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The lure of Mexico

Cover Story
|Written By Arshy Mann
The lure of Mexico

When Guillermo Cruz Rico moved to Canada in 2005, he left behind a life as a criminal lawyer in Mexico City, the megalopolis where he’d been born and raised. But in less than a year, he had settled down in Toronto and was working as an in-house consultant for Greenspan Partners LLP, the reputed criminal defence firm.

His first case involved a liquidation that overlapped in Canada and Mexico, where he was given responsibility over the Mexican side of the transaction. “It was my first exposure to the Canadian system,” says Cruz Rico, in a lilting Spanish accent.

He worked on a number of other files, both for Greenspan Partners and on his own. Most of them involved Canadians running afoul of Mexican law in one way or another. Some of his clients were facing charges of organized crime and drug trafficking.

At the time, the Mexican Drug War was just beginning to make headlines internationally. In 2006, President Felipe Calderón had sent federal troops into the state of Michoacán in an attempt to stop a wave of drug-related killings. The incursions marked the beginning of a conflict between the Mexican state and drug cartels that would leave over 100,000 people dead and still continues today.

Cruz Rico was not happy with the approach of the Calderón government.

“At the end of the day you are not able to deal with something that is an issue of public safety with a military intervention and war,” he says. “When you are trying to deal with a situation like that with violence, you are creating more chaos.”

But in the midst of the violence, Cruz Rico got an unexpected request. A Canadian company reached out to him and asked him for some advice.

“They had some questions about Mexico,” he says. “And I said, ‘honestly, I have been practising mainly criminal law in Mexico.’ But they said: ‘We have some concerns, we have lawyers in Mexico and we are not getting the proper answers that we are looking for.’”

That was a turning point for Cruz Rico who now leads Cruz Herrara Ltd. in Toronto. Since then, he has been assisting Canadian companies and individuals looking to do business in Mexico, both as Ontario’s first foreign legal consultant for Mexico and, more recently, as a lawyer called to the bar in Ontario.

Canada and Mexico have been doing a brisk business for decades. This year marked the 20th anniversary of the North American Free Trade Agreement, which greatly expanded levels of trade and investment between the two countries. As of 2012, Mexico was Canada’s third-largest source of imports and the fifth-largest market for Canadian exports.

But despite the commitment demonstrated by a handful of Canadian corporate giants like Bombardier, Scotiabank, Linamar, and Magna, many Canadian companies seem strangely wary about Mexico.

“Even after the 2009 financial crisis made it plain the U.S. economy had entered a period of stagnation, Canadians seemed more interested in the far-off and more uncertain prospects of China, India and Brazil — economies characterized by high growth and large populations but also formidable market access barriers,” wrote Laura Dawson, president of Dawson Strategic, in a recent report for the Canadian Council of Chief Executives.

Mexico’s reputation for violence certainly hasn’t helped. After almost a decade of feverish media coverage, many Canadians are now more likely to associate Mexico with gangland executions in Ciudad Juárez than white-sand beaches in Puerto Vallarta or humming factories in Monterrey. But mirroring the trajectory of Cruz Rico’s career, Mexico’s past may be associated with crime, the future will be all business.

On Aug. 11, Enrique Peña Nieto, the youthful president of Mexico, signed into law what may prove to be some of the most important legislation in Mexican history. The target was the oil and gas sector, which has been a government monopoly for three-quarters of a century.

The energy reforms were the capstone in a sweeping effort to break down Mexico’s old monopolies and oligopolies and turn the country into an easier place to do business. Telecommunications, education, and electricity have all been targets, but the sweeping changes to the oil and gas business are the most revolutionary — and represent the biggest opportunity for Canadian companies.

Since 1938, Petróleos Mexicanos, better known as Pemex, has managed the oil and gas industry on behalf of the Mexican state; private ownership of oil and gas reserves was constitutionally barred. But over the years, Pemex became a cash cow for the government, providing an enormous percentage of the country’s budget. While production skyrocketed on the American side of land and sea border, Pemex wasn’t able to adequately fund new exploration initiatives or develop current fields, leading to declining oil and gas production over the past decade.

“They’ve realized for a number of years now that they’ve needed foreign capital and foreign expertise to come in to help rejuvenate their production levels,” says Ryan Keays, an oil and gas lawyer for Norton Rose Fulbright Canada LLP, who has been going down to Mexico for the past year and a half in order to follow the development of the reforms.

Previous administrations have made incremental changes. In 2000, foreign companies were allowed in as contractors and were paid on a fee-for-service arrangement. But since they couldn’t book reserves and didn’t have a share in the upside of any projects, interest was limited. In 2008, an attempt at more significant reform was watered down in the Mexican Congress. It wasn’t until the election of Peña Nieto in 2012, who ran on a platform of sweeping economic reform, that real change looked possible. Last year, the government amended the Mexican constitution allowing private ownership for the first time; the August legislation finalized the rules, which foreign companies would have to play by, and Pemex’s role in the system.

