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Mexico’s Top Court Sets Back President’s Electricity Strategy

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Mexico’s Supreme Court on Wednesday ruled that changes in regulations for the country’s electricity market giving priority to the state-owned utility over private power generators is unconstitutional.

The ruling is a setback for President Andrés Manuel López Obrador’s plans to restore the dominance of state-owned energy companies, and bodes badly for a bill he sent to congress this week that would give the state-owned utility CFE a commanding position in the power market.

It also could set up a confrontation between the court and the president, a nationalist who seeks to reverse key parts of a historic energy-sector overhaul carried out under his predecessor that ended Mexico’s state monopoly on the oil market and opened electricity markets to greater private investment.

Mexican courts are emerging as an obstacle to Mr. Lopez Obrador’s drive to centralize power, say analysts. A number of lower court decisions have gone against the government in the energy sector, and the Supreme Court had stopped the government from lowering the salaries of senior officials at autonomous institutions such as the central bank.

Wednesday’s ruling by a 4-1 vote knocks down key aspects of a policy published last year by the Energy Ministry that required the national power grid operator to take electricity generated by CFE before cheaper options from private generators that have invested billions of dollars in the country, especially in wind and solar stations. The ministry argued that the change was necessary to ensure network reliability.

The policy was challenged at the Supreme Court by the country’s antitrust commission on grounds that it violated constitutional principles of free competition and market access.

“The feeling that this decision of the court leaves us with is that one way or another, there is still a good system of checks and balances,” said Rodolfo Rueda, senior counsel at Thompson & Knight LLP who focuses on energy projects in Latin America.

The ruling comes two days after Mr. López Obrador sent to congress a bill to change the electricity laws that would further limit competition in the electricity sector in favor of the CFE, and put billions of dollars of private investments at risk.

Analysts said the court ruling makes it much more likely the proposed bill, if enacted into law, would also be struck down.

“The bill is much more aggressive against the rights of private investors than the reliability policy, so this is an unmistakable indication that the proposed reforms in the bill would be unconstitutional,” said Pablo Zárate, managing director in Mexico of FTI Consulting, a global consulting firm.

At present, the law requires the cheapest electricity to be used first and the most expensive power last, with the idea that the savings can be passed along to consumers. The rules have favored private-sector generators of wind and solar energy over many of CFE’s older generating plants, which have higher costs.

Under the proposed changes, hydroelectricity would be the first energy placed on the grid, followed by any power generated by CFE, electricity from independent power producers under contract to CFE, then private solar and wind power, and finally other privately owned power plants.

CFE, which for many decades enjoyed a monopoly, has large hydroelectricity stations, a nuclear power station, and plants that run on natural gas, coal and fuel oil, but little in the way of solar and wind power.

The proposal also allows regulators to revoke permits for private generators that built plants under a 1992 law allowing companies to generate electricity for their own use, and require them to request permits under the current law.

Mexico’s largest business organization called the bill “an indirect expropriation” and said it violated the constitution. It added that the bill also goes against international trade, investment and environmental protection agreements.

The bill is supported by legislators of the ruling Morena party, which has a majority in the lower house of congress and the Senate.

Last month, the outgoing U.S. secretaries of state, energy, and commerce sent a letter to their Mexican counterparts saying the López Obrador administration may violate the United States-Mexico-Canada Agreement trade pact if regulators block permits to private companies in favor of Mexican state energy firms.

“While we respect Mexico’s sovereign right to determine its own energy policies, we are obligated to insist that Mexico lives up to its USMCA obligations,” they said.

Write to Anthony Harrup at anthony.harrup@wsj.com

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