Special Report: Mexico's drug cartels, now hooked on fuel, cripple nation's refineries

[January 24, 2018]  By Gabriel Stargardter

SALAMANCA, Mexico (Reuters) - The first call, from someone claiming to belong to the Michoacan Family drug cartel, came in February 2015.

"They said they knew who I was and where I lived," said Alberto Arredondo, who got the call at work as a pump technician at an oil refinery in the central Mexican city of Salamanca. "They wanted information."

At first, Arredondo hung up.

"But they were insistent," he said, calling back and demanding details of when fuels would be pumped and through which pipelines.

Over the next two years, Arredondo said, he would be hounded, kidnapped, pistol-whipped and stabbed so severely that surgeons removed his gall bladder. In December 2016, he fled to Canada, where he now seeks asylum from gangs that steal fuel from Salamanca and five other refineries operated by Pemex [PEMX.UL], the state-owned oil company.

Fuel theft is fast becoming one of Mexico's most pressing economic and security dilemmas, sapping more than $1 billion in annual revenue from state coffers, terrorizing workers and deterring private investment in aging refineries that the government, following a 2014 energy reform, hoped instead would be thriving with foreign capital.

Because of government offensives that toppled narco kingpins in recent years, Mexico's drug cartels have splintered and are eager for new sources of revenue. Now, their increasingly dominant role as fuel thieves pits two of the country's biggest industries - narcotics and oil - against one another.

The cash-rich cartels, believed by the Mexican government to generate well over $21 billion each year, are an increasing threat to Pemex, which in 2016 reported revenue of about $52 billion and generates about a fifth of government income.

"The business is more profitable than drug trafficking because it implies less risk," said Georgina Trujillo, a ruling party congresswoman who heads the lower house energy commission.

"You don't have to risk crossing the border to look for a market," she added. "We all consume gasoline. We don't all consume drugs."

Pemex did not respond to detailed questions from Reuters about the cartels and fuel theft. Among other questions, Reuters asked about the cartels' impact on the refineries, Pemex's security measures and how the company responds to extortion and violence against its employees.

One senior Pemex refining executive, who asked not to be identified, said, "We worry about the influence of organized crime," but would not discuss the issue further.

Fuel theft is not new or unique to Mexico. But cartels are taking it to calamitous new dimensions and, in the process, bolstering their bottom line.

"Fuel theft just makes these groups more powerful," according to one senior official from the U.S. Drug Enforcement Administration, who asked not to be identified.

By targeting refineries, already suffering from a lack of investment, Mexico's most notorious criminals gain access to nerve centers for much of the country's fuel supply.

That threatens an oil industry that accounts for about 8 percent of Mexico's economy and creates yet more uncertainty for a country already reeling from U.S. threats to dismantle the North American Free Trade Agreement.

(Graphic: As illegal fuel taps soar, refineries suffer - http://tmsnrt.rs/2DgsoX9)

"It hurts the national coffers, weakens national security and hinders the reform and development of Mexico's energy market," said Gustavo Mohar, a former Mexican energy and intelligence official.

BLEEDING MONEY AND FUEL

Between 2011 and 2016, the number of unauthorized taps discovered on Mexico's fuel lines nearly quintupled, according to a recent report by the federal auditor. Repair costs surged almost tenfold, to 1.77 billion pesos ($95 million).

A May 2017 study, commissioned by the national energy regulator and obtained by Reuters via a freedom of information request, found that thieves, between 2009 and 2016, had tapped pipelines roughly every 1.4 kms (0.86 mi) along Pemex's approximately 14,000 km pipeline network.

After decades of poor upkeep, the refineries are bleeding money as well as fuel. In addition to unscheduled outages, which cause big operational losses, maintenance problems have led to fatal accidents, including fires and explosions.

Together, the refineries have accumulated annual operating losses of about $5 billion in recent years. Production of refined products, meanwhile, fell to just over 700,000 barrels per day in 2017. That's about half the production levels at the refineries' peak in 1994.

The 2014 energy reform is the landmark economic initiative of President Enrique Pena Nieto. It ended more than seven decades of monopoly of the oil sector by Pemex.

It also gradually phased out subsidies that kept retail fuel cheap, causing prices at the pump to climb by an average of nearly 25 percent since 2014, even though global oil prices fell by as much as 75 percent during that period.

Higher prices were meant to attract foreign oil companies and other private investors.

