Mexico Seeks Energy Reform

Roberto Eraña & Alexander P. Trueba

Mexican President Enrique Peña Nieto unveiled his energy reform on August 12 that proposes to open up the energy industry by allowing private and foreign investment in the sector.  The proposal, the cornerstone of Peña Nieto’s domestic agenda for economic growth, will structurally change the industry in an effort to position Mexico for stronger job creation, lower energy costs, and to revive an industry plagued by decreased production and high inefficiencies.

Reforms to the energy industry are a delicate subject in Mexico.  The industry has been state-owned by Petroleos Mexicanos (Pemex) since 1938, when foreign oil companies were nationalized.  It is a major source of national pride given it provided the then young country with a sense of independence from foreign interference, a feeling that persists.  The President’s challenge will be to sell the changes to the country and reverse oil’s nearly mythical image.

Key Oil & Gas Reform

The most prominent change will allow Pemex to enter into profit-sharing contracts with private companies, bringing much needed technical expertise and capital to oil, natural gas and shale projects such as deep water drilling and exploration.  The shift in policy is needed given crude oil production has dropped 26% to 2.5 million barrels a day from a peak of 3.4 million barrels a day in 2004, as production from established reserves in shallow water and inland fields has declined.

From 1979 to 2007, Mexico produced most of its oil from the giant Cantarell field, which used to be the second largest reserve in the world. The massive output from that field, and others like it, allowed Mexico to defer investment in technology or explore new reserves without repercussions.  However, production from the Cantarell field has dropped 80% from its peak, with other fields reeling from similar results.

Mexico is still a major player in the oil industry, currently the world’s 10th largest producer of crude according to OPEC. It has an estimated 14 billion barrels of proven oil reserves at its disposal, third in Latin America only to Venezuela and Brazil, in addition to possessing significant gas and shale reserves. Unfortunately, due to limited capital and low historical investment in technology, it has neither the necessary techniques nor the funds to adequately take advantage of the untapped resources. At its current pace, Mexico is slated to become a net importer of oil by 2020.

Additional Reforms

The President’s plan also calls for allowing new players in electricity generation to compete with the state-owned monopoly, CFE (Comisión Federal de Electricidad).  The President hopes that by allowing competition, new investment and market forces will lead to higher supply and lower costs.  Manufacturers in Mexico currently pay nearly double per kilowatt-hour compared to the US, and even though consumers receive subsidies, they also pay 25% higher rates than the US.

Other proposed reforms reach into gasoline refining.  While Mexico is the third largest exporter of crude to the US, they import half of its gasoline form the US.  The reforms will allow for competition in the refining, transporting and storing of gasoline, all areas that lack modernization and capacity.

Pemex and Fiscal Reform

As part of the process to open the energy industry to competition, the President’s proposal calls upon changes to Pemex itself.  Currently, Pemex sends nearly all of its profits to the federal government, with no flexibility to do otherwise.  In fact, 33% of the Mexican government’s revenues come directly from Pemex.  The proposal would allow Pemex to treat the government like a shareholder, and pay dividends when appropriate. The government would still receive significant revenues through taxes on the company, but the proposed flexibility would insure the company has much needed discretion in capital investment so that it does not continue to fall behind.  Initially the government would take in less revenue from Pemex, which would be funded by widening the base of products the value added tax (IVA) applies to, now to include food and medicine among them.  Over the long term, as production and efficiencies improve, Pemex’s contribution to the national budget is expected to increase.

Convincing Politicians, Foreign Investors

Mexico’s refusal to cede ownership of the oil reserves may prove to be a key obstacle in drawing the full attention of major oil companies.  Profit sharing arrangements do not allow investors to recognize the reserves on their balance sheets and therefore may impede share price growth. Limiting upside for investors may restrict the flow of capital. However, the proposed structure for the reforms was likely a careful decision and compromise Peña Nieto made in an effort to enact change by delivering a proposal the people could get behind and ultimately pass.

Internally, the reforms will require amendments to articles 27 and 28 of Mexico’s constitution, which grant the public sector exclusive control of the oil and gas industry. The amendments will need two-thirds support in both Mexican houses of congress to pass, followed by a majority of state legislatures. The President’s party, the Institutional Revolutionary Party (PRI) enjoys a majority in congress and is supported in this endeavor by the conservative party, the National Action Party (PAN), which proposed their own aggressive energy reform recently.  The President’s chief of staff, Aurelio Nuño Mayer, has stated that he is optimistic that the bill can be ratified before the end of the year.

To do so, it may need to overcome public sentiment, which was recently reported at 65% opposing opening the energy sector. Additionally, they should expect public demonstrations and rallies staged by the leftist opposition leader Andres Manuel Lopez Obrador, who has used similar tactics in the past.

