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Nearshoring is transforming global supply chains and driving immense growth across North American markets, particularly in Mexico. On this episode of Market Points, you’ll hear from Rodrigo Echagaray, Head of Latam Equity Research and Head of Global Product Management, as he moderates a discussion with Francisco Suarez, Analyst, Latam Cement, Construction and Real Estate; Konark Gupta, Analyst, Transportation and Aerospace; Tristan Richardson, Analyst, Clean Technologies and Energy Infrastructure; and Patrick Bryden, Analyst, Head of ESG Research.
They’ll discuss how nearshoring is driving significant growth in manufacturing and real estate in Mexico, while accelerating the integration of North America’s air and railway networks. They’ll also cover why ESG is critical to nearshoring and North America’s clean-tech boom.
Let’s get started. Here’s Rodrigo Echagaray.
Rodrigo Echagaray: Geopolitical risks, U.S.-China trade conflicts, COVID-19 lockdowns to name a few, have underscored the importance of de-risking supply chains through nearshoring. The need for more reliable, resilient, and sustainable supply chains is an increasingly important focus for countries and company boards driving long-term capital decisions. The need for nearshoring has spurred government initiatives including a ‘Made in the Americas’ approach that we believe will greatly benefit USMCA partners. We think Mexico is now the epicentre of nearshoring and in fact, Mexico became the top U.S. trading partner this year. And we don’t see that momentum waning as companies look to aggressively re-configure entire supply chains by relocating production. The experts on this panel hold a firm grasp of nearshoring trends and a strong local presence in Mexico and will provide their insights that can help companies navigate this transformational moment in North America.
Francisco, can you kick us off and share your insights on how nearshoring has helped Mexico become a manufacturing and shipping hub?
Francisco Suarez: Yes, sure, thank you. The reason why we are so optimistic about the industrial real estate is that this industry is at the epicenter of this major transformation in the region’s value chains, and as a result, demand has skyrocketed. Nearshoring is not new, but demand has accelerated, driven by three factors. First, the need to improve resiliency in value chains. That became clear after the pandemic. Secondly, USMCA. That increased North America’s value content in trade. And thirdly, geopolitical risks. Major spending programs like the Inflation Reduction Act, CHIPS and Science Security Act, just reinforces these trends. Why? Because our value chains are deeply integrated. A sweetener to this story is the recently announced tax breaks in Mexico for new investments linked to nearshoring. So, for years, since 2013, supply of industrial real estate has grown at rates of 9% on average. But demand has outpaced supply by roughly 15%. And as a result, we’re totally sold out in most markets, particularly in the North. And we see a spillover effect that has increased demand in other regions like Central Mexico, where major clusters in auto, electronics and aerospace are located. But let me give you some examples on the ground. A Canadian-based and Fortune 500 company in the auto value chain is expanding capacity in its joint venture in electric vehicles powertrains that supplies operations in Mexico for General Motors and Ford, but also for Tesla in Texas. Also, a U.S.-based and Fortune 500 company in the pharma industry not only has increased capacity bringing production lines from Europe to Mexico, but the workforce of this operation has helped to fill the needs of labour in operations in the U.S. by sending crews temporarily to the United States. A set of more exciting examples are linked to the new value chains that are strongly needed in North America. See Foxconn and Quanta, both from Taiwan, that have announced major investments in Mexico. These examples address the major need to increase production capacity in microprocessors and also the need to create an ecosystem to support the transition of the auto industry to electric vehicles. And of course, a new Gigafactory from Tesla is also in the making in the city of Monterrey, a city that so far has captured 50% of investments linked to nearshoring. But these figures just capture part of the story, Rodrigo. For every building used for light manufacturing, a value chain and its logistics needs need to be created. This is a major reason why we think that the rent growth in Mexico has more room to grow with low levels relative to those seen in the United States.
