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Rodrigo Echagaray: Welcome to Market Points. I'm Rodrigo Echagaray, Managing Director, Head of Latin America Research and Global Head of Product Management at Scotiabank. On today's episode, we'll explore Mexico's nearshoring potential amid ongoing global tariffs and escalating trade tensions between the U.S. and China. Could these circumstances present Mexico with a new manufacturing and economic opportunities?
A big question to resolve will be Mexico's ability to generate enough electricity to power future manufacturing and industrial growth. Joining me today to discuss these challenges and opportunities are Francisco Suarez, analyst of Latam Industrial Real Estate and ESG, and Eduardo Suarez, VP of Latin America Economics.
Francisco, thanks for joining us today.
Francisco Suarez: My pleasure, Rodrigo.
RE: Eduardo, great to have you with us as well.
Eduardo Suarez: It's a pleasure to be here. Thank you very much for the invitation.
RE: Let's jump right in. Francisco, you've recently co-authored a new Scotiabank Focus On Nearshoring Report titled Electricity in Mexico: From Bottleneck to Opportunity. How critical would you say is electricity infrastructure to multinational companies considering nearshoring in Mexico?
FS: The short answer, a lot. My coverage of industrial real estate companies in Mexico allows me to identify trends on investments made by multinationals along their value chains. And what I found is that in the vast majority of Mexico's major industrial clusters, electricity is one of the biggest bottlenecks to expand operations.
To make matters worse, in my conversations with representatives of these multinationals, their existing operations already faced stoppages in their production due to power outages on many occasions in a calendar year, and the impact varies a lot across industries because some activities are far more energy intensive than others.
The less impacted are those related with logistics. But in contrast, the auto industry and particularly in energy intensive activities like the manufacturing of powertrains, that not only increases their cost, but also increases the likelihood of production disruptions that could impact the entire value chain in North America, due to how these value chains are highly integrated. This is also crucial for the new value chains that North America needs along the complex semiconductor value chain, and also on data centers that, as you know, they are very high in energy intensive activities.
This brings me to a crucial point here, how energy is crucial for the competitiveness of Mexico, and in turn, the competitiveness of North America. In the document we wrote, we compared the cost of electricity for industrial use across thirty-two countries. The conclusion is that Mexico is the least competitive in North America. If Mexico is able to make electricity more affordable, more sustainable, and more widely available, the integrated value chains in North America will be far more competitive.
RE: Eduardo, in your view, why has Mexico historically struggled to invest adequately in energy infrastructure, and how has this affected nearshoring prospects?
ES: The energy sector in Mexico, it has a very complex political history. It's deeply embedded in almost a voter and Mexican citizen psyche.
Ever since the oil expropriation in 1938, there has been very deeply discussed and, and I would say almost embedded, rhetoric in Mexican voters that oil, it's owned by Mexicans and that the private sector does not have the right to exploit an asset that is owned by the population. That started something that was initially focused on oil but has increasingly expanded its arms to also affect the power sector.
I spent the first part of my career in the moment when that started being reversed. Since the 1930s, all the way through the eighties and, and most of the nineties, the energy sector in Mexico was deeply controlled by the government, by three companies, Pemex on the oil sector and, and the power sector by CFE and Luz y Fuerza.
After the 1994 crisis Mexico started pushing for a greater role in the private sector and by foreign investors that coincided with the signing of NAFTA. And then after the 1994 crisis we started having important fiscal constraints, which meant that the government was forced to open up the sector through to PPPs at the time they were called Pideas, that allowed private investment, not ownership, but investment through build, operate, and transfer PPPs.
That was the first time in Mexico we started seeing a material increase in the supply of power that allowed and helped facilitate the boom of the Mexico manufacturing sector through those Pideas before the private ownership of assets was allowed, we saw the private sector go from essentially generating zero percent of Mexico's power to more than a third.
In 2013, that'll open even further. The 2013 reforms allow the private sector to actually own assets. And it got to, at one point, even go above 50% of power generation, depending how you measure it, and that's also the time when we started here having a boom in renewables, et cetera.
It also coincided with one of the few times in my career where I've actually seen Mexico's power cost become more competitive. We went from more than 40% surcharge over the U.S. for manufacturing sector power to something much more competitive with the Americans.
That once again changed with these complex political realities of the country in 2018 when the government started reversing the rules of the sector. The problem with that is investing in the energy sector has very large tickets with a long horizon. And a country that has a constant change of the rules of the game is not very good for providing certainty. So, I think one of the very important topics which will be on the table in domestic politics, but also, as part of the update of the North American Trade Agreement, will be the role of the private sector and the vehicles it is allowed to have. I would say that as it stands and given some of the legals and uncertainties we have right now, not only about the government's plans for the sector itself, but also the judicial reform, the rules of the game in the North American trade agreements, all those things will probably mean we remain on hold in investment because as I said earlier, long-term investors like long-term certainty.