They also attracted criminals, who undercut licensed retailers by selling stolen fuel at a discount. With know-how gained from extorting sectors including agriculture, transport and mining, drug gangs began applying their tried-and-true methods at refineries.

Using the habitual narco offer of "plata or plomo," or "silver or lead," gangs extort refinery workers into providing crucial information. Their tactics, coupled with fighting between groups jockeying for access to the racket, have led to a surge of violence in cities like Salamanca, home to a third of the fuel taps discovered in Mexico in 2016.

Mutilated corpses of refinery workers, police and suspected fuel thieves increasingly appear around the city, terrifying its 260,000 residents. Cartels routinely festoon Salamanca with "narcomantas," banners that mark territory or spell out grisly threats to rivals.

In Guanajuato, the surrounding state, investigators opened 1096 murder cases last year, 14 percent more than in 2016. That is a 71 percent increase over 2013, Pena Nieto's first full year in office.

Interviews with Pemex and Mexican security officials, authorities in Guanajuato and locals affected by fuel theft describe an increasingly desperate situation for the industry and the regional economy.

Interviews with Arredondo, the former pump technician, and Juan, a cartel member and admitted killer turned federal informant, show the heavy toll inflicted on people on both sides of the theft.

Juan, whose last name Reuters agreed not to disclose because of his ongoing role as an informant, is no longer in Guanajuato. His information is believed by the government to be credible and has been corroborated upon further investigation, according to one senior federal security official.

"DON'T PASS THROUGH SALAMANCA"

The Salamanca refinery, the second-oldest Mexican refinery in operation, was inaugurated on July 30, 1950. It was part of a nationalistic push by Mexico, 12 years after the government expropriated foreign oil assets and created Pemex, to assert economic and industrial might.

Located in Guanajuato because of the state's central geography, with easy access to Mexico City and far-flung corners alike, the refinery became a symbol of progress. It put Salamanca, previously a farming town in a sea of sorghum fields, on the map.

Quickly, though, Salamanca and the refinery would also come to be associated with some of the deadly risks of the oil business. Jose Alfredo Jimenez, a legendary singer of Mexico's traditional ranchera music, penned a still-famous song after a brother died after getting sick at the refinery in 1953.

"Guanajuato Road," as the song is titled, leads to places where "life has no value," he sang. "Don't pass through Salamanca," he continued, "the memory pains me there."

The refinery grew to dominate the local economy, its fortunes rising and falling along with those of the Mexican oil industry. Although thieves targeted the pipelines leading to and from the facility, they rarely caused significant loss.

In recent years, that changed.

One particular gang of "huachicoleros," as fuel thieves are known, now dominates the racket.

Allegedly run by a local, Jose Antonio Yepez, the gang is known as the Santa Rosa de Lima cartel, after a small town 60 km east of Salamanca. Yepez, himself known as "El Marro," or "The Mallet," is wanted by federal authorities and suspected of crimes ranging from drug trafficking to fuel theft.

Little is publicly known about him or his organization.

Reuters was unable to reach Yepez for comment.

Juan, the informant whose account of the organization has not been reported before, said he joined the gang in 2013.

Originally from the neighboring state of Jalisco, he was earning 600 pesos ($32) a week as a day laborer when a friend phoned about work in Guanajuato that paid many times more.

That April, Juan said, he moved to the town of Villagran, about 25 km east of Salamanca. Initially, he worked for the gang as a lookout, earning 5,000 pesos a week to report on soldiers and federal police driving through the area.

Soon, though, he graduated to filling up giant, 60,000-liter fuel tankers at a ranch called "El Caracol," connected by buried hose to a pipeline about three km away.

The chief fuel tapper, known as Fito, bragged to Juan and the gang about his refinery contacts and his unique tapping skills. Other tappers simply siphoned fuel from near the pipeline. Fito lined a hose along the underside of the duct, burrowed it far away and then ran it underground to the ranch.

The technique made taps difficult to detect, allowing the gang to milk pipelines continuously. One tap ran four years undetected, Fito boasted.

"ONE OF US"

By late 2013, El Marro's outfit faced incursions by others, Juan and federal security officials say. The interlopers included major gangs like the Zetas, the Knights Templar and a successor cartel known as the Michoacan Family, to which the people who extorted Arredondo claimed to belong.

To deter them, El Marro built up a militia.

"El Puma," a Marro lieutenant, recruited Juan for the force.