RE: Thank you, Francisco. Manufacturing is certainly growing in exciting ways. But can you also talk about how nearshoring is having an effect on transportation and specifically on North America’s air networks?
FS: Yes, for sure. Regional airports in Mexico play a key role in nearshoring and this reinforces the trends of air travel integration that we have seen over the past decade. Recent announcements made by Air Canada and Delta are examples of how important it is to create direct flights from Toronto to Monterrey or from Detroit to the city of Querétaro. Airports also benefit from the major structural capacity constraints that we see in Mexico City. But there are other angles. The airport of Tijuana alleviates the congestion that we see in the airport of San Diego in Southern California. This is on the back of the cross-border express, that is literally a bridge that crosses the United States-Mexico border connecting directly to this airport. As a result, the airport is likely to continue to experience above average growth, not to mention that the Tijuana market is already a pharma and electronics manufacturing hub.
RE: And staying on track with the importance of transportation networks to nearshoring, Konark, how are railways benefiting and changing in response?
Konark Gupta: Thanks, Rodrigo. Railroads will certainly benefit from nearshoring over the long term, but they’re also currently one of the key enablers of the theme. Let’s first look at what nearshoring means for the rail transportation industry before we talk about the enabling side of things. North American railroads are considered a true backbone of the economy, given they account for about 40% of the freight tonnage that is carried over long distances – more than any other mode of transportation. So, trade flow, and particularly transcontinental trade flow is essential for rail traffic. Since the trilateral trade agreement between U.S., Canada and Mexico, previously known as NAFTA, began in 1994, the U.S. imports of goods from Mexico and Canada have grown at a 6% compound annual rate to nearly $900 billion today. The U.S.-Mexico import trade has grown at twice the rate of U.S.-Canada imports over the past 30 years. NAFTA was recently re coined as USMCA in 2020. While the pandemic and geopolitical events have forced businesses globally to rethink and de-risk their supply chains by moving closer to their partners and end-markets in North America. As a result, some supply chains are moving back to North America and new factories are being set up here, which is requiring a lot of raw materials, machinery and workforce. Job creation, localized production and the flow of finished and unfinished goods will incrementally contribute to the North American trade flow and therefore to the railroad industry over the next few decades. With Mexico being the epicenter of nearshoring due to its proximity to the U.S., demographics and attractive costs, rails are going to play a very important role as key enablers of nearshoring. So, let’s talk about what exactly they are doing to facilitate this.
In 2021, Canadian Pacific Railway proposed to acquire Kansas City Southern Railway, which had operations in the U.S. and Mexico. The $31 billion merger was completed in April of this year, marking the beginning of a new nearshoring chapter as the merged company called CPKC became the first and only single line railroad connecting Canada, U.S. and Mexico. Right off the bat, CPKC launched a new train service called MMX or in Mexico Midwest Express, which connects the U.S. Midwest to the key Mexican markets of Monterrey and San Luis Potosi, where a lot of industrial action is happening today. The company is hoping to replace a lot of trucks in that North-South corridor, thereby creating environmental benefits, which I will talk about shortly. Following the footsteps of CPKC, other major railroads got together to create yet another alternative for shippers in the U.S. Midwest to Mexico corridor. For example, Canada’s largest railroad, Canadian National Railway, joined hands with Mexico’s largest railroad, Ferro Max and U.S. bellwether Union Pacific, to launch a train service called Falcon Premium. Both MMX and Falcon will provide environmental benefits by replacing a significant number of trucks in the truck dominated U.S.-Mexico corridor. Rails are about four times more fuel efficient and emit 75% fewer greenhouse gases as compared to trucks. While nearshoring represents a very big opportunity for rails in the long term, there are some challenges that need to be addressed in the shorter term. For example, potential industry reforms in Mexico where railroads are private, but they operate on state owned tracks under long term concessions. Rails also face competition from trucks around the U.S.-Mexico border, while blockades and thefts have had some impact on rail operations in the past.
