Shine a light on Cuba

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All eyes were on Cuba last week following every detail of President Obama’s visit to the island nation, not least the potential investment opportunities that a political opening may offer. In a previous post I addressed some of the difficulties U.S. investors face because of the economic embargo imposed by the U.S. on Cuba. This post is dedicated to the investment environment in Cuba, and the opportunities that are coming into view for the energy sector.

Foreign Investment Act 118

In April of 2014 the Cuban parliament adopted Law No. 118 to promote foreign investment in the country. It was part of a wave of reforms aimed at increasing the productivity of the economy set in motion in 2008 by Raúl Castro, who was elected President after Fidel’s official retirement. In addition to attracting foreign capital, these reforms have sought, with varying degrees of success, to reduce the size of the state and encourage the growth of a local private sector.

The new law provides both change and continuity. Among the novelties welcomed by investors are expanded areas of investment, including areas previously out of reach such as utilities; tax breaks on profit and labor taxes; and authorization for 100% foreign-owned enterprises (though with the potential loss of tax breaks).

Continuity can also be found in this new law in the central role assigned to the state in guiding investment through a presumably streamlined, but still elaborate authorization process, and a preference for investments in the form of JVs with state-owned Cuban enterprises. Not much change either in the relationship between firms and the labor force. All hires must be carried out through a government employment agency. The agency charges firms for labor contracts in convertible currency, but pays workers in Cuban pesos, pocketing the difference, and effectively taxing labor to the point that it may no longer by competitive and eliminating the ability of firms to use compensation as an incentive for productivity.

The most important question is not whether Cuba can attract FDI, but whether it can retain it. According to the Financial Times, 60% of all foreign-private investments undertaken in Cuba since the fall of the Soviet Union have failed. Surely many would have failed anyway, but investors consistently report difficulties in maintaining a good relationship with the state, which plays conflicting roles as partner, supplier, banker, and regulator.

Mixed signals, a tradition

This is not Cuba’s first attempt at attracting FDI. In 1995, in the midst of Cuba’s “Special Period”, a euphemism for the country’s severe economic crisis following the fall of the Soviet Union, the government passed Law 77 opening up many areas of the economy to foreign investment. This law also allowed the establishment of 100% foreign-owned enterprises (though none were ever authorized), acquisition of real estate by foreigners, and the creation of duty-free zones and industrial parks. But it had limited results, mainly because the government balked at its own success.

Among the enduring accomplishments of Law 77 we can count investments in the hospitality industry, which is the mainstay of the economy today, attracting 3 million tourists a year; nickel mining and smelting, singly the largest foreign exchange earner; and exports of rum and tobacco. Other success stories, however, involving joint ventures with Cuban state-owned enterprises, were abandoned, taken-over, or allowed to fail. Once the economy climbed out of deep scarcity, the government started backing out of its reform efforts, mainly in the form of endless obstacles to new undertakings or renegotiation of existing ventures that led to foreign firms to exit the country.

For the period 1993-2009, Cuba attracted cumulative inflows of foreign investment of USD 3.5 billion (compared to USD 14 billion in Costa Rica and USD 50 billion in Vietnam) (for more detail go here). The government now estimates it will need at least that amount per year to bring economic growth to an annual rate of 5-7%, the minimum necessary for a positive and sustainable transformation of the economy.

Opportunities in energy

The past two years the Cuban government has published an Investment Portfolio detailing the projects it considers a priority for the country (2014 and 2015). Energy projects figure prominently in them, as it has become imperative to reduce dependence on Venezuela for fuel purchases.

In terms of electricity generation, the Cuban government is seeking to move away from dependence on fossil fuels by increasing electricity obtained from renewable resources from 4% to 24% by 2030. Policy seems oriented to maintaining the decentralized and small-scale features of the system (currently 40% of capacity) by replacing small diesel generators with similarly small-scale renewable energy sources. The province of Granma, for example, has become the testing grounds for a 100% green energy supply matrix. Currently, 37% of the electricity supply in Granma province is from renewable sources, including 1,628 small off-grid PV systems, 11 bagasse generators, 36 mini and micro-hydropower plants, 938 windmills that pump water, and nearly 1,000 commercial and domestic applications of waste energy.

The 2015 Investment Portfolio includes the following renewable energy projects: 16 bioelectricity (50 MW); forest biomass (multiple); PV solar parks (100 MW) and 3 wind farms (174 MW, 102 MW, 51 MW).

Cuba has also been pursuing JVs to exploit oil and gas reserves from on-shore and off-shore fields. The Portfolio includes 4 new projects in JV with CUPET, the Cuban state-owned oil company, in the modality of production sharing. Two projects are in shallow waters in the Exclusive Economic Zone of the Gulf of Mexico, one in on-shore fields, and one for secondary recovery of existing fields.

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