Economic Impact

Mexican government officials approximate that the reform could add 1% of growth to the economy by 2018 and up to 2% by the year 2025.   In the short term, the most important impact would be felt via Foreign Direct Investment.  Total net annual inflows to Mexico averaged $20 billion over the last five years with the energy sector only receiving $360 million.  Investment Bank CIBC estimates this proposal could jumpstart total FDI and projects it as high as $50 billion within 10 years.

In the decade after joining NAFTA in 1994, FDI quadrupled and exports to US and Canada tripled, driving sustained economic growth.  Mexico is hoping that changes to the energy sector will promote growth in other areas, having a trickle down effect as cheaper energy supply drives investments in manufacturing, infrastructure and other projects.

For the moment, the President’s reform seems to be a good middle ground compromise, neither too radical nor too conservative. If passed, the plan’s success will hinge on how investors view the opportunity after they carefully review the details in the law and related legislation.  Nevertheless, the bold proposal is, at a minimum, a step in the right direction.

Sources: Reuters, Wall Street Journal, El Economista, Forbes, Global Post, Milenio, El Diario, LA Times, NY Times, Financial Times, CNN Mexico, McClatchy, The Globe and Mail,


Commodity Dependence: A look back at the “Decade Of Latin America”

Rob Wagstaff & Alexander P. Trueba

For the last decade, Latin America has ridden a commodities boom on its way to economic expansion. LatAm’s dependency on commodities is no secret and has grown to the point where today, commodities account for close to 60% of all exports for the region, excluding Mexico. For many of the region’s economies, China is their largest export destination. However, as China’s growth now begins to moderate and global commodity prices drop, what some call “the decade of Latin America” seems to be inching closer and closer to a tipping point. All signs suggest that Latin America will be forced to diversify its economy in order to maintain its place amongst the fastest growing regions of the world.

LatAm Thrives, China & Commodities Main Drivers

As China’s economy began expanding at an average rate of 9.5% during the first 5 years of the 21st century, and at an even quicker pace shortly there after, a need for natural resources outside of its local inventory arose. A developing industrial power requires fuel to motor its industry, food to feed its growing population and metals to expand its infrastructure. Enter Latin America; blessed with a vast array natural resources and raw materials, LatAm was able to capitalize on high Chinese demand and reap the benefits of elevated commodities prices and large orders for over a decade. China quickly became one of the world’s largest trading nations. Between the years of 2001-2010, China grew to import almost 53% of the world’s iron ore, 45% of the world’s soybeans and 18% of the world’s copper.

Simultaneously, key Latin American economies increased their percentage share of world commodity exports; Brazil
grew to rank second globally in iron-ore, Brazil and Argentina ranked second and third respectively in soybeans and
Chile first in copper. Annual trade between Latin America and the developing super-power grew nearly 1,200% during
the same time period according to the United Nations (UN). As a result of these elevated commodity prices and partially due to China’s economic ascendance, Gross Domestic Product (GDP) in Latin America averaged nearly 4% growth over the last decade, compared to 2.7% the previous decade. Unemployment in countries such as Brazil, Chile and Colombia hit all-time lows. LatAm also took positive
measures to alleviate poverty, which once stood at 48% in 1990 and now currently sits at 28%, according to the UN.
They even have managed to grow their middle class by nearly 50 million people since 2003, 30 million of which come
from non-Brazilian countries.

Historical Commodities Effect on Brazil, Changes for the Future

One nation that benefited greatly over the last decade from the commodities boom is Brazil. The South American country is rich in natural resources and is the world’s second largest exporter of iron-ore, a material used in everything from infrastructure construction to automobile assembly. Iron-ore makes up 15% of Brazil’s total exports. The Amazonian nation is also the world’s second largest exporter of soybeans, ranking ahead of Argentina. China is its most important market for both exports. Chinese imports from Brazil grew from nearly $1 billion in 2000 to $44 billion in
2011, a staggering amount of growth. Yet, contrary to popular belief, its Sino-dependence might be much lower than once believed. Exports to China are worth less than 2% of GDP according to a 2013 BBVA report, signifying that Brazil depends heavily on diverse export base to multiple countries other than China to help fuel GDP growth. Still, this diverse export base is primarily commodity driven, made up of sugar, coffee and beef, leaving it susceptible to price fluctuations.

In Q1’13 Brazilian exports fell by 8% and economic growth came in at 0.6%, under forecast for the 5th straight quarter, showcasing the enduring effect that a long-term commodities slump could have on them. Infrastructure and logistical insufficiencies have decelerated economic growth as well. Historically, mismanaged windfall commodity revenues have contributed to this deficiency. Brazil’s investment ratio stands as one of the lowest in LatAm at 18.4% of GDP. Only 5% of Brazil’s roads are currently paved and lines to get into some large ports are reportedly up to 15 miles long. Brazil has realized its shortcomings and is taking measures to amend the situation by investing more in domestic infrastructure. Earlier this year it passed a $26 billion bill to revamp its port infrastructure, which the government estimates could cut logistics costs by 30%.