"Now you're one of us," Juan said he was told by El Puma. He handed Juan a gun and said the first order of business was to take down an emerging gang made up of bandits recruited from as far away as the Pacific coast.

El Marro, a proud local, told his gang that they had the upper hand on their own turf, Juan recalled. "No dog is brave beyond its home," El Marro said.

Juan said he and fellow militia members killed six of the rivals.

Later, a group of Zetas approached El Marro and demanded three pesos for every liter of fuel he stole. El Marro's gang arranged a meeting with the Zetas.

A sign is pictured of Mexico's national oil company Pemex's refinery in Salamanca, in Guanajuato state, Mexico September 19, 2017. Picture taken September 19, 2017. REUTERS/Edgard Garrido

Before the meeting could begin, however, Juan and his colleagues ambushed 13 of the rivals, killed them and buried them in a mass grave in a region they refer to as the "Bermuda Triangle." In total, Juan said he had killed about 30 people.

Reuters could not independently verify Juan's claims.

The senior federal security official said the details and scope of the events Juan described are consistent with the bloodbath around Salamanca. Juan, aged 55, is the government's single best source of information on fuel theft across Mexico, the official said.

As the gang's strength grew, El Marro grew prominent. He bought land and racehorses and commissioned songs from a local band, a practice common among narcotraffickers to manufacture their personal mythologies.

In "Bermuda Triangle," his signature "corrido," as the songs are known, the group sings that "the competition sweats and fast will be finished because the Mallet rules here and he and his men hammer."

Yepez also built up a payroll that Juan and government security officials say includes politicians, local, state and federal police, and state and federal prosecutors. Juan said on several occasions he personally delivered a payoff of 30 million pesos to one official to ensure that law enforcement turn a blind eye to the theft and extortion.

Juan named the official he allegedly gave money to, but Reuters could not independently verify the payment. Prosecutors have not charged the official with any crime.

Around late 2014, police surrounded El Marro, Juan and other gang members near the town of Celaya. El Marro remained calm, Juan recalled.

"I'm going to make a quick call," the boss said.

The police promptly let them go.

Graft among Salamanca police got so severe that the state recently fired the entire local force and replaced it with Guanajuato state officers. State police referred questions about the incident involving El Marro to state prosecutors, who did not respond to requests for comment.

The payoffs, like the theft, are all possible because of the gang's refinery sources. "That's where we got everything," Juan said. "It's the brain."

"I TOLD THEM EVERYTHING"

Arredondo, the former refinery worker, grew up in Salamanca and is now 37 years old. He had been a pump technician for more than a decade when the extortionists phoned in 2015.

His job involved delivering gasoline, diesel and jet fuel through pipelines.

After the first call, Arredondo said he went to a manager, who told him not to disclose any information. Then the gang called again, threatening to kill him.

Arredondo folded, giving the caller details of a diesel delivery.

After work that day, a motorcyclist approached and offered Arredondo an envelope. "The patron sends this," the helmeted rider said, using a Spanish term for "boss."

Arredondo said he declined the package. But the message was clear.

Despite salaries similar to his, a modest 30,000 pesos ($1550) a month, some of Arredondo's colleagues had grown affluent, buying expensive cars and watches and sending their kids to schools abroad. One colleague bragged of renting a strip club for one night, splurging on drinks and prostitutes for himself and for friends.

"They were providing information," Arredondo realized.

Such payoffs, he said, "never interested me."

After rejecting the envelope, Arredondo said he sought to lie low. He moved house. But the thieves wanted more.

In February 2016, as he left a supermarket, armed men pulled up and told Arredondo to climb into a white van. They yelled, threatened to kill him and drove him to a ranch.

There, another group waited. The leader of that group berated him, demanding to know details about the pump team. "I told them everything," Arredondo said, explaining the team's eight-hour shifts, each staffed by four workers.

The group leader was unconvinced. He grabbed a pistol and struck Arredondo with the butt, cutting his forehead. The men forced him back into the van, drove off and tossed him by the roadside.

Going to the police was out of the question. That year, two refinery colleagues were killed. Family members of the victims told Arredondo that the colleagues had informed police about threats from fuel thieves.

Police referred questions about those deaths to the Guanajuato state attorney general's office. A spokeswoman there said it had records of three suspected murders of Pemex employees in recent years.

A Reuters review of local press coverage found at least seven alleged murders of Pemex workers around Salamanca since 2012. The company and law enforcement rarely confirm employment details of victims after such killings.

