Mexican Goulash - independent power projects are not in jeopardy in Mexico

Mexican Goulash - independent power projects are not in jeopardy in Mexico

August 01, 2002

Contrary to published reports, existing independent power projects are not in jeopardy in Mexico. However, future projects are in a constitutional limbo that could last at least a year.

Supreme Court Ruling

The headlines seemed serious and the initial reactions were alarming. Some commentators said that a ruling by the Mexican supreme court in April cast doubt on the constitutionality of private involvement in the Mexican energy sector, while others reported that it would force a nationalization of the existing independent power projects. At the other end of the spectrum, the Mexican government was giving a much narrower view of the scope and effects of the court’s decision. The fact that several weeks passed between the court’s press release announcing its ruling and publication of the decision allowed for more confusion and wild speculation about its contents and effects. Once published, the length and dense reasoning of the decision did not help quickly to clarify some of the prior confusion.

Now that there has been time to review and analyze what the court said, it is clear the decision does not have the catastrophic effects that were initially feared.

Chadbourne polled a number of developers and lenders, and their Mexican lawyers, who agreed unanimously that the court’s ruling does not affect the legal underpinnings of the existing private power projects nor, at least as currently conceived, does it undermine the government’s program for additional private projects. The court did not order, require or authorize a nationalization of existing projects.

The clearest short-term impact of the decision is it will delay — and maybe even require a cancellation of — some Pemex-related projects that were in the early development stages; such projects relied on the ability to sell substantial excess capacity to the Comisión Federal de Electricidad, or “CFE,” under authority created in the government’s May 21, 2001 reforms that were declared unconstitutional by the court’s ruling.

There is less consensus about the long-term effects of the court’s decision. The court made clear in the ruling that the Fox administration has very little, if any, constitutional standing unilaterally to increase the scope of private-sector involvement in the power industry, putting to rest any hopes that the government would be able to introduce reforms without having to deal with the opposition parties in Congress.

There is also no denying that the court’s ruling casts serious doubt on the constitutionality of private power, although some Mexican lawyers and market participants — developers, in particular — seem dismissive of the practical importance of the court’s views. The government already faces political obstacles to achieve an expanded role for the private sector. The court’s decision raises the question of whether a constitutional amendment, as opposed to an-easier-to-obtain legal amendment, is needed to allow for increased private sector involvement in the Mexican power market.

Constitutional Issue

The battle lines were drawn in May 2001 when the Fox administration issued a decree amending some of the rules that apply to cogeneration and self-supply projects. The amendments allowed self-supply projects to be built without any capacity limits or restrictions, and such projects could sell to CFE up to 50% of their installed capacity; the earlier regulations had set a ceiling of 20 megawatts. The amendments allowed cogeneration projects to be built without any restrictions and to sell all of the plant’s excess capacity to CFE.

Congress challenged the decree before the supreme court, arguing that any such amendment required action by Congress and that, therefore, the government had exceeded its constitutional powers. The Fox administration responded that it had simply amended a prior presidential decree that was never challenged, and that the original limitations on the size of self-supply and cogeneration projects were not a matter of statute but rather presidential action.

The court sided with Congress, but did not follow Congress’ reasoning. It chose to address the more sensitive and basic question of the limited role of the private sector in the power industry under the Mexican constitution, which was not what Congress had asked it to do. The court said the following.

First, article 27 of the Mexican constitution gives the state the exclusive right to undertake all activities related to the electricity public service — generation, transmission and distribution — and no private concessions in these areas may be granted. Article 28 lists the electricity sector as one of the government’s exclusive strategic areas. Article 25 confirms this exclusive role.

Second, the court considers that these articles and the relevant constitutional history mean the private sector is not constitutionally authorized to render the electricity public service nor any of the specific operations needed for that purpose. In the court’s view, the private sector is entitled to generate its own power and sell limited amounts of excess capacity to the CFE. However, it is not constitutionally possible — as the government’s decree would have allowed — to have a plant where a significant portion of the capacity is dedicated to supplying energy to CFE; such generation would be for the purposes of the public service where no private party is allowed to participate. According to the court, the constitution establishes that “the generation, transmission, transformation, distribution and supply of electricity, for the purposes of rendering the public service, belong exclusively to the Nation and may not be granted to the private sector.” The court went on to say, in its most direct and clear repudiation of private participation in the power sector, that the self-supply framework created by the government’s decree is unconstitutional, as it allows the private sector to be primarily involved in the selling of power to the CFE. The concern that this immediately raises is:what is the constitutional status of private power projects whose main activity is to sell power to CFE?

Finally, in what Mexican lawyers characterize as a legal aside, the court suggested ominously that the existing “Public Services Law” that governs the electricity sector may also be at odds with the constitution and that Congress should consider amending it.

Significance

On its face, the court’s ruling looks very bad for private power projects. Then, why is it that owners of existing plants and their lenders are not concerned?

The reason is the constitutional review rules in Mexico allow for the filing of constitutional challenges only during a relatively brief period immediately after the enactment of a law or decree. Every Mexican lawyer with whom Chadbourne talked agreed that it is virtually impossible that the “Public Services Law,” as amended in the early 1990s, could now be set aside by the supreme court. Theoretically, the CFE may have some legal standing to challenge, on a case-by-case basis, the power purchase arrangements entered into with its private power suppliers, but in the unlikely event that this cause of action were to be admitted by the courts, it would have very damaging financial and political consequences for the CFE and the Mexican government. Hence, it is not considered a likely prospect.

To sum up, the mechanisms for private involvement in the power sector continue to be legally available and the court’s ruling does not affect either the current legal framework or existing projects. However, for future projects, developers and lenders are still faced with a confusing legal picture. On the one hand, there is a Supreme Court ruling that considers private power in Mexico to violate the constitution (other than on a self-supply basis). On the other hand, the legal framework for private power remains fully valid and enforceable (as stressed even by the supreme court, which goes to great lengths in its ruling to underscore the limited scope of its decision).

Future reforms to allow for increased private involvement in the power industry are uncertain. The Fox administration has said in the past that a constitutional amendment is needed to provide the legal certainty required to allure private investors and lenders, a position that was implicitly endorsed by the supreme court in its ruling. However, the opposition parties that control Congress have rejected a constitutional amendment and have offered at most to pass an amendment to the “Public Services Law.”

The government appears to have accepted political reality and will go forward with trying to introduce amendments to existing statutes rather than the constitution. However, allowing increased private sector involvement through a legal reform would not address the court’s views of the intrinsic incompatibility between such involvement and the Mexican constitution. Thus, such legal reform could be challenged again before the supreme court and may succumb to the same constitutional arguments that sank the presidential decree.

Under Mexican law, Congress and the president have the primary role in challenging each other’s actions in the supreme court. Therefore, a reform bill having the backing of both the government and the opposition parties faces less chance of being challenged. In any case, any reform bill would only achieve a solid legal and constitutional standing after the constitutional review period expires without any authorized party filing a challenge.

The timing and contents of any reform are unclear. Congress has not convened in special session this summer to discuss energy reform, as had been originally proposed. Therefore, any reform bill would not be discussed at the earliest until the ordinary sessions starting in the fall and as part of the regular, and traditionally crowded, Congressional calendar. It is unclear whether the government and the opposition parties would be able to reach agreement in any event on the scope of permitted private sector involvement in the domestic power supply. The expectation in Mexico is the most that is possible at the moment politically is an upgrade of the existing framework, possibly clarifying or improving certain regulations, but without any dramatic changes or major overhaul.