RE: Thanks, Konark. The growth in building materials, particularly demand for cement in Mexico, is another huge opportunity we’re watching. Francisco, can you talk about that segment?
FS: Yes, thanks so much. I think that in construction, steel and cement companies benefit from nearshoring, and we are seeing already that the markets are totally sold out both in Mexico and in the United States. There are trade restrictions to import steel from China, but that is not the case for Mexican steel. So, I think that in the United States, you have to see that residential construction spending has been on decline, but that has been totally compensated by the growth in industrial construction. And as a result, cement and steel markets are totally sold out. You have to take into account that there’s a set of tariffs that restrict the imports of Chinese steel to the United States, but that is not the case for Mexican steel. And as a result, we are seeing expanding capacity on steel in Mexico. I think that our key message that I have for the audience in general is that if Mexico is able to capture just 3% of the gross leasable area that you see in industrial real estate in China, that means that Mexico’s industrial real estate market will double its size from current levels. So, the opportunities are big, but it is not only about real estate. As mentioned, yes, every light manufacturing building requires a value chain, a lot of logistics embedded, but there’s also need for residential real estate in the regions that are benefiting the most from nearshoring. And also, there is a strong need for more infrastructure. If we require more exporting capacity, then we need to invest more in highways, in border crosses across the entire U.S. and Mexican border. And as a result, that is another source of demand for steel and cement.
RE: Thank you, Francisco. And along with the tremendous growth we’re seeing across industries, opportunities and innovation around ESG are reaching new heights thanks to nearshoring. Patrick, can you talk about why ESG is so important for this process?
Patrick Bryden: Yeah, for sure. You know, we’ve seen ESG kind of become, I would say, the glue of this process with nearshoring and securing of supply chains. And there’s a lot of reasons for that. You know, we’ve had a pandemic followed by inflationary pressures and geopolitical tensions. And so, there’s basically a trend of rising protectionism. And these events, you know as noted, have really exposed supply chain vulnerabilities. And more broadly, it’s made people scrutinize them in a much deeper way. So, there’s no question that sustainability is part of that story. And when we talk about nearshoring, what I think we’re really focusing on is not just the supply chain resiliency, but business resiliency. So how companies in particular, as people invest in them, fare through these kinds of challenges. And that concept is tested in the equity and debt markets every day. But, you know, through our work, we’ve come to know a number of, I would say, ground-breaking leading experts in sustainability. And one of them is George Serafeim out of the Harvard Business School. When we have these kind of market shocks, it creates opportunities for insights into companies. And so there was a study led by George and his colleagues that evaluated over 3,000 companies using natural language processing and news coverage of corporate responses to the COVID-19 pandemic. And interestingly, what it found is that the companies with effective responses and navigation offered better relative market performance. So, the market could actually see it. And I think that the findings clearly speak to how businesses are positioned with respect to human capital, supply chain and product and services responses through inflection points like that. So, I think things like carbon intensity, worker rights, social license to operate, etc., these are all simply under a much stronger microscope, as our ability to evaluate data continues to rise.
RE: Patrick, what is the nearshoring trilemma? Which is a term that we coined at Scotiabank a couple of weeks ago when we published our nearshoring report.
PB: In energy markets, there’s an adage known as the Energy Trilemma, and this idea is commonly cited by many organizations today, such as BP or McKinsey and Company, who are examples of people who we deal with in our investment research day-to-day. What it speaks to is the need to balance energy security with affordability and sustainability, and that’s obviously a very prominent consideration in today’s day and age. We see a very clear analogy to what we’re discussing here now. Namely that there’s also, Rod, as you put it, a nearshoring trilemma at play. And we think that includes the following components. So, the first is the security of supply chains. These need to be reliable. The second may sound obvious, but it’s perhaps the sharpest point of it all, is attractive economics. The numbers always need to go around for businesses. And then the last piece is sustainable solutions. Companies simply must have an answer to sustainability questions today. And this really is the glue that kind of holds that trilemma together.