Andean Region Effect/Mexico Outlier

Far and away the world’s largest copper producer, Chile relies heavily on commodities for economic stability. It has maintained its position as the world’s leading copper exporter for the past 50 years. Copper accounts for about threefifths of export receipts, 20% of government revenues and 15% of Chile’s GDP. In turn, over the past 12 years, China has imported more copper than any other nation, needing the metal for countless property and infrastructure projects. However, prices have dropped almost 5% in the past 12 months partially due to the Sino slowdown and the results could spell trouble for the Andean nation. If prices continue at the same pace, Chile could lose up to $4 billion in revenue from copper exports and up to $2 billion in royalties from private and state-owned firms. Of note, first quarter 2013
GDP growth came in under projections at 4.1%. Mexico seems to be the country in Latin America best built to withstand a commodities price reduction. With an economy less tied to commodities and driven more by services and manufacturing, Mexico does not depend on China and commodities in the same manner as other LatAm nations. Mexico is much more reliant on its northern neighbor, the United States, which has safeguarded them from the current weak global economy. In 2010, 74% of all of its exports were to the United States, and 73% of its imports originated there. The majority of these exports were not commodities, but instead industrial manufactured-exports such as automobiles and electronics. However, the veil of protection the United States provides can also act as a negative, exemplified by Mexico’s lack economic production during the most recent US downturn, when their growth slumped and bottomed out at negative 6.0% in 2009. Economic reliance on one nation can be just as harmful as reliance on a certain economic sector such as commodities; Mexico must diversify to insure against any possible future U.S. slumps.

Signs of Change: Diversity Out of Necessity

Despite the previously stated advances and benefits associated with its commodity-driven growth, Latin America would benefit greatly from a more balanced economy. By investing more in sectors such as infrastructure, education, service industries and technology, Latin America will be better suited to face current and future global market conditions. Some countries have already taken steps to improve their economic foundations. For example, Brazil’s $26 billion port infrastructure improvements, Chile’s education budget increases that now stand at $12.8 billion, Mexico’s recently enacted labor reforms, and Peru and Panama’s new capital city metro systems are steps in the right direction. Nevertheless more must be done in the upcoming years if Latin America is to retain its place amongst the fastest growing regions of the world. The good news for LatAm is that its economic foundation is strengthening. With growing political stability, a surging middle class and an increased emphasis on domestic investment, the region has the basic platform to improve upon current economic growth.

Sources: Wall Street Journal, Bloomberg, Diplomatic Courier, BBVA, Reuters, Financial Times, Eurasia Review, The Observatory of Economic Complexity, World Crunch, World Bank

Clean Energy in Latin America

Raymond A. Perez & Alexander P. Trueba

Over the last decade, energy consumption in Latin America has grown at a pace of 3% per year due to a surge in economic activity. Fortunately, the region has been blessed with some of the most precious natural resources on the planet, many of which are crucial in the development of clean, sustainable energy. Yet still, many of these resources remain unharnessed, leaving a window of opportunity for investors as countries in the region continue to grow at a rapid pace while the demand for energy increases.

Although global investment in clean energy diminished nearly 11% in 2012, led by reduced incentive programs in select European countries, Latin America ex-Brazil is bucking this trend. New financial investment in clean energy within the region increased 127%, totaling $4.6 billion. Specifically Mexico, Chile, Uruguay and Peru experienced dramatic growth when compared to 2011 investment totals.

New investment in Mexico, a hotbed for renewable energy investment given recently enacted regulations, leaped 595% and reached $1.9 billion. Much of this investment was focused on the wind ($1.3 billion) and solar sectors ($300 million). Mexico has vast renewable potential given its landscape and geographic location, with an estimated 45 GW of solar and 71 GW of wind power potential. Mexico generated 26% of its electricity through renewable clean energy in 2012. Its goal is to increase that figure to 35% by 2024.

In 2012, four wind farms were erected and became operational, raising Mexico’s current wind power capacity to 1.7 GW. These investments helped wind power surpass geothermal energy as Mexico’s the principal clean energy source. During this period Mexico took a step forward in solar energy investment. Capitalizing on the nation’s level desert land and long sunny days, Martifer SGPS SA, a Portuguese energy firm, agreed to construct a 20 MW solar farm in northern Mexico and Sonora Energy Group de Hermosillo (SEGH) began work on a 39 MW photovoltaic plant in the state of Sonora. In early May, U.S. President Barack Obama visited Mexico and praised it for its commitment to reduce carbon emission through solar and wind technologies. The President even hinted at a new energy partnership between the two nations.

Much like Mexico, Uruguay has taken a leap into the forefront of the clean energy movement, exemplified by the fact that almost 80% of its electricity is produced by hydroelectric plants. Although much of the hydroelectric potential has already been tapped, the nation still shows much promise. Total new clean energy investments in 2012 totaled $105 million, a 285% increase when compared to 2011. Uruguay has a goal of having 90% of all of its electricity come from renewables by 2015. It must now turn to leveraging its solar and wind capacities if it is to be successful in attaining this goal. As of August 2012, 21 wind farms were under development in Uruguay, and just this past week the government issued a declaration to stimulate the development of 200 megawatts of solar-energy projects.

