Mexico’s new mining law may affect silver supply

Mexico tightens its mining law. Process was ongoing since several years, but this time it has been backed up by legislative changes. How and if that may affect worldwide supply of silver?

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Silver Mexico in a glance

M

exico has long been number one in global silver production accounting for 20% plus of global supply. In 2022 1 bln 4 mln ounces of silver has been supplied worldwide from primary and secondary sources altogether. Of these, 822 mln were effect of mining production, with nearly 200 mln ounces ‘Made in Mexico’. That means, every 4th silver ounce mined worldwide comes from Mexico. Including recycled volumes supply, that would be every 5th ounce. And at the same time, Mexican 200 mln ounces per year exceeds Poland’s KGHM silver production about 4 times.

Above was strong 2% y/y growth in production largely driven by the ramp-up of new projects that have come on-line in recent years. Exploration stage, obtaining legislative agreement and building mining infrastructure (in most cases open pit mine) may even take 10+ years in total before officially starting mining. Even expansion of existing operations usually takes couple years. Hence growth experienced has to be attributed to decisions and investments being made few years in the past. In this context, we strongly suggest remembering date ‘2018’, as we intend to explain its meaning later in a text.

Silver bearing ores are abundant in Mexico, especially in states of Zacatecas, Durango and Chihuahua. Silver is normally present as an accompanying metal to the lead, copper and gold bearing ores. Normally, approx. ¾ of worldwide mined silver comes in a form of by-product of industrial metal mining. However, in case of Mexico silver tends to form ores of higher concentrations, actually making primary silver mining operations possible and more financially viable at the same time. This is not something usual in the world making country one of the crown jewels of silver mining sector.

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According to Silver Institute, 11 of 30 top silver producing mines are located in Mexico, with five of them being in a top ten. Overall, mining is being considered as a fundamental pillar of Mexico’s economic development. Which is itself very interesting, as of 1190 projects in total 63.3% are being postponed, 25.7% is in exploration stage, 6.55% produces and further 3.60% being in development stage. Hence true magnitude of Mexico’s mineral potential seems to be vast but also a largely unknown. However, growth on all-in-sustaining-costs - especially on energy and fuels site – may turn onto price growth on commodities, making many resources located deeper in earth’s crust financially viable to extract.

Contribution of ining sector to the Mexico’s industrial GDP stands on 8.3%. In terms of full GDP, mining is responsible for 2.3%, with just silver generated about 20% of above. In 2020, government data had shown that sector employed nearly 350k people and contributed 1.5 bln USD in taxes, with an additional 1.84 bln USD generated from exports of metals and minerals. Deloitte calculated foreign mining sector's share of the Mexican mining sector being high, at 70% in 2010, with most foreign miners originating from Canada and USA.

Latin America is being considered as top region for mining and exploration investments, due to its mineral abundance, geographical proximity to North American miners, and legislative ‘friendliness’. In 2021, approx. 11.24 bln USD has been spent under corporate explorations strategies of nonferrous metals. Approx. 24% of the above went to explorations in Latin America region, with about ¼ of this (0.6 bln USD) for various projects just in Mexico.

Long-term decline in ‘friendliness’

Abundance of silver and other metals (including zinc, copper, gold and lithium), low legislative entry point and relatively cheap labour costs, have long made Mexico an important pillar of the international mining sector. In 1990, sectoral mining taxes and royalties were abolished to invite international investors. That made Mexico the only country from Latin America – region of great mineral abundance – being without this type of sectoral taxation until 2014. International miners with operations or wanting to enter Mexico were limited until then to 27% corporate tax. In comparison to costs of taxation in other countries of the region, that was being considered as highly incentivising, especially to junior miners from Canada and USA.

