Cuba: Barriers to investment to persist despite moves to liberalise the economy


02 Dec 2015

Cuba: Barriers to investment to persist despite moves to liberalise the economy

  •   Investor interest in Cuba has grown since the normalisation of relations with the US and the introduction of the Cuban Law on Foreign Investment (LFI) in March 2014.
  •   Nevertheless, several key obstacles to investment remain. Analysis of the tourism and oil and gas sectors and the flagship Mariel special economic zone demonstrate some of the common challenges investors will face entering the Cuban market. 
  •   Most notable among these are the government’s continued dominance in the economy, the dual currency system, slow bureaucratic project approval processes, inhibitive joint venture and labour obligations, and ongoing uncertainty over the lifting of US sanctions and the impact on trade this can have.  

Tourism

With a value of approximately USD 2.6 bn per year, tourism is Cuba’s second largest source of foreign revenue and attracts approximately 3 mn tourists annually. The number of tourists visiting grew significantly in 2015, with an 18 percent increase in foreign travellers until September. The number of US nationals travelling to Cuba increased 54 percent in the first nine months of the year, facilitated by Washington’s removal of travel restrictions. The eventual removal of the US embargo on Cuba and full opening of travel will fuel an even greater increase in US tourism to the country. The International Monetary Fund (IMF) has predicted that 3 mn more US tourists will travel to Cuba each year if the US embargo on the country is fully removed.

The growth in tourism has also seen Cuba become an increasingly attractive destination airport for international airlines. JetBlue began its first direct flight from New York to Havana in July, the same month that Carnival Corporation announced it would become the first major US cruise operator to offer trips to Cuba departing from Miami. Furthermore, Delta Air Lines, United Airlines and American Airlines have all expressed interest in becoming flight carriers. Air China will become the first airline to fly direct to Cuba this month. Construction and the hotel industry will be another industry to benefit from the tourist boom due to growing demand combined with shortages of accommodation. Travel agencies have reported a record number of bookings at the approximately 61,000 hotel rooms on the island, with some already reserved for the next 18 months. The government’s November 2015 portfolio of investment opportunities includes multiple hotel and villa construction and management contracts.

The March 2014 Cuban Law on Foreign Investment (LFI) includes important measures to incentivise investment. The law limits the government’s ability to seize foreign assets and ensures compensation through arbitration in the event of expropriation. It also offers benefits for investors entering into joint ventures, the principle mode available for investment in tourism. The LFI grants companies an eight-year exemption on profit taxes, which will be halved from 30 to 15 percent. The law also eliminates the 25 percent labour tax.

The requirement to enter into joint ventures ensures that companies must undertake due diligence on prospective partners, especially due to the links they may have with the Cuban government. The tendering process and selection of joint venture partners could also increase exposure to corruption, which although currently low by regional standards, could increase as investment in large construction or other multi-entity projects involving multiple parties grows. Incidences of foreign investors being prosecuted for corruption without charge or due process are rare but have been known to occur. In 2011, two executives from the British Coral Capital Group, who had invested USD 75 mn and planned to invest a further USD 1 bn into luxury hotels and golf courses on the island, were jailed without clear charge for almost two years following a secret trial. Upon their release, the executives said they had been accused of espionage and obscure breaches of finance laws.

Investors must also anticipate a lengthy government approval process. For example, the UK company Esencia waited eight years for final approval to build the Carbonera luxury tourist resort, condominium and golf course in joint venture with the Palmares state enterprise, controlled by the tourism ministry. The project has since been acquired by the UK property developer London & Regional, who plan to invest USD 500 mn.

Despite positive measures introduced by the LFI, investment security will remain a concern in light of Cuba’s failure to ratify the International Centre for the Settlement of Investment Disputes (ICSID) convention. Due diligence to mitigate the risk of ownership claims made on land by US nationals and businesses is also advised. The US Justice Department has validated 5,913 claims by US citizens and corporations for USD 8 bn worth of property seized after the 1959 Cuban revolution. In 2011, the Canadian consortium Standing Feather International annulled plans to build a USD 410 mn golf course and beachfront hotel in Guardalavaca after receiving a legal complaint from a Cuban exile family claiming ownership of the site.

Mariel special economic zone

The 290 km sq Mariel special economic zone is the Cuban government’s keystone economic project, set to be the country’s main hub for the low cost manufacturing of products for export, including to the US. The zone offers investors a preferential tax and investment regime including the duty free import of equipment and materials, the deferral of profit taxes for up to 10 years, and 50-year - as opposed to 25-year - operating contracts. Moreover, at 12 percent, the profit tax rate is 3 percent less than in the rest of the country. Despite government preference for joint ventures, a commitment has been made to allow full foreign ownership, and five of the eight investments approved so far are entirely foreign-owned. These investments come from Spain’s Profood Service, Mexico’s Devox Caribe and Richmeat, and Belgium’s BDC International and BDC Tec.

Cuba has a good pool of highly educated low-cost labour, but all investors in Mariel must recruit workers via government work agencies. These employment agencies must be paid transaction fees and determine all employment terms such as wages and work hours. Furthermore, the payment of workers is distorted by the dual currency system, whereby foreign companies pay workers’ wages to the government in the hard convertible peso (CUC), and workers are subsequently paid in the soft national peso (CUP), valued at 25 times less than the CUC. Government pledges to phase out the dual currency announced in October 2013 have yet to see progress, underscoring the slow pace of economic reforms.

Like the tourism sector, the government’s efforts to streamline the lengthy investment approval process for Mariel have not delivered. All applications for investment in Mariel are centralised through the Council of Ministers and should be returned in under 90 days. However, in practice the approval process extends beyond the length of time stipulated as foreign businesses seeking joint ventures must develop joint plans with one or more ministries. Despite being inaugurated almost two years ago in January 2014, thus far only eight companies have been approved to invest amid more than 300 applications.

Oil

The Cuban government is seeking to expand investment in oil activities in 2016. Current plans for exploration include deep-water drilling by Angola’s Sonangol in the Gulf of Mexico in late 2016, although no licensing rounds are currently scheduled. Despite high reserves of untapped oil, estimated by the US Geological Survey to amount to 5-7 bn barrels, regulatory challenges are likely to slow investment in the sector.

The capital intensive requirements of drilling offshore and the ongoing US embargo, which prevents IOCs from using rigs in Cuba with any more than a 25 percent component of US technology, will remain a major obstacle for international oil companies (IOCs). A history of unsuccessful exploratory campaigns by IOCs in the country will further deter investment at a time of low oil prices. In 2012, three deep well campaigns by Repsol, Petronas and PDVSA were suspended after the failure to find commercial quantities of oil. IOCs must be willing to enter into joint ventures with the government, as any investment in Cuba’s natural resources requires the state to retain a majority stake. IOCs will also face a higher profits tax of up to 22.5 percent related to the exploitation of natural resources.

Despite these obstacles, investment in Cuban oil has the potential to provide lucrative returns. The Canadian resource company Sherritt operates the three onshore commercial fields of Puerto Escondido, Yumuri and Varadero West, producing 18,000 barrels per day at a cost of approximately USD 10 per barrel, one of the lowest oil operation costs in the world. Sherritt’s experience in Cuba exemplifies the potential high returns the Cuban market can offer, something that will drive interest across several sectors despite ongoing political challenges.   

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