I should also double underline, that as we’re touching on here today, there’s another tidal force at play, and that is that there are subsidies to foster nearshoring and energy transition. And these can be very positively assumed domestically, but globally it has the effect of creating a subsidy war, if you like. So, think of the IR provisions that we’re discussing today and what the competitive response is in the European Union or Canada, or let alone China when it comes to important areas such as critical minerals. So really, there’s a very competitive situation underway globally, and I think it’s actually somewhat akin to an arms race, if you like, where countries and companies are trying to get ahead of this.
RE: And what other Scotia specific insights or anecdotes support the nearshoring trilemma?
PB: Well, that’s an excellent question. I think the way in which energy was weaponized in the Russia-Ukraine conflict and the ability of liquefied natural gas markets from North America and elsewhere to fill the gap within one year is quite an incredible example. It gives you a sense for how important security issues are. And it’s also notable that while there were some coal power plants fired up in Europe to deal with the challenge, by and large, the biggest salvation has been the globalization of LNG. And typically, it takes about a decade or up to a decade to get LNG supply chains up and running. And in a lot of examples, it happened in a matter of months when it truly mattered. And so near-term, we see an all of the above solution and energy markets and energy transition, which therefore includes hydrocarbons. And it’s a tough time with inflation on top of it all. But I think over the medium term you are seeing a lot of stimulation in areas like nuclear, uranium, hydrogen, renewables, etc., that will be spurred on by these security questions. And so nearshoring is definitely part of that theme.
RE: And ultimately, what is the role that ESG can or should play as an enabler of nearshoring?
PB: Yeah, that’s such a multidimensional question, so let me try to tackle it. Consumers traditionally vote with their chequebooks, but more and more we’re seeing, I would say, a very grassroots form of demand for sustainability. And to maybe put some numbers to that, the world’s capital market is $400 trillion in size. It’s about a quarter equity, three quarters debt. About 10% of that number is of the divestment movement, where people have formally signed on to say, ‘Okay, we don’t want to be investing in hydrocarbons.’ And you could infer the other bookend of that would be people who are just seeking pure profits and they’re not worried about any impacts. I think the real middle, that 80%, is where there’s a gradient of concern on sustainability. And I think that engagement, if you like, from consumers and investors, is very real. So certainly, as supply chains and the nearshoring question have come to light, I think the scrutiny on all those issues has become much more heightened and sustainability really fits into that. So again, we think that’s really kind of the glue of this near shoring trilemma.
The other thing is that we believe the companies that demonstrate sustainable practices will differentiate themselves. And why do we believe this? Well, it’s not so much that they’re good at ESG or nearshoring or supply chains. It’s just more of a deeper hallmark that these companies are better run, they think more deeply about risks and opportunities. And so, the expression of that are these decisions and these strategies. So, in short, our view is that the business adaptation that will drive nearshoring, part of that is ESG performance. And again, you know, I would double underline that that is the glue that investors will be looking for as they make decisions on allocating capital.
RE: Thanks, Patrick. And ESG needs have, of course, sparked new energy solutions and in turn, a boom in clean tech manufacturing in North America. Tristan, can you highlight what’s happening?
Tristan Richardson: Sure. It’s really interesting. I joined Scotiabank only three weeks before the IRA was signed into law here in the United States. It turns out to be, I think, somewhat serendipitous, really, as we here at Scotia are truly a North American focused bank. And, IRA, we’ve talked a lot about it, there’s been much written about it. But it’s very hard to argue that this isn’t one of the most sweeping pieces of legislation that we’ve seen in decades around nearshoring to become law and it’s been in place only 18 months or so. And I think Pat put it eloquently, when you talk about not only supply chain resilience, but business resilience, margin resilience, earnings resilience. So clearly, we’ve seen a lot written about what the IRA is and what it will do. But I think more than a year in now, I think it’s important to look at maybe a few anecdotes of what the IRA has incentivized already. We’ve already seen a substantial shift in the clean tech space on investment in new manufacturing capacity. That is, you’re seeing large scale investment for solar panels, which was once exclusively the province of China and now coming to North America and specifically in the U.S. We are seeing that in the energy storage space. Battery technology is coming back to North America and that manufacturing capacity is coming back. This is not a will happen, this is happening already. You’re also seeing this in carbon capture as well as hydrogen. And these are areas that maybe explicit or brick and mortar manufacturing capacity isn’t coming back to North America because these are so nascent. But really, this is expertise, know-how, intellectual property that is originating here in North America and I think it’s explicitly a byproduct to the IRA.
