Change is coming to the Mexican freight rail industry, but it’s too soon to determine whether the push for reform will lead to a major overhaul or something much more moderate.
Shippers will get a better idea in the coming weeks as the Mexican Senate is expected to vote on a rail-related bill after the lower chamber in early February passed legislation that would require the two rail concession holders to share their lines with third parties. Kansas City Southern de México and Groupo México, operator of Ferromex and Ferrosur railroads, argue striking their concession agreements, which last for another 14 years, would hamper their operations and decrease investment. The government granted the duo 50-year concessions to run their businesses, but the railroads' rights to be sole operators of their respective lines last for only 30 years.
The striking of contracts could also send harmful signals to foreign investors, as President Enrique Peña Nieto tried to build on the country’s success in attracting foreign direct investment. Rail reform proponents contend that jump-starting what they see as lagging rail investment and lowering freight rates is worth the risk.
The push comes as Mexico enjoys a manufacturing boom. Accessibility to U.S. and Canadian markets, rising transportation costs and competitive labor costs with China have spurred shippers to open shop south of the border and expand existing factories. The Mexican railroads, particularly KCS, which has the only U.S.-Mexico cross-border network, have rode the wave that started with auto manufacturing and aerospace and has since expanded to white goods and even apparel.
National Effort, Shipper Frustration Driving Overhaul
Two factors appear to be driving the Mexican rail reform push. Since taking office in 2012, Nieto has aggressively sought economic reforms and has successfully overhauled the country’s tax code, opened up the fiercely government-controlled energy sector and even made some inroads in breaking the nation’s telecommunications monopoly. That many rail shippers believe they don’t have a vehicle to challenge rail rates also appears to be fueling rail reform momentum. Unlike in the U.S., where shippers can gain some rate relief via the Surface Transportation Board — albeit not enough according to some — Mexican railroads just give authorities their lowest and highest tariffs, said Marco Avila, CEO of EFENSA, a Mexican rail repair and maintenance company and consulting firm.
What type of shape the proposed reform takes depends largely on which side can lobby better. The U.S. Secretary of Commerce reportedly raised concerns about legislation by Mexico’s House during a February trade mission to Mexico, in which KCS executives participated. Union Pacific Railway told Nieto in a letter that it would curb investment in Ferromex, of which it owns a quarter, if the concessions were broken, according to Reuters.
Despite the pressure, Avila told the JOC that he thinks the major elements of the House bill will become law, as Nieto gave the bill his blessing. The head of the National Steel Chamber and friend of the president convinced Nieto to get on board with the reform bill, according to The Economist. Avila expects the government will strike the exclusivity element of the carriers' concession agreements and allow shippers to run their own trains on the networks.
“Most of the users don’t know how to run a railroad, and the railroads will do anything they can to obstruct service,” Avila said.
The Senate will pass a less aggressive version of the House's bill that will maintain the concession agreements and could create some safeguards for shippers that have access to only one rail line, said Erik Markeset, a Mexico City-based logistics consultant and principal and founder of logistics consulting firm Tsol who has spoken with an unidentified senator involved in the debate. Markeset told the JOC he has heard the majority of House deputies didn’t even read the legislation and were simply attracted to the mention of reform in the bill’s executive summary.
“I think the Senate is going to be reasonable,” Markeset said.
To the Best Lobbyist Goes the Spoils
KCSM President Joe Zozaya told Bloomberg that he is optimistic the Senate will reject the House’s plan to strike the concession agreements and pass language that would increase connections between the carriers. The presentation of a study – conducted by the Organization for Economic Co-operation and Development and in close collaboration with Mexico’s Ministry of Transport – to a Senate committee backed up the railroads’ argument against striking the concessions. Between 2007 and 2012, the two concession holders invested 27 trillion pesos, or roughly US$2 billion, in their infrastructure, according to OECD’s International Transport Forum. The report also sided with KCSM and Grupo México in saying that allowing third parties to operate the existing networks would hamper operations and future capital spending.
The report noted that rail tariffs and trucking rates have increased to a similar degree in the last three years, and mirror those seen in Canada and the U.S. The freight tariffs of the three railroads are also among the lowest in Latin America, according to the report.
“Tariffs nevertheless remain much lower in real terms than before the reforms, especially when subsidies to rail prior to (the 1995) reform are taken into account,” the report said. “Tariff freedom inevitably involves fluctuations and we see no evidence of misuse of railway market power.”
OECD also praised KCSM and Grupo México’s operations, pointing to how traffic has doubled since the industry was privatized. The nation’s GDP expanded 56 percent in the same period. The railroads’ share of the surface transportation market has grown from 19 percent to 25 percent since 1995. When excluding the mining sector, Mexico’s two rail concession holders operate the most productive networks in Latin America, the report’s authors said.
“The performance of the industry has shown continuous improvement since 1995. The quality of management, technical quality of railway infrastructure and rolling stock, capital and labor productivity, traffic levels and market shares have all improved markedly, a transformation in industry prospects that hardly seemed possible prior to the reforms,” according to the report.
The report doesn’t address the sensitive issue of reciprocal or competitive switching. The House bill would require Mexican railroads to publicize the rates they charge for switching cargo from their lines to competitors. The Canadian government requires the country’s two major freight railroads to give shippers access to each other, while the U.S. Class I railroads have fought against shipper pushes to force them to switch cargo to competing lines. The report does recommend that Mexico increase the amount of pricing and capacity data it collects from carriers, pointing towards a potential compromise between the railroads and those bent on an aggressive overhaul.
Compromise or Legal Fight Ahead
Even if Mexico strikes the concession agreements, the railroads could have some legal recourse. Changes to the agreements could violate the Mexican Constitution and the North American Free Trade Agreement, said KCS spokesman Doniele Carlson. KCS declined to comment on the legal action, but Ferromex CEO Rogelio Velez last month hinted to filing an injunction to stall, perhaps indefinitely, the legislation if it becomes law, Reuters reported.
When such powerful forces – a reform-bent government urged on by dissatisfied shippers and the rail industry – are at odds, the likeliest outcome is some type of compromise. That’s why the coming weeks of intense lobbying will likely determine whether one side walks away happier or both sides leave nonplussed.