The opening up of Mexico’s oil and gas industry will put in place a number of steps, with differing opportunities, for Canadians to get involved along the way. The reforms opened with the “Round Zero” process, which has already kicked-off and will determine what acreage under its control Pemex gets to retain.

Pemex will clearly retain their currently producing fields since they’ve already invested significantly into the infrastructure of those fields and have developed them to the current point,” says Keays.

But the ultimate fate of exploration blocks, and blocks in which Pemex has made discoveries but hasn’t started producing, is still up in the air. Some of these will be retained solely by Pemex, while other portions will be auctioned off in a joint-venture bid round, where foreign companies will be able to team up with Pemex.

The rest of it, especially the prized deepwater offshore blocks, will be apportioned out in an open-acreage bid round, which is expected to happen in December 2015.

“The main target of the reforms ultimately is the deepwater,” says Keays. “There’s a recognition by Pemex and by the government that they don’t necessarily have the expertise nor the capital to pursue the exploration of the deepwater on their own.”

Most of the international attention will be focused on the deepwater blocks, which are likely to fall into the hands of European and American majors. Canadian companies, says Keays, will likely have more of a role to play in other areas of industries.

“After the deepwater, probably the next biggest piece would be the shale resources and unconventional,” he says. “It’s not a prize of the same magnitude as the deepwater, it certainly is a key priority of the Mexican government to see the development of the shale industry there.”

South Texas, just across the border, has seen a boom in shale development over the past few years. Those same geologic formations stretch into Mexico, prompting many to expect a bonanza of development to take place there.

Keays expects Pemex to retain much of this acreage and bring in foreign joint-venture partners who have expertise in shale — a major opportunity for Canadian companies.

“Shale has been something that has gained in prominence in the Western Canadian basin over the last number of years and something that we’re one of the leaders in internationally,” he says.

“There’s recognition internationally that Canada has a lot to offer in those technologies and particularly with the service companies and their expertise and experience.”

He also expects Pemex to bring in foreign operators to help redevelop mature fields, an area that Canadian companies excel in.

“A lot of the conventional plays in Western Canada involve mature fields and trying to extend the lives of those fields and trying to extract incremental production from those fields,” he says.

Oil and gas that is difficult to extract due to complex formations and geology is another area Keays expects extensive Canadian involvement.

“When you look at shale development, mature fields, complex plays, those are the types of projects that lend themselves to small- and medium-sized companies, and that’s an area where we have both the expertise and capital for lots of startups that could get into that sector,” he says.

Mexico has been trying to woo Canadian players down south for a number of years — in 2008 they opened a consulate in Calgary to further ties with the oil and gas sector. But Keays says while he is seeing a growing interest in Mexico amongst Canadian companies, many players are still skeptical.

“I think the big thing that everyone’s asking about is, is this real? Is there traction this time around, because they’ve gone down this path a number of times before and it’s always sort of fallen on its face one way or another,” he says.

According to Keays, some small- and mid-cap firms, along with the service companies that had already been operating in Mexico, have shown a greater interest than larger oil and gas corporations.

“There are a lot of people that are sniffing around this and trying to get in front of the curve on reforms and understand what’s going on and strategizing how to go about entering Mexico and what the best approach would be,” he says.

Cruz Rico has also seen an increase in the number of energy companies approaching him with interest in Mexico.

“The people who have approached me mainly want to know how things are working, what the policies involved and who the key players are,” he says. “And the most important part is how they would be able to participate once everything is in place.”

But Keays thinks as the various bid rounds progress, Canadian companies will take a closer look at Mexico. I think that’s just sort of an awareness question and as the reforms have gained a lot more traction, it’s starting to have a much more real feel to it.”

Frank Alexander, an oil and gas lawyer at Dentons Canada LLP, says while the reforms certainly make a much more attractive destination for oil and gas companies, some questions remain unanswered.

“Most countries in the world that have petroleum regimes offer what we call stabilization,” he says. “So essentially it means they’re still sovereigns, they still have the legal power to pass any law they want, but if they do pass such a law unilaterally damaging the fiscal position of the oil company, then the oil company will be entitled to damages.”

Only a handful of very developed countries, like Canada, the United States, and the United Kingdom, don’t provide some form of stabilization. But Mexico has yet to spell out whether or not energy companies will have any form of recourse. And there are already a few worrying signs. Alexander points out that the exploration and production contracts include specific clauses for “administrative rescission.”

“In other words the government will have the right to terminate the oil company in certain circumstances such as where there is an unjustified suspension by an oil company of its operations, where the oil company has made an assignment of interest that was not approved by Mexico, or where the oil company failed to comply with its exploration and or development obligations,” he says.

On top of that, the Mexican legal system is sure to present difficulties to any firms that don’t trod carefully, a lesson many Canadian mining companies have learned the hard way.

The third rail – land ownership

Canada has long been a dominant player in Mexico’s mining industry. Around 75 per cent of total foreign investment in the mining sector comes from Canada, and Canadian giants like Goldcorp Inc. and Teck Resources Ltd. have had a presence in the country for many years. But despite their success, many firms have tripped up when it comes to the issue that has long been the third rail of Mexican politics — land ownership.

