Commentary: Weighing Mexico’s security risks

Back in 2004 I attended an annual general meeting for a client that had acquired a gold-silver mine in Mexico. It was one of many Canadian juniors at the time who had managed to acquire small-scale mines with good expansion possibilities and, in a rising commodity price environment, had the potential to turn an explorer into a producer virtually overnight.

The board of this company was comprised of a number of experienced explorers, developers and operators. As sometimes occurs at AGMs of small companies (much to the chagrin of legal counsel worried about disclosure issues), responses to questions from shareholders quickly unfolded into a discussion on the overall state of the mining industry, commodity prices and favourable jurisdictions.

Everyone seemed bullish on Mexico as the place to be. The argument seemed to make a lot of sense, too: good mineral endowment, a local mining culture and a U.S. dollar-denominated economy all make for an attractive mining jurisdiction.

Moreover, the influence of the North American Free Trade Agreement in opening up Mexico to foreign investment was firmly taking hold, and extending to structural legal and regulatory reforms for the administration of mineral tenure.

Over the next few years Mexico’s star shone brightly in the mining industry.

Fast-forward to 2012: while the above argument is still valid (indeed, Mexico’s recently planned move to an electronic mineral tenure system is evidence of its continued commitment to efficiency), Mexico’s reputation as a favourable jurisdiction is not as secure. Security concerns seem to overshadow everything else these days.

This is especially the case for junior exploration companies, who seem to have been more adversely affected than the producers. Exploration companies do not have as much established infrastructure in and around their projects, and typically have smaller numbers of people working in more remote areas with limited-access options — often the same remote areas favoured by the drug cartels for their operations.

Explorers are also less able to implement security measures due to the costs involved and the pressures in a bear market to spend money wisely and “in the ground,” to the maximum extent possible.

A number of mining companies have quietly exited from some of Mexico’s more troubled states, unwilling or unable to pay maintenance costs in the face of so much uncertainty, and unable to attract joint-venture partners to share costs and risks.
But many companies remain in Mexico, and overall investment in the mining industry in Mexico remains strong, particularly with producing mines and late-stage development projects.

Strategies can be employed to manage the current security challenges for companies, and the central theme of many of these strategies is having community and social-relation (CSR) programs.

None of this is particularly new or really novel to Mexico — CSR programs are the key to developing a social licence to operate in any jurisdiction. The types of programs being conducted in Mexico are common to many developing jurisdictions where security issues are prevalent in remote areas.

The real issue in Mexico is the speed at which security issues have arisen after so much economic, social and political progress over the past 25 years.

The two most common approaches are quite different. Many companies seek to engage local communities from the outset and to forge relationships through social programs, infrastructure development and providing meaningful employment. At the other end of the spectrum, other companies are attempting to carefully manage interaction with local communities, limiting contact to maintain a more formal relationship. Typically these companies require expatriate employees to remain in camp and not visit the local communities. The goal here is to tread lightly on local customs, while avoiding any misunderstandings, problems and feuds that can quickly escalate into wider actions against the company.

In many regions where the drug violence is on the verge of being out of control, it is difficult for any CSR initiatives to bear fruit. Maintaining a low profile in the community is really the only way to try to stay clear of the potential violence in those areas.
Producers are more likely to maintain a low-profile approach, since operating mines typically have more on-site security in place and greater infrastructure to support operations, without as much interaction with nearby communities.

There is also the reality of producers having extracted mineral products on site, which is a significant security issue. Many gold producers maintain absolute secrecy over when gold pours take place at the mine site.

Similarly, transportation schedules are also a closely guarded secret. Rail service is not as widespread in Mexico, so many mines in Mexico ship products by truck over remote, single-access roads that are prone to robberies.

Some companies are resorting to building airstrips to fly precious-metal mineral production to ports, but that bears its own risks, in addition to the cost. In certain remote areas, aircraft are generally either government security forces or drug cartels carrying out illegal activities, so mining companies need to constantly identify themselves over radios to avoid being mistaken for one or the other.

Site visits by directors and executive officers also tend to be closely guarded secrets in remote areas, to reduce possible kidnapping and extortion risks. It is a common practice to ensure that all cheques and banking transactions require two signatures, to avoid instilling too much operational authority in one person.

The good news is that Mexicans seem to understand these challenges, and despite the setbacks, the mining industry in Mexico continues to roll forward with significant levels of investment.

The challenge will be what happens next if security problems continue over the long term.

The key to long-term success for any country’s mining industry is exploration. As the current generation of mines become depleted, it is essential to replace that production with new discoveries.

Overall, Mexico is relatively unexplored compared to other jurisdictions, but if exploration companies are unable to raise money for Mexican projects and efficiently explore their properties, there may be continued challenges ahead.

— Alan J. Hutchison is a partner and group manager at the Vancouver office of Fraser Milner Casgrain LLP (FMC). He practises in the areas of securities and corporate/commercial law, with an emphasis on mergers and acquisitions, corporate finance and corporate governance. Hutchison also practises in the areas of mining and energy law. Visit www.fmc-law.com for more.