Fraser Institute provides annual surveys of mining and exploration companies. It attempts to assess how mineral endowments and public policy factors such as taxation and regulatory uncertainty affect exploration investment for miners of varying market caps. Simply speaking, it takes several factors under consideration and present them in indexed way, which shows attractiveness of certain jurisdictions or territories for establishment or running mining operations. Among responders are mostly presidents and vice presidents of mining entities but also managers and other senior members of management – so people with usually vast experience and mining business knowledge. Survey is being conducted in anonymous way so we could assume that responds are being made without typical corporate restraint. In other circumstances that could possibly result in unforeseen consequences of various types. Of course, not all countries are represented (usually survey consists between 60-100 separate positions depending on the year it was taken on), and certain jurisdictions are being divided onto states or territories, as decentralisation is root reason for great differences in local mining and tax laws.

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In 2013 Mexico scored 71 points on 100 possible making it 2nd most mining friendly jurisdiction in Latin America and effectively making it in top half for surveyed territories. Mexico maintained similar scores throughout 2014 and 2015, falling to just below 70 in 2016 and then to 65 in 2017. Year 2018 brought elevation to near 74 points, but since then, Mexico has declined in a rank oscillating between 65-67 points in between 2019-2021. For 2022 country scored 60 points, making it 2nd worst jurisdiction in region of Latin America and 37th on 64 surveyed this year countries and regions. That comes in line with regional nationalisation trends in part of Latin and South America, as seen on example of Chile, Peru and said Mexico.

So why is that? Let’s dive deeper onto index. Just to underline clearly – below refers to 2022, so before latest changes to mining law have been introduced:

• Fraser Institute’s policy perception index gives Mexico 40 points on 100 available,
• Best practices mineral potential index scores Mexico with 75.5 points which is considered as encouraging investments,
• Uncertainty considering administration and regulations is around 10 points, which is considered as not encouraging, but also not deterrent to investments,
• Similar could be said about uncertainty concerning environmental regulations,
• Survey shows that miners have concerns about regulatory duplications and inconsistencies, but also perceive current Mexico’s legal system as not friendly. And same could be said with regards to its taxation regime,
• There are lot of concerns regards to disputed land claims, and socioeconomics agreements, however with regards to protected areas policies seem to be rather clear and consistent, but not deterrent at the same time,
• Quality of infrastructure is perceived positively, in some regions even as encouraging investments,
• However, labour regulations and work disruptions are being perceives as great issue,
• Same with security of infrastructure and operations. It is perceived as encouraging, but still very much lagging to what most of the other regional countries may have to offer That pushes Mexico to the very bottom of surveyed list with only South Sudan and Burkina Faso being below and Mali just above. All three known well for instability and corruption,
• Availability of Mexico’s labour and its skills are highly perceived by mining entities, placing Mexico on 15th position on 64 surveyed in 2022.

To summarise above onto one. Mexico is abundant in natural resources, among which are lithium, industrial metals, gold and (what interests us in the most in this context) silver. However, in the last years, country’s friendly approach to international miners had changed, changing development opportunities and possible entry points for new entities. Many barriers had been introduced, which seems to be part of wider regional trend consisting among many, Peru, Chile and said Mexico. Mining entities grow concern about administration, legal and tax changes, but also status of disputed lands. They also remain uncertain and concerned regards to, interpretation or enforcement of existing regulation.

Legislative changes of April 2023

On 28th of March, two drafts had been presented by president Andrés Manuel López Obrador and government, with purpose to overhaul current mining law. On Friday 21st of April, vote to it to the House of Representatives was carried with 251 in favour and 209 against, after what could be record fast-track process. This happened in the middle of the night, with opposition party not attending out of the protest. Eventually bills had been passed through Senate on 29th of April. However, it was only one part of 18 related pieces of legislation passed at the time.

Legislators noticed that bills had been written in the language pointing out strongly on rights of indigenous population, need to protect natural environment and addressed water scarcity problems. Using Environmental, Social and Corporate Governance (ESG) to back it up, seems to be very smart move. However not the first, as i.e. similar attempts were drafted in the previous years by Chile.