So, I think we're going to have a little bit of a hold before things realign, but again, come back to gravity and reality. The government has important fiscal constraints and without private investment in the sector, we are really going to struggle to invest enough in the sector to keep the manufacturing sector rolling.
And I think that reality will eventually sink in, and the government and the private sector will need to sit on the table and find a framework which is mutually beneficial.
RE: Francisco, your report highlights significant opportunities around solar energy in Mexico. Why is solar a particularly timely opportunity now?
FS: To begin with, Mexico is a privileged country that makes the cost of solar production very cheap compared to other parts of the world. Furthermore, it is even less costly in the locations where the major industrial clusters are located in this country.
Secondly, Mexico's new administration created just a new regulatory framework for projects of up to 20 megawatts in capacity that are perfectly ideal for industrial parks. These projects require a combination of power storage capabilities or power backups to renewable energy in order to minimize the disruption to Mexico's congested grids. And these projects can be executed quite fast because the regulation reduces significantly any form of red tape as well, and this is something that we didn't have before.
I think that we should be covering also the several benefits that we see because this is a huge opportunity. For instance, a tenant of an industrial building could see savings of at least 15% in regions where we see limited imbalances between supply and demand of energy. But these savings can actually be twice as much in other regions. If in addition, such systems could entirely eliminate the stoppages that they face already in production, that also reduces their production costs as well.
Lastly, multinationals are particularly very interested in cutting their carbon footprint in their entire value chains.
Now let me put some numbers to the benefits that I outlined. On the major industrial clusters we follow in Mexico, we conservatively estimate savings in utility bills of roughly a billion dollars per year for the tenants. For the landlords, we see their NOI margins increasing perhaps by a hundred basis points. And the cuts in carbon emissions that we see are equivalent to 11% of what the entire power industry in Mexico generates currently.
RE: Francisco, which industries or companies stand to gain most from adopting solar energy solutions?
FS: I think that the entire auto industry, that includes the big three, General Motors, Ford, Stellantis, but also the European based companies are likely to benefit a lot. Consider as well the new investments we see in Mexico from Foxconn, potentially Nvidia, Flex, and the data centers that Amazon wants to build in Mexico.
Avoiding production related disruptions, decarbonizing their value chains is part of their strategy. So clearly, we see a lot of benefits in adding resiliency in value chains along these lines as they try to find out certain solutions on energy related problems that we see in Mexico.
Now, companies like DHL, UPS, Kuehne + Nagel, and Geodis, that have a logistics edge are likely going to cover a higher percentage of their electricity needs in these solutions, paving the way for more savings in their utility bills as well. And also, important to mention here, all of these multinationals have a lot of commitments on ESG, so clearly these benefit as well.
Now, let's talk about the real estate companies that we cover in Mexico.
By investing in energy, all of these companies will be far more competitive, and that increases the entry barriers to the industry. In general, as I mentioned previously, I see NOI margins expanding, higher rents for these companies, as well as higher values for the buildings that, at the end of the day, will become far cheaper to operate.
RE: Eduardo, considering the current regulatory landscape, do you see significant private sector investment materializing in Mexico's power infrastructure?
ES: I very much agree with Paco that the framework that was rolled out for self-generation is doing the job, and that's something that a lot of the clients I've spoken to in that sector have expressed.
On the larger scale projects, I think the challenges currently are still very important. The first one I would say is the judicial reform. These contracts are very long term by nature and require very large tickets. And we're going through an overhaul of Mexican judicial system, which will essentially roll out a system that does not exist anywhere else in the world and will remain untried for some time. And that requires investors to gradually become comfortable with the risk it entails.
The second one has to do with the PPP framework, where I think a lot of the issues need to be clarified, things around prices, and a lot of the different nuances of it.
What makes me a little bit more comfortable in the long run is that eventually, gravity pulls the apple to the ground, and I think almost any asset is attractive at the right price. And the combination of need with a certain price existing means that eventually, I think a negotiation and outcome will be reached.
There are various reports that almost 70% of industrial parks in different regions of the country have suffered blackouts over the last couple of years. The scarcity of power is real. If you look at the macro data, Mexico currently has the smallest spare power generation capacity essentially in the last 40 years.
So, there is a need for power, it's very clear. The framework currently needs to be tested. And there's also a third factor, which is the government has its hands tied on the fiscal front. Last year we saw a blowout in the deficit to almost 6% of GDP.
That needs to be brought down at least 200 basis points of GDP the government plans it for this year, it should be this year or next. But that means they're going to be constraining resources. With that constraint, they're going to have to become more flexible, and I think that it’s eventually going to bring the government and the private payers onto the negotiating table so that they can find that magic price, which makes the apple fall to the ground.
There's a third element there, which I think despite the politics and the discussion around it, there's still a North American partnership. If you look at the interest of the Canadian government, you look at the interest of the American government, and the companies of both countries, there is the desired intent for the playing field to become more level for the players in the power sector in those countries going forward.
I think that will come up in the negotiations of USMCA as we head into 2026.
