework or business environment for the investment; (ii) violate the investor's legitimate expectations, which were relied upon by the investor to make the investment; (iii) are discriminatory; or (iv) violate due process or result in a denial of justice, among others. The investor's legitimate expectations can be based on Mexico's legal framework, contractual undertakings, and any undertakings and representations made by Mexico. Changes in Mexico's legal framework may potentially breach the FET obligation if they represent a reversal of assurances made by Mexico to the foreign investor.

When considering legal action against Mexico, investors should carefully examine their treaty coverage. Each treaty contains unique procedural requirements, such as temporal limitations on bringing an international claim. Further, the applicable treaty may contain a "fork-in-the-road" provision, which can require an investor to choose between bringing a domestic remediation proceeding or an international arbitration. If an investor believes its treaty rights potentially have been violated by the Reform Initiative, international counsel should be consulted in order to preserve and maximize potential claims and remedies.