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President Enrique Peña Nieto at a facility in Veracruz in March in connection with the 76th anniversary of Mexico's oil nationalization. (Photo: Veracruz Government)
Wednesday, October 8, 2014
Perspectives

Mexico Oil: The Cartel Risk


Cartel cash to Mexican governor highlights investments risks.

LATINVEX SPECIAL
Tenacitas International

MEXICO CITY, MEXICO -- Following the momentous opening of Mexico’s hidebound oil and gas sector, the graft-ridden Gulf state of Veracruz has seen its stock rise, as investors ponder a potentially lucrative move into the oil-rich region. But the state has a long history of drug cartel violence and political corruption, so any investment requires careful weighing of the many risks involved.

Last month, Mexican President Enrique Peña Nieto signed into law a divisive energy reform that opened up a sector nationalized in 1938, allowing foreign firms to join state oil giant Pemex in exploiting the energy reserves of the world’s No. 10 crude producer. Early next year, Mexico will auction 28,500 sq km of oil and gas fields, in the first bite of the apple for investors. The eastern state of Veracruz, the second-biggest oil producing state and holding large parts of the massive Chicontepec basin, is certain to be one of the most coveted areas. But it is also one of the riskiest.

The Zetas, one of Mexico’s most bloodthirsty cartels, were formed in the neighboring state of Tamaulipas by Gulf Cartel leader Osiel Cárdenas to ensure his own protection, and have since set up shop in Veracruz, stealing oil, extorting businesses and terrorizing the population. And political leaders have historically done little to help – a worrying signal for investors seeking stability as a precondition for any investment. In 2004, Fidel Herrera of the incumbent Institutional Revolutionary Party (PRI), which has dominated Mexican and Veracruz politics since early last century, was elected governor. This month, U.S. court documents emerged in the Mexican press, indicating that $12 million of Zeta cash was spent on Fidel Herrera’s 2004 campaign.

Key testimony, which dates back to 2013, came from one of the cartel’s key accountants, Jose Carlos Hinojosa. Hinojosa detailed a complex and elaborate cartel structure, similar to those found in big corporations. Hinojosa’s own trajectory gives a fitting example of the level of collusion between politics and organized crime. Hinojosa started his career at the federal prosecutor’s office in Tamaulipas, but was eventually recruited to work “full-time” for the Gulf cartel, with whom he had been dealing on behalf of the prosecutor’s office for several years.

In Veracruz, Hinojosa alleges, the Zetas avoided legal trouble by copying the example of the Gulf cartel in Tamaulipas, paying “fees” to top state officials. While Governor Herrera’s name is never mentioned by Hinojosa, previous testimony from an FBI agent points directly to the governor’s office, which he says was given money by the Zetas in exchange for “freedom of range, freedom of moving the narcotics in the state of Veracruz”.

The accusations against Herrera are the latest in a string of charges, which include influence peddling and interference in municipal elections made against the man whom Forbes placed number eight on its 2013 list of Mexico’s “most corrupted individuals”.

In 2010, Javier Duarte de Ochoa became the new state governor, and his arrival was greeted by a wave of unprecedented violence. By then, the Zetas had outgrown their affiliation with the Gulf cartel and decided to break free, embarking on a ferocious territory battle.

Homicide rates soared, as did extortions, kidnappings and assaults. Bodies were dumped on the sides of the roads by the dozen, causing residents to stay indoors at night and schools and stores to shut for days at a time. Duarte, powerless in the face of such bloodletting, came under fire for playing down the number of victims.

A year after Duarte’s election, the bloodshed led to military intervention. In an attempt to crack down on corruption, 900 local officers were fired and the Mexican navy took over police duties in the port city of Veracruz.

From 2011, Mexican security forces began making major inroads, killing or capturing many of the Zetas’ top leaders, said Alejandro Hope, an independent security analyst who was formerly part of the Mexican intelligence unit (CISEN). But, Hope added, Veracruz is not yet free from the scourge of the Zetas: “They’re just far more decentralized.”

While violence seems to have dwindled, it is difficult to assess the extent to which corruption has remained in Duarte’s government. In a 2013 recording published by MVS Noticias, the public security ministry can be heard explaining to newly elected mayors how infiltrated the Zetas have become in local politics, with 97 of Veracruz’ 212 municipalities compromised.

In April, official numbers for homicides were revised up from 600 to 900, “or about the equivalent of Spain’s annual homicide rate,” Hope said. “Yes we have a decrease in violence since the peak of 2011, but the idea that violence is somehow manageable is simply not true.” A cause of concern for the federal government, which is banking on healthy interest in Mexico’s energy opening.

Big foreign companies, many of which are already in Mexico working for state-run Pemex, can afford the kind of expensive, large-scale security protocols that a state like Veracruz currently requires. And violence might not be so much of a problem for companies looking to bid on offshore deep-water projects.

But Mexico also needs massive infrastructure investments, with plans afoot to build roads, pipelines and storage tanks, which are critical to meeting the population’s growing appetite for energy and the expected increase in production. New ports will be constructed and terminals will be extended to boost efficiency and better compete in a market-driven environment, the government says. For such large-scale projects, states like Veracruz will require the intervention of domestic and foreign mid-size players too, less likely to be able to pay for expensive security operations.

And with political corruption so widespread in Veracruz, the U.S. Foreign Corrupt Practices Act, which promises heavy penalties on U.S. firms involved in corruption abroad, should give some U.S. companies pause for thought before investing.

Ultimately, said Mike Vigil, a former Drug Enforcement Administration agent who worked 13 years in Mexico, only a complete eradication of the cartels and their tentacle-like business interests will engender a risk-free investment for foreign investors.

“Cartels have created a new business model, it’s no longer the drug trade, it’s extortions, kidnappings and other kinds of crime,” he said. “So what you need is a top-to-bottom dismantling of these organizations.”

Republished with permission from Tenacitas International.

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