About 7% of Mexico’s mining concessions are located within protected areas. Local Ministry of Environment and Natural Resources states, there are 671 mining concessions occupying 1.5 million hectares located within 70 protected areas. Apart of these, many concessions had been also granted in country’s exclusive economic zone and federal maritime-terrestrial zone. Mexico’s Ministry of Environment showed on this occasion report, regards to damages caused by mining operations in ecologically sensitive habitats. This is considered to be an effect of most liberal in Latin America Mining Law from 1992, which was highly incentivising and friendly towards foreign investors to local mining sector.

So, what are the main legislative changes? First and foremost, even though amendment of mining law should primarily apply to new concessions, some provisions may and will impact existing concessions. That effectively makes ‘lex retro non agit’ rule non applicable in this occasion. Focusing on details:

• There is reduction of the duration of mining concessions from 50 years with possibility to renew for another 50 years, to 30 years original concession renewable for another just one time of 25 years. Decrease on concession duration by nearly half, is perceived as potentially adversely impacting long-term operations and long-term investments,
• Restrictions on mineral extraction had been introduced. Concessions now must expressly state specific minerals which are to be extracted. Failure to do so, may effect in fines and even 5-10 years in prison for the extraction of unauthorized minerals. This point leaves lot of space for adverse interpretation as it is rarely possible to extract solely one mineral from a deposit,
• The first-come-first-served system is replaced by a public bidding process, eradicating any incentives for miners to seek and identify new mining sites. They simply may be out-bidded by a ‘bigger fish in the tank’. That effectively eliminates any advantage that miners had in being the first to discover a new mining site,
• Mexican government now has exclusive exploration rights, through the Mexican Geological Service or other federal entities. It is the State that decides if, when and where to explore. This may lead to exploration coming to a halt, as Mexican Geological Service does not have the resources (both fiscal and technological) or same incentives that mining companies have to undertake exploration. But although it may not have technical capacity nor funding to run these, it still may hire foreign miners currently present in Mexico, and ask them to conduct the assessments in their behalf, for certain incentivising on i.e. share of assessed resources,
• Legislation adds additional environmental obligations for concessions and prohibition of mining activities in areas without or with scarce water or in natural protected areas. So in result it implements strict rules protecting local waters, environment and indigenous populations,
• More in a subject of water – new law includes requirement that mining projects must recycle at least 60% of the water used in mining operations,
• New package includes also prohibition of water rights transfer for use in mining projects and new causes for termination of water rights. That means, State may revoke rights to use water by local miner which may result basically in inability to mine and process ore, as water is vital for mining activities,
• Additional environmental obligations were introduced, with regards to compensating for mining activities. That is providing compensations for social impact. Hence miners are now under obligation to enter into an arrangement with local communities, indigenous or not, for the superficial use of land. They would have to pay those communities minimum of 5% of the tax result declared in accordance of Income Tax Law.

New propositions followed nationalisation of country’s lithium resources, considered one of the greatest in the world. That favours newly established state-owned miner in expense of foreign miners. Needless to say, that it happened to the great discontent of US and Canadian miners, and yet again has to be considered as a part of local, wider trend. Chile – one of the top world’s lithium producing countries - also announced its plans to nationalise its booming lithium industry.

President Obrador is being considered internationally as charismatic, but populist. In the past he strongly objected plans to allowing foreign capital to make joint-ventures over various projects with national oil company Permex. He is known for being advocate of keeping natural resources nationalised and used (directly as minerals and indirectly in the form of revenues and profits) for the benefit of State and local communities. Since he resumed presidency in 2018, not even a single mining concession has been issued in Mexico.

To finish this chapter, different media may provide different data in regards to percentage or concession’s lengths. It comes from the fact, that initial proposition had been slightly modified and bill itself had been originally presented in two versions. Hence, we had drawn numbers presented, from report made on 12th May 2023 by King & Spalding - US international law firm.

International miners outraged

Administration of President Andrés Manuel López Obrador managed to pass amendments to mining bill. Magnitude and pace of these changes basically made miners to fall asleep having operations in one jurisdiction, and wake in the morning, having their assets under totally different law.

