I. CENACE Resolution

While arguably addressing issues concerning the efficiency, quality, reliability, continuity and safety of the Mexican National Electric System (Sistema Eléctrico Nacional) ("SEN") during the COVID-19 pandemic, on April 29, 2020, the National Center for Energy Control (Centro Nacional de Control de Energía) ("CENACE") (the SEN operator) issued a resolution1 that may have an adverse impact on wind and solar electric generation projects in the country ("Resolution").

The Resolution reflects a major change in policy concerning the participation of the private sector in Mexico’s electric industry through the construction and operation of wind and solar electric generation projects and the sale of associated energy. Contrary to most other countries that have issued regulations to accommodate and support intermittent sources of electricity in their interconnected systems, Mexico's current administration has decided that they should be excluded or subordinated to more traditional forms of electric generation. Note that almost all wind and solar electric generation plants and projects in Mexico are owned by private sector companies.

II. Background – 2013 Energy Reform

a)  Wholesale Electricity Market

Following the 2013 Energy Reform and the issuance of the 2014 Electricity Industry Law (Ley de la Industria Eléctrica) ("LIE"), the generation and wholesale of electricity in Mexico is subject to a regime of free enterprise and open competition. The state-owned Federal Electricity Commission (Comisión Federal de Electricidad) ("CFE"), through its subsidiaries and affiliates, became just one competitor in this new market.

Under the LIE framework, the Wholesale Electricity Market (Mercado Eléctrico Mayorista) ("MEM") was created as a spot market operated by the CENACE where generators, suppliers and qualified customers (acting directly and not through a power marketing company) gather to sell and buy electricity under a real-time system with marginal costs. The CENACE is required to dispatch the system's power plants based on a merit order of ascending operating costs, under which the lowest operating cost power plant satisfies system energy demand before the next lowest operating cost plant is dispatched.

b)  Clean Energy Incentives

Under the LIE, the main mechanism to promote clean energies is the requirement imposed on qualified offtakers participating in the MEM to acquire Clean Energy Certificates (Certificados de Energia Limpia)("CELs") representing a percentage of their electricity consumption (as determined by the Ministry of Energy (Secretaría de Energía) ("SENER")). The CELs obligation applicable for 2020 is 7.4%.

Furthermore, the three auctions carried out by CENACE to award contracts for the sale of electric energy, capacity and CELs were exclusively directed to clean-energy generators, as a mechanism to both promote the development of clean energy projects and ensure the issuance of sufficient CELs to permit qualified offtakers and load-serving entities to comply with their clean energy obligations. In addition to the above, the law provides for several tax incentives applicable to renewables (among others, 100% tax deduction on the purchase of
machinery and equipment2).

Based on the results of such auctions, 65 new clean energy power projects will be developed (40 photovoltaic plants and 25 wind farms; around half of them already in commercial operation), which represent an investment of approximately USD $8.6 billion. The average price achieved in the third auction in 2017 was USD $20.57 per megawatt-hour, which is very low under international standards. This policy also brought benefits from reductions in greenhouse gases emissions and helped Mexico get closer to complying with its commitment under the Paris Agreement.

In addition to the CENACE auctions, private companies have built numerous renewable energy generation projects supported by power sales agreements negotiated on a bilateral basis with qualified purchasers.

III. Context – Current Administration Measures that Impact the 2013 Energy Reform

The Resolution and the potential publication of a new reliability policy3 stands as the fourth significant measure issued by the current administration against the 2013 Energy Reform concerning the electric industry. The first measure occurred at the beginning of 2019 when the government cancelled the Fourth Electricity Auction, which award was originally scheduled for November 2018, precluding wind and solar companies from entering or expanding their participation in the MEM.

The second measure entails reports by several grandfathered electricity generators4 that the Energy Regulatory Commission (Comisión Reguladora de Energía) ("CRE") has withheld requests to change their self-supply generation permits to include additional or change existing partner-consumers, precluding the generator from delivering energy to the load points of such new partner-consumers. Note that the Electricity Industry Law does not give discretion to CRE to withhold approval of such requests.

The third measure occurred in October 2019, when SENER announced a change to the eligibility criteria for obtaining CELs, including the output from CFE’s old hydro plants and Laguna Verde nuclear plant as CEL generators. The purpose of this measure was to strengthen CFE's position, on one hand, by allowing CFE as generator to sell CELs, and on the other, by decreasing the market value of the CELs required to be acquired by CFE as a load serving entity. A further effect was to reduce the economic value of the CELs for wind and solar generators. In any case, court rulings in November and December halted the government's proposed change to the eligibility criteria; however, final resolution has yet to be issued.