The calls to Arredondo intensified, now directly to his cell phone. He told managers once more, but said they were little help.

Arredondo moved again. But the men from the van caught up with him, lingering outside his new home and making sure to catch his eye.

"I felt cornered," he said.

He moved a third time.

On Oct 18, 2016, his 36th birthday, Arredondo went to a bar. As he left, a man stabbed him in the stomach and ran off, not bothering to speak or even rob him.

For two months, he recovered at his parents' house. The day before he planned to return to the refinery, he went home. But there were the gang members, yet again.

"I realized that this was never going to end," he said.

Arredondo immediately bought a plane ticket for Canada, where he once vacationed. He took a bus to Mexico City the next morning and left his country that night.

"NO LONGER A BLESSING"

Arredondo is not the only one now fleeing Guanajuato.

Before the surge in violence, the state's location had made it a hub for manufacturing and logistics and an emerging hotbed for business. Investment in Guanajuato, which peaked at $2.9 billion in 2015, is now falling steadily, reaching less than half that amount for most of 2017, according to state figures.

Up to 15 percent of Salamanca's 10,000 businesses have closed, said Francisco Gonzalez, head of a local chamber of commerce. "The refinery, and Pemex in general, are no longer a blessing for us," he said.

The refinery is underperforming, operating at just over 60 percent of its capacity in 2017 and getting less funding than in years past.

Despite Pena Nieto's promise to modernize the sector, low oil prices have handicapped investments in the six refineries. The 2017 budget allocated 18.92 billion pesos for refinery upgrades, less than half the 39.77 billion spent in 2014.

Efforts to lure private investment, meanwhile, have struggled.

Last month, Pemex reached a preliminary deal with Japan's Mitsui & Co Ltd to complete a $2.6 billion coking plant at its refinery in Tula de Allende, north of Mexico City, according to two people familiar with the decision. [nL1N1PB1JD]

But Pemex officials last year sought separate refinery funding from companies including Valero Energy Corp <VLO.N> and Tesoro Corp <ANDV.N>, according to two people familiar with those efforts.

Neither company was interested. [nL1N1I7012]

Mitsui, Valero and Tesoro, which last year changed its name to Andeavor, declined to comment.

"There is no incentive to invest in the Mexican refining system," said John Auers, executive vice-president of Turner, Mason & Company, a global refining consultancy, citing "organized crime and corruption."

The report commissioned by Mexico's energy regulator assigns blame inside and outside the sector. "The problem is corruption, not just in security and judicial services, but also inside Pemex," it read.

In public pronouncements, Pemex has vowed to crack down. The company said in an October statement it had fired an unspecified number of employees for unspecified illegal activity at Salamanca's storage and distribution center. It did not elaborate.

"What we're starting to see is that we're approaching the end," Pemex Chief Executive Jose Antonio Gonzalez Anaya told lawmakers recently, referring to what he described as gains against fuel thieves. In late November, Pena Nieto named Gonzalez Anaya finance minister and announced a new Pemex chief.

Few in Salamanca see any end to the problem in sight. Police increasingly seize vehicles, including school buses, ambulances, and delivery trucks, gerryrigged to carry stolen fuel.

"El Marro," on the offensive after continued incursions by rivals, in October published a YouTube video in which he shouts expletives and vows to hunt down members of the Jalisco New Generation cartel. Behind him, about 70 men brandish automatic rifles, cheer and empty their magazines into the sky.

Juan, the former gang member, said he recently found religion and a girlfriend, with whom he had a son in 2016. He left the gang in early 2017 and sought out authorities.

Arredondo, meanwhile, is hoping for asylum.

In June, the Immigration and Refugee Board of Canada rejected his initial petition. Although it called him "a largely credible witness," the panel recommended he relocate within Mexico, suggesting two cities where the Michoacan Family is not present.

A spokeswoman for the refugee board said it could not comment on specific applications for asylum.

Arredondo appealed the board's decision and has a "good shot," said Christina Gural, his Canadian lawyer. Just in case, though, Arredondo is researching asylum possibilities in other countries, including Australia, Norway and Finland. Of one thing he is certain.

"I can't return to Salamanca," he said.

(Reporting by Gabriel Stargardter in Salamanca. Additional reporting by Gary McWilliams in Houston and Ana Isabel Martinez, Adriana Barrera, Marianna Parraga, David Alire Garcia, Dave Graham and Dayann Burbano in Mexico City. Edited by Paulo Prada.)

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