This happened despite of many sectoral warnings. Country’s mining chamber issued warning, that implementation of said changes may cause loss of 9 bln USD in lost investment in coming years, and affect over 400k jobs directly. This had been backed by Association of Mining Engineers, Metallurgists and Geologists of Mexico adding to the above also indirect jobs related to sector That effectively tallied them up to 3.5 mln.

Of all the miners it is Canadian juniors who may be most concerned, as they represent major chunk of sector international present in Mexico. Ottawa stated, that proposal could affect overall Canadian investments in Mexico, and its mining sector. It may also have impact on North American competitiveness and supply chain resiliency. Just this voice confirms, that reform was directed towards foreign miners who benefited from nearly 3 decades of one of the most liberal and incentivised mining law in the region and world.

Another voice of concern came from Ross Beaty, who openly called new legislation hostile to the industry. Legendary precious metal investor most likely knows what is saying, as he made career of investing in high-risk, high-return projects located mostly in Latin America. Of course being chairman of Pan American Silver and Equinox Gold Corp – entities with strong regional presence – explains somehow his strong stance. In line with previous assessments on how law changes may impact jobs in Mexico, Beaty said that responsible mining by Mexican and foreign mining companies has been a massive boon to many communities in Mexico that rely on the jobs, demand for services and community benefits mining provides.

But, contrary to the foreign voices, Mexican miner Grupo Mexico stated at the end of April, it doesn’t concern government’s proposed mining reforms as a risk to the operation of its mining portfolio.

For miners, sudden changes in policy – especially these introduced with immediate effect - make investment in ‘legislatively unstable jurisdictions’ hard to justify. Especially when – according to new legislation – authorities are able to cancel licences if no work has been done on concessions in two years. It happens in the case of many junior miners, as after making initial geological and exploratory job, they spend next couple years looking for investors. In the meantime they produce prospects, visit mining convents seeking for funds, assure claims to the land, start process of obtaining concession, make attempts to organise specialised equipment and crew. For potential investors it means freezing money for a period of several years, until grand mine opening. Now another factor had appeared, which puts financial viability of many planned and existing operations under question mark. Additionally this also creates uncertainty among business whether their assets may or not be nationalised in case of silver prices would take off.

So, what of physical silver?

Main question to ask is – what does Mexico seeks? Is it just hunt for share of revenues being made by miners or genuine attempt to get them rid of Mexican land and to replace slowly by local-made entities? Interesting is, how new mining law looks in comparison to i.e. Swedish or polish. It may appear, we could discover lot of similarities. One is sure – miners in Mexico have been taken on a “short leash” now.

It is possible that downgrade of mining conditions in most important jurisdiction among silver producing countries may cause companies to try to just maintain current production. They may also decide not to expand its operations or even wrap up those less promising projects. Some junior miners may also decide on leaving Mexico in search for more friendly jurisdictions. In certain time perspective, new law may and will have a chance to affect silver’s worldwide supply figures in already tight market. In effect, industrial or jewellery silver sectors may carry on drawing more white metal from above ground silver inventories, markets may loose on stability, and we may experience more issues with availability of silver.

On the other hand many miners already present in Mexico, may want to start cooperating with local government on the basis of being contractors or joint-ventures for/with Mexican Geological Service in exchange to access and have a share of explored ore. Possibility of such depends however of State’s good will and determination of miners to do so. At this moment it is really hard to assess anything, as law had been introduced just few weeks ago, so we are unsure of how strictly, at what scale and pace State may want to action against transgressions or even simply presence of international capital. In this context we also have to mention fact, that Mexico is heavily affected by corruption. It has 126th position on 180 countries surveyed by Transparency International. Effectively, Mexico is even slightly below war-torn Ukraine and slightly higher than Russia.

Another point to consider is, how mining stocks would behave upon execution of new mining law. Key word is ‘execution’, not ‘introduction’, as bill had passed, and everyone awaits to see it in action. Potential strong stance presented by State (someone may and will eventually serve as an example), may scare investors. And that is something Toronto Stock Exchange (which is heavy with miners) wouldn’t be happy about.

What seems to be certain at this stage is uncertainty.

And what serves best in uncertain times?

Metal in hand.