DOWN IN THE DUMPS.

Investing in Mexico can be hazardous--just ask Metalclad.

IN 1993, METALCLAD, A SMALL NEWPORT BEACH, California-based company, bought a beleaguered waste depot in Guadalcazar, an isolated community in the central Mexican state of San Luis Potosi. The company invested US$25 million to build a state-of-the-art facility Since its landfill would be the nation's largest and the closest to the Mexico City area--the country's industrial core--Metalclad would corner two thirds of the hazardous waste market as soon as it opened its doors.

It never did.

Seven years later, Metalclad's story is a cautionary tale, a saga of cross-border business gone awry In Mexico, where political sands have been shifting rapidly and in unprecedented ways in recent years, the company's experience, like that of the hazardous- and industrial-waste industry in general, is the clearest case yet of how politics can thwart logic, economics and a clean environment.

"The market for this kind of business in Mexico is probably one of the top two or three in the world," says Metalclad CEO Grant Kesler. "I see zero future [in this industry] unless the government of Mexico applies the political will necessary to make these projects succeed."

Metalclad is now awaiting the final verdict in a January 1997 lawsuit filed against Mexico alleging that the government of San Luis Potosi expropriated the company's property. The lawsuit was the first filed under the North American Free Trade Agreement (Nafta). The company is asking for $90 million in damages, plus $4 million in expenses. A three-member arbitration board heard the case in September 1999. Its decision--which cannot be appealed--is expected by the end of February 2000.

Mexico produces an estimated 8 million tons of hazardous waste a year. When the free-trade agreement was signed in 1993, only an estimated 6% of that hazardous waste was treated and disposed of safely. The rest was thrown into ravines and rivers, city dumps and deserts, or simply buried behind factories.

The country's hazardous-waste disposal market alone was believed to be worth $1.5 billion annually. Then there was recycling, incineration, and clean-up of clandestine dumps. All told, Mexican authorities have estimated the country's environmental infrastructure needs to be $2 billion annually through 2010. When Nafta took effect on Jan. 1, 1994, most observers touted hazardous waste treatment as one of the industries that would most benefit from increased foreign investment.

Yet no industry has so defied predictions. Mexico's hazardous-waste industry is in total disarray. Despite millions of dollars invested in seven proposed waste-treatment projects, not one is currently going forward. All have stalled or been cancelled. In fact, Mexico now has fewer landfills for hazardous waste than it did before the trade agreement, with only one legal facility operating in the entire country

LATIN TRADE attempted to speak with officials from Mexico's ministries of Commerce (Secofi) and the Environment (Semarnap) about hazardous waste and Metalclad's lawsuit. Semarnap referred all questions to Secofi. Secofi did not respond to phone calls requesting comment. A ministry spokeswoman also failed to respond to a faxed list of questions regarding the Metalclad case.

Come to Mexico. Back in March 1993 when Metalclad committed its first $6 million to get its project underway, "we simply saw it as a business opportunity," recalls Kesler, whose interest was first piqued at a New York meeting of Mexican environmental officials with potential investors. "The message was: 'Come to Mexico.' There was a crying need for technology and capital. They simply didn't have either"

And so Metalclad, which had done little but manufacture insulated pipe and issue stock in its 60 years of existence, unwittingly walked headlong into the emergence of democracy in a country where one party, the Institutional Revolutionary Party (PRI), has held power since 1929.

The company agreed to remove 20,000 tons of waste that the previous owner had illegally buried at the Guadalcazar dump. In exchange, the authorities would allow Metalclad to renovate the site and reopen it as a legal hazardous-waste dump with a 360,000-ton annual capacity.

Metalclad hadn't spoken to the local community. But such public dialogue has traditionally not been the Mexican way. Generally, a governor or a cabinet minister's approval would steamroll over any obstacles to these kinds of projects. The press, Congress, the local authorities and community--all could be counted on to tamely go along. In this case, the company had the approval from federal environmental authorities. It even had a written letter of invitation from then-Governor Horacio Sanchez.

In 1994, Mexico witnessed one of its most competitive presidential elections ever. At the end of that year, the Mexican peso collapsed and a devalued Mexican President Ernesto Zedillo found himself battling strengthened opposition parties. Democracy was gaining a foothold in Mexico.

Run for cover. The new political realities of increasingly plural politics and emerging civic participation quickly appeared in Guadalcazar, where Metalclad was finishing work on the landfill. A suddenly vigorous opposition in San Luis Potosi used the project to attack then Governor Sanchez. Greenpeace made fighting the landfill its top priority.

The federal environmental authorities, especially those at the Instituto Nacional de Ecologia (INE)--the federal agency charged with environmental regulation, who had urged Metalclad to plunk down money and issued permits, ran for cover when Metalclad's project encountered local opposition.

