Over the past century, Mexico's mining sector has fluctuated between periods of liberalization and nationalization, deregulation and regulation, but from the drafting of the 1917 constitution until the 1980s, the sector had been de facto nationalized by constitutional amendments.
Then the economic crisis of the early 1980s began a new process toward liberalization. The 1992 Mining Law allowed foreign firms to own a majority stake in Mexican mining firms. The 1993 Foreign Investment Law got rid of regulations such as local content requirements and mandatory technology transfer. It also reduced tariffs on trade and the import of machinery and increased concession periods to renewable 50-year terms.
This framework is now under scrutiny from citizens and their elected representatives. Mexico's proposed mining royalty will not fundamentally alter the direction of the industry — it will continue to be investor friendly — but it will attempt to bring more of the benefits from the sector's growth to the government and, ideally, to those directly affected by mining activities.
The Contours of Mexico's Mining Sector
Mining is currently Mexico's fourth-largest industry, behind electronics, automobiles and energy. In 2012, mining generated $20 billion in revenues, more than 70 percent derived from gold, silver and copper production. Production of these three minerals was almost entirely exported in 2012, generating more than $13 billion in trade revenue. The industry employs roughly 330,000 people directly and 1.5 million indirectly at wages that, on average, are considerably higher than the average compensation of workers in other industries. While this is small in terms of the total 50 million-strong Mexican labor force, it is concentrated in poor areas with little alternative economic potential.
Most of Mexico's mining activities occur in four states: Sonora, Chihuahua, Durango and Zacatecas. Of the total copper output, 73 percent is produced in Sonora; 72 percent of silver is produced in Chihuahua, Durango and Zacatecas; and 68 percent of gold is produced in Sonora, Chihuahua and Zacatecas. These mining areas, particularly in the western Sierra Madre Mountains of Chihuahua and Durango, are located in regions that rank among Mexico's most violent and most socially and economically disadvantaged.
Since the reforms of the early 1990s, mining companies have enjoyed a favorable regulatory framework. Companies currently pay $0.36 to $8.00 per hectare plus corporate income tax, but they do not pay a royalty tax, despite the fact that such a tax is common in Latin America and around the world. Guatemala recently increased its royalty on precious metals from 1 percent to 4 percent, Chile recently increased its royalty rate from a fixed 4-5 percent (based on commodity) to a sliding scale between 5 and 14 percent, and Brazil is in the process of doubling its average mining royalty rate from 2 percent to 4 percent.
Because of Mexico's free trade agreements with the world's two largest economic zones — North America and Europe — machinery and capital can enter and minerals can exit the country largely tax and tariff free. Technically, the Mexican government has direct ownership over mineral deposits, but exploration and exploitation are permitted if the Ministry of Economy grants a concession. Unlike the energy sector, in which it is forbidden to book reserves or enter into production-sharing agreements, the mining sector is fully open to foreign investment and ownership.
However, a good regulatory environment alone was not enough to stimulate a boom in the mining sector. That required a spike in the price of gold and silver. From 1992-2002, mining foreign direct investment totaled $913 million. However, from 2002-2011, when gold and silver prices skyrocketed, mining foreign direct investment increased tenfold to $10.7 billion. Paralleling the spike in mining-related investment, production of gold and silver increased 294 percent and 160 percent, respectively, over the same period.
High prices have incentivized mineral exploration and have made it feasible to exploit certain areas that were previously uneconomical. For example, at El Gallo mine in Sinaloa state it costs $1,200 to $1,325 to produce one ounce of gold. With gold prices hovering at around $1,500 per ounce, if the price of gold stagnates or falls, new projects such as these with slimmer profit margins will go unexploited. While Mexico's biggest mining operations are protected from fluctuations in gold and silver prices due to higher profit margins, some of these newer projects with higher extraction costs would be negatively affected by a simultaneous drop in revenues resulting from lower mineral prices and an increase in royalty taxes.
Mexico's Proposed Mining Reform
There is a growing sentiment, both from local communities and politicians, that reform in the mining sector is necessary and timely. Local groups have long protested against mining's environmental damages and poor health and safety conditions. Politicians have recognized the need for the state to fine-tune the regulatory environment to reap the benefits of the mining boom in the form of increased fiscal revenues. Thus, Mexico's three major parties agreed in the Pact for Mexico, a broad outline of proposed reforms, to revise the country's mining concessions scheme and tie federal fees to production. However, the country's second-largest political party, the National Action Party (known by its Spanish acronym, PAN), has stated its preference in treating mining reform as part of a larger tax reform and may therefore try to get in the way of an independent mining reform.
Mexico's mining reform bill was approved in the Chamber of Deputies on April 25 and awaits approval in the Senate during the next legislative session, which is slated to begin September 1 unless an extraordinary session is called for. The bill in its current form will likely be amended and sent back to the lower house for re-approval. It proposes to levy a 5 percent royalty on mining-related earnings before interest, taxes, depreciation and amortization. The legislation is expected to generate $500 million annually in fiscal revenues. Of this, 30 percent will go to the federal government and 70 percent will go to the states and municipalities where mining activities take place. This will have two effects. First, it will slightly improve Mexico's ratio of taxes to gross domestic product, which is low by both regional and Organization for Economic Co-operation and Development standards. This will allow the government to become less dependent on taxes on PEMEX while maintaining levels of fiscal spending. And second, it will allocate more revenue to states and municipalities that are poor, violent and lack basic public goods.
Like the telecommunications reform recently passed in Mexico's congress, this mining reform has the support of some of the major Mexican mining stakeholders. Mexico's largest mining company, Grupo Mexico, supports the reform, provided that improved taxation and community spending is accompanied by legal certainty for investors. Moreover, Mexico's Chamber of Mining originally opposed the reform but has since acquiesced and is instead focusing on determining the most beneficial rate. However, other mining groups, particularly smaller foreign firms, oppose the reforms, claiming that companies already pay an assumed "security tax," referring to the increased spending required to improve security. Additionally, the reform bill will likely face a constitutional challenge regarding whether existing concessionaries will need to pay the royalty. This may slow the reform process but ultimately will not impede the reform bill from passing.
Mexico is not at a historical turning point but is tweaking the system that was put in place in the early 1990s. The mining sector is a good microcosm of Mexico as a whole; in the reforming zeal of the 1980s and early 1990s, a system was set up that radically redefined the Mexican economy, but that resulted in many suboptimal outcomes. Now, Mexico is making piecemeal reforms to the economy intended to strengthen, not redefine, its regulatory framework. Labor, telecommunications, mining and banking reform all fall into this category.
This is an important precedent for Mexico's upcoming energy and tax reforms. It will test the country's ability to generate additional fiscal revenue to offset some of PEMEX's high tax burden while maintaining spending levels. And the mining sector is similar to the energy sector because the subsoil minerals are owned by the state, but companies are granted concessions to explore and exploit mineral reserves. The problem that Mexico will need to deal with is one of timing. Increasing royalties at a time when the prices of precious metals are in decline could hurt the industry's growth prospects. However, if prices continue to go up, this royalty will raise needed fiscal revenues for the Mexican government without undermining the sector's competitiveness.
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