Category: Political Risk

Expropriation should always be a consideration for any business with overseas operations and investments. Expropriation, when a government claims privately-owned property for its own or public use, causes major disruptions to investors and is defined as political risk.  In a global economic environment still struggling through a pandemic and characterized by rising economic nationalism, firms should be fully aware of expropriation risk.  Recent Mexican government action in the country’s oil industry highlight concerns about this type of political risk.

Expropriation Pressure

Mexico’s oil industry has become the target of what former U.S. ambassador to Mexico Antonio Garza, called “slow-rolling expropriation,” as the Mexican government exerts pressure on foreign oil investors. For example, in mid-2020, Mexico passed a new regulation that requires oil imports to be held for at least five days in facilities owned by PEMEX (Petroleos Mexicanos), Mexico’s state-owned oil producer and distributor. The move slows the delivery of foreign oil and forces companies to pay fees to PEMEX, a competitor in Mexico’s domestic market. In another example, US oil firm Talos Energy was instructed by the Mexican government to partner with PEMEX in oil exploration in the Gulf of Mexico despite Talos’ previous award of exclusive drilling rights in the area. These and other actions prompted a strongly-worded letter from US government officials in January 2021, accusing Mexico of holding up permits for foreign oil companies and writing regulations to favor Mexican companies.

PEMEX Performance

Much of the Mexican government’s interest in the oil industry is focused on propping up PEMEX, which was created after the oil industry was nationalized in 1938 and formerly held a 76-year monopoly over domestic production and distribution until the industry was deregulated in 2014.

Mexico’s current president, Andrés Manuel López Obrador—known as AMLO—opposed deregulation as an opposition politician and appears eager to restore PEMEX to a position of industry dominance. At the beginning of his presidential term in 2018, AMLO unveiled a plan for energy self-sufficiency centered on PEMEX.  In May 2019, he hinted at creating an expropriation agency as part of his broader push to address the country’s income inequality. According to Gallup, ALMO’s current approval rating (62%) is four times higher than his predecessor’s (15%) who favored deregulation, suggesting ALMO has the political support necessary to implement these policies.

PEMEX Statistics in Brief

• In 2019, PEMEX posted a $36 billion loss even before the Covid-19 pandemic sent oil prices lower.
• Moody’s downgraded PEMEX’s creditworthiness to “junk” status in April 2020.
• By the end of 2020, PEMEX reported that it had missed its annual crude oil production targets for the sixteenth straight year and was carrying a financial debt of $110.3 billion.
• PEMEX is the world’s tenth largest crude oil producer and the nineteenth largest oil and gas company in the world.
• PEMEX employs over 120,000 people and supports the pensions of another 107,000 former employees.
• The company generates over a third of the Mexican government’s revenue.

Foreign and U.S. Oil Investments

Since 2014, major oil companies, such as Chevron and Shell, have made major investments in Mexico. Some recent deals include an estimated $5.7 billion investment in Gulf of Mexico deepwater exploration by Chevron, and another deepwater exploration effort estimated at $2.4 billion by Shell. It remains to be seen if expropriation concerns will dampen future oil investments, or potentially hamper Mexico’s trading relationship with the United States in general. The finalized U.S.-Mexico-Canada Agreement (USMCA) is less than a year old and both countries have strong oil and gas links. Mexico is a major market for US liquefied natural gas and petroleum exports. In return, Mexico is the second largest source of crude oil imported by the U.S. in 2020, behind only Canada.

Countering Risk

In a global economic environment still hampered by the Covid-19 pandemic, countries are impatient to find ways to protect revenue, create jobs, and address issues of development and income inequality exacerbated by the 2020 downturn.

In many countries, there are leaders who view protectionism or outright expropriation as a way to popularly assert national sovereignty, push back against alleged abuse by foreign interests, or to pursue broader social and economic goals.

Though Mexico is classified as a middle-income country, it struggles with inequality as measured by a Gini coefficient score of just under 0.5, and data from the Gallup World Poll indicates life is getting more difficult for the average Mexican. In 2020, only 26% of Mexicans said it was a good time to find a job– the lowest amount Gallup’s recorded since it started tracking in 2007.

Source: Gallup, Inc.

Gallup also asks Mexicans to rate their life on a scale of zero to ten, with ten representing the best life possible. The average life rating in Mexico dipped to six – the lowest Gallup has recorded, and a full point below Mexico’s life rating during the great recession in 2009. Gallup finds that falling life ratings are often a precursor to political instability.

The government will be eager to boost Mexicans’ spirits and economic prospects.  The viability of PEMEX, the country’s largest company, is seen as both economically important and as a symbol of national sovereignty.  National sovereignty is often evoked in AMLO’s defense of Mexico’s recent interventions in the oil sector.