IV. Resolution Provisions

a)  Maximum Capacity of Renewable Energy

The Resolution provides that the main transmission lines will operate at determined magnitudes without depending on Remedial Action Schemes (Esquemas de Acción Remedial) ("EAR"), which could mean that the operation of the main transmission systems shall be carried out without affecting the continued output of thermoelectric and hydroelectric plants and eliminating operating safeguards designed to support the participation of intermittent sources of energy.

b)  Dispatch of Must-Run Power Plants

The Resolution also provides that, to maintain control of the voltage regulation, must-run power plants will be designated (that is, those that can be quickly switched on and off to reduce intermittency). However, the criteria under which such power plants will be assigned and dispatched is not established.

The Resolution seems to indicate that the design of the wholesale power market will not be followed, but that CENACE will act discretionally. Accordingly, the dispatch of wind and solar electric generation plants in operation could be subordinated to CFE's thermoelectric and hydroelectric plants. Also, it is unclear when and how must-run power plants will begin being dispatched before wind and solar plants. As further described below, the Mexican Antitrust Commission (Comisión Federal de Competencia Económica) ("COFECE") has stated that there is no technical basis for these measures.

c)  Suspension of Pre-Operational and Operational Tests

The Resolution suspends ongoing pre-operational testing of wind and solar electric generation projects, and provides that pre-operational testing of new wind and solar electric generation projects will not be authorized. Such measure, rather than related to the COVID-19 pandemic, seems intended to implement one of the points contained in the CFE Request (Pliego Petitorio) leaked in October 2019, which provides that CRE and CENACE "shall determine the maximum capacity of intermittent renewable energy that might be interconnected to the SEN in order to guarantee the optimal operation and reliability of the SEN".

Such provisions are unclear and require an explanation regarding the scope of the suspension and cancellation, further describing the tests and the applicable period. Understanding the measure is relevant as it may cause a delay in the commercial operation of wind and solar power plants and, therefore, possible performance failures under the respective generation permit, interconnection contract, power purchase agreement and financing documents, among others.

d)  Further Actions in Electrically Isolated Interconnected Systems

The Resolution provides that in electrically isolated interconnected systems (i.e. Baja California, Mulegé and Baja California Sur) that have wind and solar power plants (i.e. the three systems), certain operational actions and strategies will be applied in order to strengthen the sufficiency, quality and continuity of the electric system.

Note that the criteria that will be followed to strengthen the sufficiency, quality and continuity of the electric system is not established by the Resolution. Again, the measure seems like an attempt to empower CENACE to act with discretion and not in accordance with market rules.

e)  Further Analysis for Granting Licenses

Finally, the Resolution provides that the applications for licenses in the National Transmission Network (Red Nacional de Transmisión) ("RNT") will be studied and analyzed to determine their feasibility, dates and times, so that the reliability of the SEN is maintained, without the dependence of EAR.

Such license feasibility study could affect, among others, the scheduled outages, thus impacting the maintenance programs of the power plants in operation. Again, it is not specified if CENACE will follow the market rules or if it will act discretionally in the aforementioned study.

V. Further Considerations

a)  Temporality

The time-frame of the Resolution is uncertain. Although it was published based on and in the context of the COVID-19 pandemic (so it should be understood as limited to June 1, when the economy is set to reopen), the specific time-frame of the measures is not provided by the Resolution5.

If the Resolution is temporary (as the lockdown due to the COVID-19 pandemic), some of its measures could be classified as emergency measures6. However, if it is intended to have indefinite effects, then CENACE could be exceeding its authority, modifying the dispatch rules approved by CRE and unduly discriminating renewable power plants7. As with the recent amendment to the rules applicable to CELs, the amendment to the dispatch rules would also require a regulatory impact analysis (otherwise, the measures could be illegal).

b)  CRE and CENACE Powers and Authority

Three governmental agencies have primary responsibility for the regulation of the electric sector. SENER is responsible for the development of policy, CRE is responsible for the regulation, and CENACE manages the power grid and the wholesale electric market, to function under principles of open and non-discriminatory access to the transmission and distribution infrastructure.

Accordingly, despite CRE being the regulatory agency and competent body to issue regulations with regard to reliability and dispatch of the SEN, it has not issued any opinion with respect to the Resolution. Considering the discomfort and foreseeable lawsuits from the MEM participants, it would be reasonable for CRE to issue a statement or resolution with respect to the Resolution and its implementation.