As for Brazil, a historic hub for biofuel production, clean energy investment reduced by 32%. However, Brazil accounted for over 50% of total new investment in Latin America ($5.2 billion) and remained ranked in the top 10 of G-20 countries for clean energy investment. Although the nation’s ethanol industry experienced weaker demand, the Brazilian government has recently cut taxes and extended credit to the sector in an attempt to revive the industry. The hope is that the cuts will lower fuel prices and diminish the nation’s reliance on gasoline imports, therefore reducing inflation. With a projected record cane crop this season, Brazil also proclaimed a blending decree that raises the blend of ethanol in gas to 25%, up from 20%. The nation is turning to other renewable sources as well, such as wind power, which managed to increase capacity to 1.1 GW given $3.5 billion of new investment. Solar has also seen a jump, as many projects are being installed ahead of the 2014 World Cup.

The Inter-American Development Bank (IDB) has been crucial in stimulating new investment in the region. Just this past month, the IDB created a $50 million energy efficiency fund specifically for Latin America, providing loans to help control electrical costs and greenhouse-gas emissions. They also approved a $41.4 million loan to fund three Chilean photovoltaic solar power plants in the Atacama Desert (26.5 MW total capacity) that will aid in providing energy to the country’s mining sector. New clean energy financial investment in Chile rose 313% to $1.0 billion. Investments were made mainly in the wind and hydroelectric sectors. This is a step in the right direction for the rapidly growing nation; it currently depends on imported fossil fuels for 60% of its energy generation. A move to domestic clean energy could save Chile billions of dollars and help it escape from its dependence on foreign oil companies.

The International Finance Corp. (IFC) also played a role in stimulating capital, investing $100 million in InterEnergy Holdings to help foster development of wind and solar power in the Dominican Republic. InterEnergy will also use the capital help the D.R. import more LNG (liquefied natural gas). The IFC also signed a $75 million loan agreement with BBVA Continental, the second-largest bank in Peru, $30 million of which will be used to expand renewable energy through hydroelectric power. In 2012 Peru attracted new clean energy investments totaling $643 million, a 176% increase compared to 2011.
As Latin America continues to grow and its demand for energy increases, the region must take advantage of the natural resources it has at its disposal. Wind, solar, hydroelectric and bio-fuels all have the potential to thrive in Latin America given its location and topography. Steps in the right direction have already been taken. Latin American governments have endorsed many renewable energy initiatives and much public and private funding has been targeted at the sector. Given these factors, coupled with an increasingly environmentally conscientious global population, the renewable clean energy industry presents an attractive alternative for investment, and will act as on of the catalysts for sustained growth in the region.


Sources: Wall Street Journal, Bloomberg, The PEW Charitable Trusts, Fox Business, The Inter-American Dialogue, Renewable Energy World, World Politics Review, IDB, The Energy Collective, Clean Technica, IFC, Reuters

Brazil Infrastructure 2013

Eugene Rostov

Recent news articles from Brazil are estimating the infrastructure needs for that country in the next 30 years of about R$ 253 billion. That estimate includes amounts of R$ 91.1 billion for railways, R$ 42 billion for highways, R$ 20.2 billion for ports, and R$ 11.4 billion for airport concessions. The High Speed Train project between Rio de Janeiro and Campinas, known by its abbreviation in Portuguese as TVA, is not included in the above estimates.

Given the extraordinary amounts involved, it is clear that domestic and international private sector money will be essential to accomplish these ambitious goals. The enormous prospects for mega public bids in turn are generating a great deal of interest by administrators of investment funds in Brazilian companies participating in infrastructure projects. In the coming months there will be, for example, public bids opened by the federal government for 10,000 kilometers of railways and 7,500 kilometers for highways. The energy in public bids for wind energy projects is expected to be more expensive this year as a result of the increase in the cost of equipment.

In addition, there will be bids for dozens of leased areas in public ports, and authorization of new private ports, as a result of the issuance of Temporary Legislative Measure (“MP”) 595. A ranking published in September 2012 in the World Economic Forum shows Brazil in the ten worst performers in terms of the quality of its port structure among the 144 countries analyzed. As many people know, the ports of Brazil are chaotic. In part this is due to the fact that the international commerce of Brazil doubled in the last ten years, and 94% of that commerce passes through the ports. MP 595 was authorized in December to reverse the performance of the country’s ports and encourages private investment in that sector. Given the critical importance of the ports to the continued economic development of Brazil, the recent legislation revokes prior legislation, which had strong restrictions on private investment. One of the practical effects of the bottlenecks in Brazil’s ports is the export of soybeans. Up to this point, those bottlenecks had simply increased the cost for the Brazilian producer. It now appears that these barriers will restrict the future growth of grain exports.