RE: And how has the IRA impacted solar investment, specifically?
TR: Great question. I mean, if we’re thinking about solar specifically, you’ve seen more than 50 new solar manufacturing capacity projects announced just since the launch of IRA. One anecdote, First Solar, one of the largest manufacturers of solar panels in the world, is dramatically shifting their capacity. So not only is this company growing capacity from 16.5 gigawatt of manufacturing capacity, growing to 25, but they are also shifting that percentage. Today, maybe somewhere around 30% of that 16 gigawatt is here in the United States. By 2026, 60% of a much larger number will be in the United States. And they’ve said specifically that they’re going to spend two and a half billion dollars over the next couple of years on this initiative. So that’s just one company and one example of how you’re seeing this dramatic shift in supply chains. And then there is economic incentives here, too, Rod. So, I think these actors are not responding purely to a business resilience focus, but also to an economic focus. These tax credits for manufacturing domestically and using domestic content carry specific and explicit economic benefits that can be recognized in the company’s earnings, that can be monetized. So, you are specifically seeing dramatic margin uplift from a lot of these companies purely by changing their sourcing from elsewhere to North America and specifically the U.S.
RE: And what about U.S. battery manufacturing?
TR: Sure. You can’t really talk about energy storage without talking about the 800 pound gorilla, which is Tesla. That domestic capacity was evolving long before the IRA. So, it’s hard to say that IRA has specifically impacted Tesla’s domestic manufacturing capacity. But, if you look outside of that, you’ve seen 20 plus EV battery, general energy storage, whether that be utility scale, residential scale, EV, 20 plus manufacturing projects announced over just the past year. And again, similar to solar, you have specific tax credits available for these standalone energy solutions. As long as you’re using domestic content, these manufacturers can recognize direct subsidies from the government. These are monetizable. These are transferable. So, you are seeing an explicit economic incentive to make these investments. And it’s happened much quicker than we all thought.
RE: And finally, what about clean hydrogen generation capacity? What is going on there?
TR: So, this one is an interesting area, too. We talked about this earlier. This isn’t necessarily bringing existing manufacturing capacity and moving it to North America. It is about developing new technologies. How do we monetize, store, transport hydrogen safely, effectively so that future applications for this molecule can be quicker to be penetrated or adopted by industry? That is much further out, but I think this is not specific just to start-ups or solar companies or battery companies. You’re seeing some of the largest traditional energy companies in the world really spend a lot of time here. You’ve seen partnerships with the Department of Energy announced with Exxon, Chevron as well. And so, you’re seeing these clean hydrogen hubs evolve very quickly. There are numbers around $10 billion of investment. Not all of that been deployed. It’s very early days still around hydrogen. But it goes back to this isn’t just a physical capability nearshoring theme. This is intellectual property, nearshoring. This is expertise. This is knowhow that is all a part of this nearshoring theme, specifically within clean technology.
RE: Tristan, thank you.
TR: Always a pleasure. Thanks, Rod.
RE: We’re truly in the midst of a major transformation of global supply chains, and we don’t see momentum easing as Mexican markets remain the main beneficiaries while Canada adapts its economy to remain positioned to capitalize.
That was a very insightful chat. I want to thank all our panel today.
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