It is possible to consider that CENACE, by privileging the alleged quality, reliability, continuity and safety of the SEN, has failed to comply with its obligation to guarantee open and not unduly discriminatory access to the RNT and the General Distribution Networks. 8 Also, CENACE might be leaving aside the principles of transparency, objectivity, efficiency and sustainability that should guide its operations, affecting the final consumer in consequence.9

c)  Negative Effect on Competitiveness

Considering the lack of clarity and substantiation of the Resolution described above, as well as the potential adverse impacts over economic competition, on May 7, 2020, COFECE issued an opinion10 providing that the Resolution includes restrictions that may have negative consequences over the competitiveness of the MEM, and therefore, issued the following recommendations:

1)  Any measures implemented by CENACE with respect to renewable power plants should be based on strict technical criteria, which shall be duly publicized;

2)  CENACE should not unduly discriminate against renewable power plants and should guarantee the economical dispatch, always considering the SEN reliability;

3)  CENACE should publish the criteria under which the effects of the Resolution will be terminated, including the term for the resumption of pre-operational tests. Such criteria shall be clear, transparent and measurable by third parties;

4)  CENACE should limit the implementation of the measures provided by the Resolution to those that are strictly necessary to guarantee the SEN reliability and only if there are no other alternatives that are less restrictive to competition; and

5)  Together with market participants, CENACE should begin the analysis of actions and regulations required to solve the issues affecting the SEN and, in the medium term, create a system consistent with Mexico's power supply and demand, reducing the social costs of power generation.

d)  Economic and Environmental Implications

Putting things into perspective, according to last year’s 2019-2033 PRODESEN power sector development plan published by SENER, wind accounted for 18.9% and photovoltaic solar for 29.4% of the 70,313 MW power projects planned for the 14-year period. Combined-cycle plants accounted for 41.6% of this figure.

According to the Mexican Association of Solar Energy (Asociación Mexicana de Energía Solar) (Asolmex), the suspension of tests could affect 28 solar and wind plants that are ready to enter commercial operation with a generation capacity of 3.27GW, in addition to 16 projects representing almost 2.07GW that are being built and would not be allowed to connect to the grid. This would endanger investments over nearly USD $6.43bn and the creation of more than 30,000 jobs, and cause additional emissions of 700,000t of CO2 per month.

e)  Further Implications

Mexico’s first private sector energy auction, organized by Bravos Energía, was scheduled for May 27, 2020. By March, 19 sellers and 9 buyers had signed up for the auction. Now, in light of the Resolution, the process faces uncertainty and might be rescheduled. London-based energy firm Vitol also has a private energy auction in the works, which process is open and can be reviewed in www.mexicoelectrico.com.

f)  Potential Disputes

Lawsuits (foreseeably amparo procedures) must be on the way. Among others, the validity of the Resolution could be disputed arguing insufficient and/or incorrect legal grounds and justification given that the various measures established in the Resolution should have been issued by CRE and not by CENACE.

Additionally, the justifications included in the Resolution refer to failures, disconnections and oscillations in the RNT that occurred before and during the COVID-19 pandemic, so the supposed justification for the issuance of these measures as a way to address the pandemic is insufficient at best.

Finally, a number of foreign companies have invested substantial amounts to develop renewable projects based on a valid regulatory system that established certain conditions. The change of such conditions could be considered discriminatory and potentially result in the reduction in value of the investment or the impossibility to pursue the project. This could trigger investment arbitration claims under the more than 20 bilateral investment treaties ratified by Mexico and also under multilateral investment treaties including NAFTA – USMCA or the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).

Contact:

Ariel Ramos: aramos@mayerbrown.com
José Valera: jvalera@mayerbrown.com
Vera de Gyarfas: vdegyarfas@mayerbrown.com
Lilia Alonzo: lalonzo@mayerbrown.com
Aldo A. Jáuregui: ajauregui@mayerbrown.com


1 See original document in https://www.cenace.gob.mx/Docs/MarcoRegulatorio/AcuerdosCENACE/Acuerdo%20para%20garantizar%20la%20eficiencia,%20Calidad,%20Confiabilidad,%20Continuidad%20y%20seguridad%20del%20SEN%202020%2005%2001.pdf

2 Article 34 XIII, Income Tax Law.

3 New reliability policy to be published by SENER based on a non-official document dated May 11, 2020.

4 Grandfathered electricity generators are those that obtained their power generation permits for their projects before the new legal regime came into effect and, consequently, kept certain benefits of the then-existing legal regime.

5 Article 3 II, Federal Administrative Procedure Law.

6 Article 12 XXXIII, XXXIV, XXXVII, Electricity Industry Law.

7 Article 8, Electricity Industry Law.

8 Article 107, Electricity Industry Law.

9 Article 109, Electricity Industry Law.

10 OPN-006-2020, issued by COFECE. See original document in: https://www.cofece.mx/CFCResoluciones/docs/Opiniones/V132/28/5125826.pdf