Unfortunately, the timeframe for these kinds of infrastructure projects, by definition, is long. For example, the first stage for the bidding of the high-speed train, which is the Concession for the Operation, started in December of last year with the publication of the bidding terms. In January and March of this year official meetings were held for clarifications for the bidders. The proposals by the competing companies will be judged and the winning concession will be formally registered in November and signed in February of 2014.

Based on the long time that such infrastructure projects need in order to be financially viable, and the enormous capital needs from the private section, the Brazilian government has attempted to create mechanisms to provide an adequate return and security necessary for such investments until the projects begin generating cash, and in various cases even after the projects begin generating cash.

In 2011, the Federal Government created Law n° 12.431, which has subsequently been amended. That Law provided a number of income tax benefits such as for (i) the financing of investment projects by foreigners through public distributed securities, (ii) the financing of domestic infrastructure projects with debentures issued by special purpose companies investing in priority segments of Brazil’s infrastructure such as, energy, transportation, basic water and waste, and irrigation, and (iii) the investments made by residents and non-residents in investment funds, which invest in the debentures of the special purpose companies mentioned above.

The recent annual publication by the World Bank and IFC on Doing Business 2013 compares business regulations for domestic firms in 185 economies of the world. In that report Brazil is ranked 130th for the ease of doing business. To start a business it is ranked 121st and the time necessary to start a company is 119 days. For dealing with construction permits it is listed as 131st. In getting electricity it is ranked 60th. As to paying taxes, it is in 156th place among the 185 economies. In the category of trading across borders it is 123rd. It comes in 116th place for enforcing contracts. Even as Brazil tries to overcome its immense structural challenges, it must also address its business regulations, which ultimately will control the administration of its infrastructure.

Regional Review & Outlook

Roberto Eraña & Alexander Trueba

Latin America and the Caribbean continue to prosper economically, evidenced by GDP growth of 3.1% in 2012, according to the United Nations Economic Commission for Latin America and the Caribbean (ECLAC). Overall, the region outperformed world growth of 2.2% in 2012. Regional economic expansion was fueled by strong demand for natural resources, the resurgence of manufacturing and an all-time high of $150 billion (Bn) in FDI.

Economists’ projections for 2013 remain bright, with growth expected to accelerate to 3.8% driven by Mexico and Peru, and an expected resurgence of the Brazilian economy. However, as is the case of all regional economic assessments, there are multiple uncertainties heading into 2013. Which country will become the next regional success story? How will political and economic turbulence in Argentina and Venezuela affect the region? Can Puerto Rico and the Dominican Republic revive themselves despite the U.S.’s slow recovery?


After a decade as the region’s most prosperous economy, Brazil suffered a setback in 2012. Due to the European crisis and China’s decreased growth, the Brazilian economy grew approximately 1.0% this past year, lower than the 3.3% originally predicted, and less than the 2.7% growth in 2011 and 7.5% in 2010. In the boom years, Brazil benefited from sale of commodities such as iron ore to China, large oil discoveries, and emergence of a large middle class. Now China has slowed, oil production does not appear as optimistic as once predicted and foreign direct investment has decelerated.

Brazil is looking at a number of stimulus measures to boost the stalling economy. To foster this bounce-back, Brazilian President Dilma Rousseff aided the passing of reforms related to tax and electricity price cuts, and is in the process of spearheading a bi- regional trade agreement between MERCOSUR and the European Union. Brazil is not only looking to bolster trade to Europe, but also within the Latin American region and will pursue more trading with its local MERCOSUR members. Economists currently forecast 2013 economic growth between 3.0 – 4.0%.

In 2013, Brazil will also need to balance stimulating growth while maintaining inflation in check. Over the previous 5 years Brazil has averaged an inflation rate of 5.2%. In January 2013 inflation rose at its highest monthly pace in over eight years, producing an annualized rate of 6.2%. Complicating this careful balance is the currency’s recent trend to weaken versus the US dollar, increasing inflationary pressures as prices on imported goods continue to rise. The central bank’s ability to fight inflation with higher interest rates is limited for fear of affecting the already weak economy. For now, the central bank is supporting a tight Dollar-Real trading range of 2.00 – 2.05, and is keeping interest rates steady at 7.25%.


Mexico’s GDP is projected to grow 3.3% in 2013, according to the Organization for Economic Co-operation and Development (OECD), a slight decline to the 3.8% growth achieved in 2012. Mexico’s 2012 economic results were achieved while maintaining a moderate debt level (low 40% debt/GDP), keeping inflation at bay around 3.5-4.0% and a peso trading between 12.6 – 14.4 range over the last twelve months, averaging 13.1 versus the dollar.