RE: Francisco, Eduardo, you both agree on some core points, but you disagree on others. To wrap this up, can each of you briefly outline your different views regarding Mexico's Nearshoring Potential? Francisco, why don't we start with you.
FS: I think that nearshoring, when I see how Eduardo frames the impact of nearshoring in the country, in the big picture on GDP and everything, he's right in the sense of saying that perhaps the importance of nearshoring moving the needle is not that great.
But in my world, I literally see the impact in these industrial clusters, in certain regions of Mexico and in the companies that we follow. Nearshoring is actually very impactful and it's going to be material. Let me put a number on that. In terms of industrial demand, nearshoring has averaged roughly 35% to 40% increase in overall demand for industrial real estate.
This is totally something that we haven't seen before. This is the reason why even though we are in the middle of potentially facing a recession ahead, and a lower demand for industrial real assets, we are sold out in many markets in Mexico because of this increased amount linked directly to nearshoring.
Secondly, at the end of the day, I cannot tell you what the ultimate outcome might be out of the tariffs or this chaos that we're seeing at the moment. But based on my view of what we think is going to happen, it is that ultimately it’s about North American competitiveness relative to that of China.
If that statement is true, we think further integrations along the key value chains that are already highly integrated. But more importantly, we see from a security point of view that actually aligns with these ideas of geopolitics that are happening these days.
I see the nascent opportunity of investing in these new value chains that North America doesn't have. For instance, we in North America, we produce zero of the most sophisticated semiconductors that are needed for everything you can think of, from data centers, artificial intelligence, defense, and the auto industry, planes, et cetera.
So, in that sense, I believe that Mexico has a certain role in these value chains. For instance, for the clusters that will be benefiting the United States with big tickets of roughly $60 billion of investments, in Mexico, our edge in semiconductors will be much more in the certain portions of the design of the components, the packaging of the components, and the testing of the semiconductors as well.
So that's why you see companies like Foxconn and Nvidia planning to invest heavily in Mexico. Also, see what Amazon is trying to do. $15 billion investment in data centers in Mexico, because ultimately, we need that as the region.
So, with that in mind I think that nearshoring at the end of the day is not dead with all this. Ultimately, I see further integration in value chains and in my world because the impact of nearshoring has been far more significant than in the entire macro picture of Mexico.
ES: At the end of the day, I've spent the better part of my career between the excessive doom and optimism over Mexico. I've seen four Mexican miracles, four Mexican catastrophes. All four have been false and true at the same time.
I became an economist in the nineties where NAFTA was supposed to turn Mexican into Canada. I'm still waiting for that one. I became head of investor relations for the Mexican government when the structural reforms and democracy were going to turn this into a country that grew at 5%. Still waiting for that one. The Mexico moment of 2013 again was supposed to turn Mexico into Canada, as was supposed to be the case with nearshoring. Reality is, over that period Mexico's growth rate has been very close to 2% always. So, no miracles.
On the flip side of that, I remember when China joined WTO in 2000, Mexico's manufacturing sector was supposed to disappear. In 2007, Mexico was not part of the BRICs, and it was supposed to be a failed state because of security situation deteriorating, the doom and gloom has also failed.
Realities at the macro level, when you add everything up together, the capacity for a country to produce depends on the availability of factors. It's very difficult for a country to come up with a huge surge in available labour, especially qualified labour, it’s very difficult to come up with a huge surge in power. It’s very difficult to come up with a huge surge in the availability of water, and those constraints tend to be what anchors Mexico's growth rate in a very mediocre state. And that's why I tend to not believe in nearshoring and the last miracles at the macro level. And the data backs it up, but once you double click, you start seeing that the macro numbers are really different from reality.
You have states in Mexico, which have consistently grown at 5%, so the miracles there have happened. You have on the flip side of that, states in Mexico, which consistently contract, the doom and gloom is true there. But reality is when you start digging from my world into Paco's world these miracles do exist, and it comes back to what I like to say, that these are not miracles.
You don't have a sudden surge in production factors. There are opportunities and the places that have done the homework, have educated the labor, have created the availability of power, have created the clusters and the security environment that's necessary for business to thrive have generally done very well.
So even though it sounds like Paco and I finally disagree on something, we don't disagree. We're just looking at the map from different altitudes. If I'm standing in the middle of a forest, in Muskoka, everything looks green. If I look at that from the sky it looks white and blue. Reality at the same place, looks different colors when you look at it from different altitudes.
RE: Those are great points from both of you. Clearly Mexico has significant opportunities in nearshoring despite the current and global trade challenges, and the truth is probably somewhere in the middle. Addressing electricity bottlenecks, especially via solar solutions, could unlock substantial benefits, it seems that is the lowest hanging fruit.
If you’re looking to take a closer look at the data, reach out to our team to get a copy of our Focus On Nearshoring report, Electricity in Mexico.
Francisco, Eduardo, thanks again for joining me today.
FS: Thanks for having me.
ES: It was a great pleasure. Thank you very much for inviting me. I look forward to joining you again.
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