Ever since the Mexican Revolution a century ago spurred a massive redistribution of land from a tiny elite to the masses, small landowners, known as “ejidos” have communal rights and privileges unique to the Mexican system. This has often brought them into conflict with foreign mining companies.

“Some companies are having quite severe problems in Mexico due to the lack of understanding of the cultural dimension,” says Cruz Rico.

In 2012, Excellon, a Canadian silver miner, had one of its mines blockaded by ejidos for 99 days. Earlier this year, the Ejido Carrizallillo led a strike that shut down mining activities at a Goldcorp mine for 33 days.

“You have to keep in mind that when you’re getting mining rights, you’re getting rights for the underground, but you’re not getting rights for the surface,” says Cruz Rico.

Groups as small as 20 individuals can claim rights to a certain parcel of land. While companies can be granted mineral rights over a block of land for up to 30 years, these leases often break down after only a few years because of conflicts with ejidatarios. The agrarian courts can even overturn leases and nullify contracts if they believe an agreement was not drafted correctly.

“I have been involved with some cases where those legal requirements were not fulfilled and the sector regulation was not observed, therefore anybody who was part of that group would be able to claim a breach of contract and would be able to ask that that contract be declared void,” says Cruz Rico. “For that reason some companies and businesspeople from Canada believe they are not getting the results that they were looking for.”

Cruz Rico says that some general counsel for mining companies believe once they’ve gotten a concession to operate a mine, have signed a lease and have obtained permits from federal, state, and municipal authorities, they’ve fulfilled their obligations and don’t need to continue talking with ejidatarios.

“If I have the title, why should I start dealing with different actors,” he says. “But the problem is that lease, maybe it wasn’t properly signed, or they are not fulfilling the specific regulations, and for that reason they find this confrontation,” he says.

Carlos Solórzano, a lawyer with SMPS Legal, which has offices in Calgary and Mexico City, has seen this sort of situation unfold often.

“Show me a failed venture in Mexico and I will show you a naive, if not negligent, business development team,” he says. “A lot of mining companies reach an agreement and then forget about the community.”

Solórzano says oil and gas companies will experience similar challenges as mining companies have in Mexico.

“One of the things that they’re going to struggle with is the social component,” he says. “Most of the operations are going to be remote areas where people have been neglected. So companies coming in will have to have very strong social policies that immediately have to deploy benefits to the community in order to gain that will that is required to have a smooth operation.”

Solórzano says he’s seen many major Canadian mining companies struggle with issues around agrarian law because they didn’t hire professionals with expertise in those areas. “They go thinking that Mexican issues can be dealt with the same way that you deal with issues in Canada, from government issues to land issues,” he says.

Companies that come into confrontation with agrarian communities can face worse than just work stoppages — a small number of disgruntled ejidatarios have been known to resort to oil theft from pipelines. Between 2012 and 2013, over 1,500 illegal oil taps caused around $1.1 billion of oil to be siphoned off.

But while some ejidatario have been known to place ludicrous demands on corporations, most are looking for fair and reasonable comprises and many make their livelihood in extractive industries.

If they want to be successful, oil and gas companies operating in Mexico will have to find ways to build relationships with these groups. While the reforms do provide greater incentives for ejidos to reach agreements with oil and gas operators, the fundamental question of land ownership will remain a thorn in the side of many companies.

But Cruz Rico says there are some fairly simple solutions to these problems. He recommends companies be forward-thinking when it comes to their corporate social responsibility policies and make sure they’re tailored specifically to Mexico. He also says it’s imperative companies ensure they’re fulfilling all promises made to landowners and that lease agreements are drafted correctly the first time around.

“If the approach to CSR changes, and Canadian and Mexicans would be able to sit and talk on the same level, things would be different,” he says. “They are two different systems, two different ways to close deals. But at the end of the day, if you’re able to create a clear channel of communication and both parties are on the same page, I think the sky is the limit.”

Solórzano agrees.

“If you pay people, if you keep work going, if you open a school, if you bring fresh water, they’re not going to bother you,” he says. “But if you don’t, if you’re greedy, you have issues.”

Mexico’s oil and gas industry still faces a number of challenges ahead. The national hydrocarbons regulator, which goes by the acronym CNH, is being given massive new responsibilities, and it’s unclear how they’ll utilize them. Violence, while subsiding, is still a scourge on much of Northern Mexico where the most lucrative oil and gas deposits are believed to be.

And though Peña Nieto’s government was able to rally a large coalition of both houses of the legislature to pass the reforms, they’re very unpopular amongst segments of the Mexican population.

Protestors have taken to wearing masks of Lázaro Cárdenas, the populist Mexican President who nationalized the energy industry in 1938. There’s a danger the reforms could be rolled back if a new administration is elected in 2018 or if the rollout of the new regime is botched in any way.

But while Cruz Rico acknowledges that difficulties are inevitable, he’s optimistic about the potential.

“If we would be able to get together and understand each other, this could be beneficial for both ends of North America.”


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