Part of Mexico’s success is attributed to the country’s resurgence in manufacturing. Mexico is benefiting from a reversal of outsourcing to China and Asia, where labor costs have skyrocketed and fuel prices have reduced the benefit of sending manufacturing to the Far East. Mexico’s competitive labor market, coupled with new labor reforms and its proximity to the U.S. have once again become an important asset. Mexican stock market also saw great success in 2012, reaching new highs and witnessing the birth of financing through public REITs (fibras) in the commercial real estate and hospitality sectors. This trend is expected to continue into 2013 given expansion into the industrial real estate.

These positive manufacturing trends and stock market evolution combined with the recent election of a pro-business president set the stage for Mexico to achieve its growth targets for the upcoming year, in spite of uncertainty in the world economy.


Peru is South America’s leading growth nation. The Andean state’s GDP grew 6.3% in 2012 and steady growth of 6.1% is projected for 2013. A rising domestic demand in connection with decreasing unemployment, which dropped to 5.6% this past December, and rising income levels is driving the Peruvian economy. Inflation has been restrained at 2.9%, borrowing costs have not been altered in the past 20 months, and the central bank intends to maintain its benchmark rate at 4.25% for the entirety of 2013.

In 2013, the country’s $177 Bn economy is getting a boost from its mining sector, which is stimulating construction and infrastructure projects. The nation is home to a myriad of mineral deposits, primarily copper and gold, but also substantial deposits of zinc and lead. Mining investment is predicted to grow to almost $10 Bn in 2013, compared to $7 Bn in 2012. All in all, the mining sector makes up 60% of Peru’s total exports and is a major driver of the Peruvian economy. Much of these exports go to its largest trading partners, the E.U., China and the United States. Recently, Peru and the E.U., where the country exports roughly 18% of its products, signed a trade agreement that will go into effect March 1, 2013 and could bolster Peruvian GDP as much as 1.0%.

Economists do see slight concerns for Peru when it pertains to their education system and political delicacy but overall growth in the next 5 years is projected to average anywhere from 4.0%-5.0%, out-producing many of its regional neighbors.


Colombia, the region’s 4th largest economy, grew at 4.5% rate in 2012, a slowdown from its 5.9% growth in 2011. The deceleration was partly due to due to tepid growth experienced by its two largest trading partners, the United States and Europe. In 2013 Colombia is forecasted to grow at the same rate as 2012, according to the International Monetary Fund (IMF). Colombia’s oil and mining exports are expected to support these growth projections, as are the recent Central Bank rate cuts, which now stand at 4.0%. The Central bank has made five rate reductions since July; cutting 125 basis points in attempts to further stimulate economic activity. The country also continues to benefit from an impeccable debt ratio (15% of GDP), political stability and growth in the oil and gas exploration industry.


In 2012 the Panamanian economy grew a region-leading 10.5%, slightly below the 10.8% expansion achieved in 2011, according to ECLAC. For 2013, Panama is projected to moderate growth to approximately 8.0%, yet still remain the fastest growing economy in the region. The main driver of this economic progress is public investment, and at the center of this investment, the expansion of the Panama Canal. Currently, approximately 4% of the world’s trade passes through the Canal, and after the $5.3 Bn expansion expected to be complete in 2014, that figure is anticipated to increase given a doubling of the canal’s capacity. In addition to the Panama Canal expansion, the country benefits from additional infrastructure investments such as the construction of the first line of a brand new Metro system throughout Panama City, slated to open in 2014, and an expansion of Tocumen International, Panama City’s principal airport.

Private investment directed to the country’s mining sector also plays a featured role in Panama’s economic development. This is due in large part to the discovery and construction of the Cobre Panama mine, Central America’s largest mining development.

The mine, owned by Inmet Mining Corporation, has an expected lifespan of over 31 years, contains an estimated 6.5 Bn tons of copper and is expected to generate more than $7.0 Bn in royalties and tax revenue for the Panamanian economy At full-scale production, it will turn Panama into one of the globe’s leading copper exporters.

However, the country faces several challenges in maintaining strong expansion, including a slowdown of Asian manufacturing (China ranks second in both origin and destination of goods passing through the canal), a tight labor market with unemployment under 5.0% and inflation of 4.6%. Further, the strong growth experienced over the last several years and a related real estate boom, have some worrying about a pullback. For now, however, the canal, recent infrastructure investments, the mining sector and regional banking and trade activity continue to drive the economy.

Puerto Rico

After six years of steep declines in economic activity, Puerto Rico is looking to break from this downward trend with estimated 0.4% growth in 2012. However, weak economic fundamentals persist and the government has already cut 2013 growth forecasts to 0.6% from 1.1%. The local economy is facing a wide range of issues including high debt levels, large unfunded public pension liabilities, tax noncompliance, unemployment above 13.5% and a declining population.