While the global economy has tremendous potential for growth post-Covid, investors should be aware of the risks that comes with investing in a country like Mexico with tremendous economic dynamism, but with a history of economic protectionism and expropriation.

Expropriation is just one example of political risk. Many investors purchase political risk insurance policies to protect their foreign investments from expropriation, nationalization, confiscation, currency inconvertibility, and/or political violence. A political risk policy can help a business pursue investments and opportunities more fully knowing that they have coverage in the case of political risk perils. It is crucial that businesses have adequate coverage and find a trustworthy broker to guide them through what they will need to protect their investments from harm.

See Securitas’ Guide to Political Risk Insurance or contact Securitas to learn more.

Since 2004, Securitas Global Risk Solutions (“Securitas”) has helped clients across the United States develop credit and political risk transfer solutions that provides value on several levels.  As a specialty independent trade credit and political risk insurance broker, Securitas is focused on developing comprehensive solutions that meet the needs of their clients, ensures complete understanding of policy wording and delivers responsive excellent customer service.

Authors:

Peter Seneca

Adam Reiland

Stafford Nichols

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Telephone: 484-595-0100

Fax: 484-582-0111

In a recent, little-publicized international arbitration decision, an intergovernmental dispute resolution body ruled on September 20, 2020 that Netherlands-based Vodafone was not liable for an estimated $2.2 billion tax bill demanded by the Government of India and that India had violated the “fair and equitable” treatment provisions under a 1995 bilateral investment treaty between India and the Netherlands. The case, titled Vodafone International Holdings BV v. The Republic of India was initiated in 2014 before the Permanent Court of Arbitration (PCA), an international body based in The Hague.

The long story of the case underscores the importance of understanding political risk for those doing business overseas.  Country-specific efforts to balance investment promotion with the need to generate tax revenue can lead to legal changes that can either unlock opportunities or increase risks for investors.  Additionally, the case shows how bilateral trade and investment treaties (BITs) create legal mechanisms that can be utilized to adjudicate disputes such as the one between Vodafone and India.

In this instance, India’s attempts to capture revenue from international investment transactions led it to pass legislation allowing transactions to be taxed retroactively, leading to drawn-out legal disputes with Vodafone and other companies.  Beginning in 2007, Indian tax authorities had unsuccessfully sound to levy taxes on Vodafone after its roughly $11 billion purchase of the Indian mobile phone company Hutchison Essar Limited (HEL).  After legal appeals by Vodafone, India’s Supreme Court held in January 2012 that Vodafone’s acquisition of HEL was not liable for taxes under India’s Income Tax Act of 1961.

Retrospective Legislation

In response to the Supreme Court decision, the Indian parliament passed the Finance Act of 2012, which amended the Tax Act of 1961 and gave its government authority to retroactively tax past transactions.  With a new law in force, India again sought to levy the tax fee against Vodafone plus interest and penalties totaling roughly $3.79 billion.

Citing the 1995 bilateral trade and investment treaty between India and the Netherlands, Vodafone invoked the treaty’s arbitration provisions in April 2014, bringing the case before the PCA.  Some six years later, under the authority granted to it by the India-Netherlands BIT,  the PCA ruled in favor of Vodafone, ordering India to stop seeking tax payments from Vodafone and pay Vodafone over $4 million in legal fees.  The Vodafone case is one of three cases before the PCA in the wake of India’s retroactive attempts to collect tax under the Finance Act of 2012.

Political Risk and Remedies

It remains to be seen how the PCA’s decision will be enforced.  Just before the PCA ruling, India’s Supreme Court had ruled against Vodafone, upholding the India’s efforts to collect revenue under the 2012 Finance Act.  These extensive and costly proceedings highlight just some of the potential difficulties that companies face when doing business overseas in countries where shifting political priorities can put investments or agreements at risk.  Solid political risk analysis, trusted legal counsel, and political risk insurance are all tools companies need to navigate global trade and investment.

Bilateral trade and investment treaties (called BITs), such as that between the Netherlands and India in 1995, are important legal instruments to understand and utilize.  BITs include agreed upon language to protect investments and encourage fair and transparent legal treatment of transactions and contracts.

In addition, BITs often create procedures, such as international arbitration, for disputes that cannot be settled in domestic courts.

U.S. Department of Commerce’s International Trade Administration (ITA) maintains a list of BITs between the U.S. and other countries.

Since 2004, Securitas Global Risk Solutions (“Securitas”) has helped clients across the United States develop credit and political risk transfer solutions that provides value on several levels.  As a specialty independent trade credit and political risk insurance broker, Securitas is focused on developing comprehensive solutions that meet the needs of their clients, ensures complete understanding of policy wording and delivers responsive excellent customer service.

Telephone: 484-595-0100

Fax: 484-582-0111