While the central government still supports these efforts, it lacks the power to impose its will, say former Instituto Nacional officials. After suffering through years of economic crisis, deceit and corruption, Mexicans oppose everything the government proposes, whatever the possible benefits. "A government that stepped on the rights of communities--that was corrupt, bureaucratic, unjust--has lot of guilt and that guilt hampers its actions," says Gabriel Quadri, former director of the Instituto Nacional de Ecologia.

Soon after the federal government's support weakened, Sanchez turned against the landfill, only six months after inviting the company to the state. He made his sudden about-face largely because of the emerging power of citizens groups, feistier media coverage and growing political competition. Before, under one-party rule, politicians like Sanchez never had to worry about the opposition. But now, it was open season on the old guard--especially a governor who supported a landfill or waste-treatment center.

Metalclad eventually did meet with community leaders near the site, but it was too late. Positions had hardened. Sanchez later designated 600,000 acres of Metalclad's site as an ecological preserve--effectively stopping the project and setting the stage for the company's lawsuit under Nafta.

The company's later projects to develop waste facilities in Mexico battled the taint of San Luis Potosi. When Metalclad tried to open another treatment center in the state of Aguascalientes, a local priest wrote that the project would harm plants, animals and people, "as has happened in other places where these companies have been expelled"--in a clear, if inaccurate, reference to that San Luis Potosi project that was never permitted to begin operations.

Metalclad turned to legal action to recoup its lost investment. In 1999, it sold all its holdings in Mexico and is preparing to leave waste-handling altogether and merge with a U.S. high-tech firm. The company's CEO, Kesler, plans to write a book about his experiences investing in Mexico.

Meanwhile, San Luis Potosi remains a state pocked with clandestine dumps. The 20,000 tons of illegal waste at Guadalcazar remains where it was buried years ago.

Center of refuse. The Metalclad case has affected hazardous-waste infrastructure development in Mexico ever since. It also has reoriented the approach of federal authorities to promoting hazardous-waste investment. Unable to sell simple landfills to the people, the government came up with the waste-treatment-center concept--known by its Spanish-language acronym as a Cimari--which included recycling, reuse, incineration and landfilling. But the centers fared no better than the simple landfills. Local opposition has stopped several proposed centers and today the federal government has ditched efforts to find sites for them.

Metalclad's case may also serve to define several issues in the free-trade treaty. Mexico has argued that the agreement's provision to protect investment through the arbitration board does not apply to municipal governments. "It's a very short-sighted view," Kesler says. "Imagine the impact of a decision that would say that the investment protection provisions don't apply to the municipal level. A municipality can expropriate your property ... and you'd have no recourse. The chilling effect it would have on investment is so dramatic that you can't imagine they would make that argument just to win one particular case. But they did."

Kesler believes the arbitration board will set a definition for expropriation under the free-trade treaty, as well as establish a way to value property that was expropriated before it even had a chance to earn income. "What kinds of parties are protected by Nafta? What legal entities? An enterprise? An investment enterprise?" he says. "What do those words mean? We're going to find out.

"I think this case is going to have a very dramatic impact upon future investment in Mexico in all sectors. If [Mexico] wins the argument that [investment protection] doesn't apply at the municipal level, I think the U.S. Congress would repeal Nafta. Those who voted in favor of Nafta expected that it would protect investment regardless of the level of government."

Hazardous quagmire. Whatever the decision of the free-trade treaty's arbitration board, Mexico still has a hazardous waste question to resolve.

In 1998, the Cytrar landfill in Hermosillo, Sonora--one of the two existing Mexican landfills when the free-trade agreement went into effect--was denied a permit renewal. This means that Rimsa, in the town of Mina, Nuevo Leon, has the only functioning public hazardous-waste dump in Mexico. The site is an arduous 12-hour truck ride from the Mexico City region, where more than half of the country's hazardous waste is produced. Meanwhile, Mexico is systematically poisoning itself with millions of untreated tons of hazardous and industrial waste.

Any solution will likely have to wait for a new president to take the oath of office in December. The environmental bureaucracy of President Ernesto Zedillo has stopped pushing hazardous-waste landfills and treatment centers. "All of this should really make us think about giving more authority to the states to resolve their waste problems, instead of Mexico City," says Jorge Sanchez, a former federal environmental regulator of hazardous waste.

Six years into the free-trade treaty, investors are standing on the hazardous-waste sidelines. "The authorities have sent the overwhelming message to the investment community that the conditions don't exist to invest here' says Manuel Murad, an environmental engineer who also once worked at the environmental regulatory agency INE.

All the Mexican government needs to do, Kesler says, is show they have the political will to make these projects succeed. "If they do that," he said, "They'll attract more capital than their wildest imagination could conceive.