The high debt level of approximately $67 Bn, compared to a $64 Bn economy, and constant budget deficits led to a recent downgraded of Puerto Rico to Baa3, one rating above junk, by Moody’s, and caused S&P to issue a statement indicating a likely downgrade. These ratings are important given the large amount of US fund managers that invest in Puerto Rico debt due to its favorable tax treatment. A rating of “junk” would force a significant reduction in the ability of these managers to invest in the securities, driving up yields and future borrowing costs.

Looking to lead the turnaround is the newly elected governor, Alejandro Padilla, who announced a wide range of initiatives including reduction of bureaucracy and other incentives for creation of new businesses, and efforts to enhance exports by taking better advantage of Puerto Rico’s close legal and economic ties to the United States. While the administration believes this will create 50,000 in the next 18 months, no mention was made of how these programs will be financed. The administration’s ability to deliver economic growth will largely hinge on the success of these new programs, balanced with a credible plan to deal with the debt and budget deficits.

Dominican Republic

The Dominican Republic’s economy grew 4.0% in 2012 and is expected to grow 4.5% in 2013, based on estimates published by ECLAC and the IMF. This projected growth is the same as 2011, yet lower than the robust 7.8% growth in 2010.

Much like Puerto Rico, the Dominican Republic is highly reliant on the United States, the endpoint of over half the country’s exports. Traditionally an agriculture-based economy, the service sector has been growing and is now the islands leading employer due to the growth of tourism.

Economic growth in 2012 was supported by an expansion in government spending, while the private sector and private consumption pulled back. One IMF study cited government expenditures increased 40% in 2012 and the budget deficit expanded to 8.5% of GDP, almost double the level of 2011 (4.5% of GDP). 2013 budget deficits are projected to reduce to $1.5 Bn (2.7% GDP), though the government will continue to fund them by adding to the already heavy $23.6 Bn of debt (44% of GDP). The reduction in projected deficit for 2013 is expected via a series of tax law changes passed by congress last month, including an increase in the sales tax. The country will need to keep a close eye on the economy as these deficit reduction efforts many negatively affect them.

Long term, the nation will need to address its high unemployment rates, 14.6% in 2012, and considerable income inequality with roughly 40% of the population living in poverty. One area of opportunity is the mining sector, where one of the world’s largest gold mining operations, located in Pueblo Viejo, is expected to produce up to 1 million ounces in 2013 and considerable employment.


Sources: Wall Street Journal, Reuters, Financial Times, Merco Press, RTT News, Caribbean Business, News Room Panama, Vocero, NY Times, Dominican Today, Bloomberg, IMF , MSN, CNN, Huff Post, Hispanic Business


Latin America Private Equity Update

Robert Wagstaff & Alexander P. Trueba

Private equity activity in Latin America remains strong with a reported 90 closed deals in the first half of 2012, a 38% increase from the same period the previous year, based on a recent report by the Latin American Venture Capital Association (LAVCA). While dollars invested stayed relatively the same at $2.7Bn, the lower average transaction size reveals increased focus on mid market deals.

Brazil continues to be a leader in attracting investments due to its size, infrastructure needs and growing economy. The country attracted 83% of total capital invested and 57% of the number of deals. In September of this year, H.I.G. Capital made its initial investment in the Brazilian market, acquiring Cel Lep Idiomas, an English language school chain. Carlyle, which has invested over $1.7 billion in Brazil since 2009, purchased a 60% stake in Brazilian furniture retailer Tok & Stok, as well as an 85% stake in Ri Happy, Brazil’s largest toy store chain.

Yet, large deal making might not be the future in Brazil. A burgeoning middle class and the proliferation of SMEs make for attractive prospects for private equity firms investing within the country. Sectors such as consumer goods and education stand to benefit from these trends.

A survey conducted by Coller Capital and LAVCA, which polled 105 international LPs investing in private equity funds in Latin America, showed that 38% of LPs planned to increase their level of investing, while another 49% expected to keep the their same level of investment in the region. The joint survey revealed that the top three reasons for investing in the region were: availability of deal flow, economic growth and political stability.

Mexico, a country that exhibits these well- desired characteristics, further enhances its investment case given favorable valuation metrics and fewer players chasing deals, especially versus more developed and crowded markets such as Brazil. These trends seem to be helping investors get comfortable with the Mexican headline risk that has been present for the last few years. Indeed, for the first half of the year, Mexican private equity firms invested $228 million compared to $84 million the same period the year before, an increase of 170%. Next to Brazil, Mexico received the highest amount of private equity investment for the period, representing 8% of invested capital and 10% of regional deal volume.

A testament to the investment opportunity in Mexico, other investment vehicles have started to take form, partially helped by recent regulation changes. New public REITs (called Fibras) have raised capital in the public markets to invest in real estate (Fibra Uno) and hospitality (fibraHotel), with a pipeline of other deals on the way, including a new vehicle from Macquirie Group to acquire industrial properties. Further, as the Mexican pension managers (afores) reduce their Mexican government debt holdings and move toward corporate investments, private equity will get its share of these investment dollars. In February 2009 only 0.2% of these pension fund investments were in alternative categories, which increased to 2.6% by February 2012.

