MEXICO CITY—A dispute in Mexico over gas pipeline contracts is threatening to undermine fragile business confidence at a time when it is already shaken following the resignation of the country’s finance minister.

The dispute is about whether CFE, the state-owned electricity company, will honor seven multibillion-dollar pipeline contracts with U.S., Canadian and Mexican companies agreed before Andrés Manuel López Obrador took office as president and which the government says are exorbitant and unfair.

This month, CFE began talks with the companies to seek to force them to renegotiate terms for the pipeline projects, including the subsea South Texas to Tuxpan pipeline beneath the Gulf of Mexico built by Canada’s TC Energy and IEnova, a unit of U.S. group Sempra Energy.

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The dispute could overshadow ratification of NAFTA’s successor, the USMCA free-trade treaty, which already faces hurdles in the U.S.

The government has been at pains not to scare away foreign investors since it took office in December, but unsettled many when it scrapped a partially built $13 billion airport project even before taking office.

Confidence took another hit when Carlos Urzúa quit as finance minister this month, citing his “many” disputes with the president and the “imposition of officials who don’t know about public finances.” In an interview with Proceso, a news magazine, Urzúa said the pipeline dispute had been one area of dispute.

The projects comprise 3,230 km of pipelines, representing investment of almost $5 billion, and are designed to transport nearly 7.5 Bcf/d of gas to CFE plants for power generation. The Texas-Tuxpan pipeline is finished but not yet in operation; the others have been held up because of community disputes.

“Some people are now questioning why we want to revise the contracts of the CFE,” López Obrador told one of his daily press conferences this month. “The thing is, if we pay so much in tariffs for gas used to generate electricity, we’re going to have constant pressure to increase tariffs and we’re not going to do that?.?.?. they were bad [projects]
excessive.”

The CFE recently angered investors by filing for international arbitration over the contracts although it hoped negotiations would prevail.

But “this action risks sending a negative signal to U.S. and other international investors about the business and investment climate in Mexico”, the U.S. Chamber of Commerce said in a statement, urging López Obrador to keep his word to U.S. CEOs at a conference in April that his government would honor existing contracts.

An executive at one Canadian company in Mexico said the dispute was stoking fears that the CFE would like to expropriate the assets. Despite promising radical change in Mexico, López Obrador insists he would never resort to such market-unfriendly actions.

Manuel Bartlett, the octogenarian CFE CEO, also dismissed the suggestion. “No! What a horror. This is a good-faith negotiation. We are not going to lose. We are going to arrive at a civilized accord with these companies,” he said.

Rating agency Moody’s Investors Service, which has already turned negative on the outlook for the Mexican economy, said the legal dispute “undermines market and investor confidence [and] disincentivizes future partnerships with the private sector.”

“The signal abroad, that Mexico does not respect contracts is very tough, especially when the economy is not going well and you need investors,” said Gonzalo Monroy, an energy analyst. Most analysts and institutions have slashed 2019 gross domestic product growth forecasts to about 1% but the president insists: “We’re doing really well.”

López Obrador regularly excoriates past governments for what he says are failed neoliberal policies that put the market first, but his desire to put the state in the driving seat of the economy is hampered by a lack of cash. It costs an estimated $1.5 million per km to build a pipeline—cash the CFE, which lost $740 million in the first quarter, does not have.

The government has already upset the energy sector by halting a reform designed to open up the oil sector to private investment and canceling electricity auctions.

Bartlett, a pugnacious politician best known for having overseen Mexico’s 1988 presidential elections that were blighted by a suspicious computer crash, says the renegotiation efforts should come as no surprise since López Obrador has already made plain that the contracts are too costly for his austerity-minded government.

The CFE has already paid the contractors more than $600 million despite the pipelines not having delivered a molecule of gas, said Bartlett, who disputes force majeure clauses and fixed costs payable under the contracts.

However, NAFTA experts say the companies are protected under Chapter 11 of the free-trade pact, which is still in force.

Experts say the CFE does not have a legal case for its renegotiations. The clauses it objects to are common and, as Luis Asali, a civil and administrative litigation lawyer, said: “It is absurd for [the CFE] to complain about a clause they wrote into the contracts.”

The best it can hope for is a refinancing of the terms, or a contract extension, said a source close to one of the companies. “They aren’t just going to give away a third of their profits to the CFE.”