Mexico and Brazil are clearly in investors’ crosshairs, but they are not alone. Colombia saw a dramatic increase of private equity investments in the first half of 2012 to $99 million. Additionally, The Carlyle Group recently launched a $125 million investment fund focused on Peru. A Grant Thornton survey of worldwide investors ranked Peru number two, Colombia number three and Mexico number eight in a list of new “high-growth” markets. In that same survey, 78% of executives expected to increase their investment activity in Latin America; while 22% said that their investment activity would remain the same. As firms gain experience working in the large economies of Brazil and Mexico, they will no doubt further engage other stable economies such as Colombia, Peru and Chile.

However, a bit of caution should be taken by recent capital raising and development trends. In the first half of 2012, $1.9Bn was raised by private equity firms investing in Latin America, a 60% decline from the same period in 2011. While the drop-off is not a surprise given it follows record- breaking fundraising of $10.3Bn and $8.1Bn in 2011 and 2010 and is likely due to a built up of dry powder, the decline comes on the heals of slowing GDP growth inBrazil. Thecountryhaddisappointing Q3 results and is now expected to grow 1.5% for the full year, down from 2.7% in 2011 and 7.5% in 2010. With Brazil accounting for such a large share of the industry in the region, at the very least, these are two trends investors need to track closely .

At the end of the day, given the significant amount of capital raised in recent years, the future of the asset class in the region will depend largely on the returns these new funds generate. Stable political environments, combined with favorable macroeconomic trends and the rise of a middle class, will all be the base for potential positive returns for these funds, as well as additional investing activity within Latin America.


Sources: LAVCA, Wall Street Journal, Reuters, Financial Times, E Financial News, Bloomberg

Mexican Manufacturing Revival

Raymond A. Perez & Alexander P. Trueba

After trailing China in attracting U.S. companies for outsource manufacturing and production for over the last decade, Mexico is making a comeback principally driven by a changing global landscape and soaring Chinese wages.

China burst onto the world economic scene in the early part of the 21st century, joining the World Trade Organization (WTO) in 2001 after a long 15-year negotiation.  China’s growth as a leading outsource location was fueled by a difficult economic period in the United States where anemic revenue growth forced managers to turn to cost reduction efforts as a way to increase margins and boost the bottom line. For this, China offered a seemingly endless supply of low cost labor, modest transportation costs (with oil hovering under 35$/barrel at the beginning of the decade) and a world class logistics and infrastructure network capable of supporting both large and small operations looking for a competitive edge. China had the perfect economic recipe that would enable it to become a world leader in manufacturing exports.

Mexico’s origin as an outsourcing hub began in the late 1970’s due to high U.S. interest rates and a resulting strong dollar; all but guaranteeing Mexico a competitive advantage to U.S. based manufacturing.  Economic turmoil and increased global competition in the early 1980’s sped up the process, culminating with the passing of NAFTA in 1993.  One leader in outsourcing was the U.S. auto industry, making high profile closures in Michigan, while opening new factories south of the border.  Of course, Mexico has always benefited from its strategic location bordering the U.S.  Initially, U.S. managers were more comfortable with keeping the outsourcing near by, but as the outsourcing matured, by the 2000’s managers were not afraid to send production half way around the world, especially given cost benefits.

The shift toward Asia-centric outsourcing took its toll on Mexico.  According to Barclays, China cut 60 basis points of growth from the economy in Mexico each year between 2002- 2006. However, it seems the tide has turned back to favor Mexico; the once business friendly labor force in China is shifting toward unrest, with workers demanding more benefits and increasingly resorting to strikes.  As a result, wages have skyrocketed.  According to the Boston Consulting Group, wages in China increased 10 percent annually from 2000-2005 and 19 percent annually from 2005-2010.  Similarly, Reuters reported that average hourly wages in Mexico are now 20% lower than in China, compared to 10 years ago they were approximately 188% more expensive.

Also playing a significant role in Mexico’s revival is the current price of oil, which has been in the $75-$100/barrel range over last few years, significantly increasing the cost of doing business abroad. Mexico’s proximity to the world’s largest importer allows for cheaper transportation costs and quicker delivery of goods to the American market. The average transit time for shipment from China to the U.S. is 30 days; from Mexico the delivery time can range from a few hours to a few days. This flexibility gives Mexico a distinct edge in goods produced to supply the U.S. consumer market.

The culmination of all these market changes has seriously eroded the benefit of Asia-centric outsourcing and has led some managers to increasingly opt to “reshore” jobs to the U.S. and Mexico, given benefits of simpler supply chains, less inventory in transit, and flexibility in production schedules. These benefits and market conditions are ideal for Mexico to take back the global manufacturing stage, which it once stood atop, and give the nation an edge over China.


Sources: Wall Street Journal, Bloomberg, Reuters, Emerging Money