Mexico
A potential as big as the current deficit
The Mexican chemicals industry’s trade deficit of almost US$21 billion is both an illustration of the industry’s structural constraints, and, turned around/looked from upside down, an estimate of its room to grow. It is in this kind of half-full, half-empty glass exercise that McKinsey, together with the industry’s main association, ANIQ (Chemical Industry Association of Mexico), engaged earlier this year, delimitating between the two scenarios with a big “if”: If the industry continues on its current path, Mexico might be importing US$40 billion worth of chemicals by 2035; if, however, it could tap into its current potential, the industry could almost double its size by 2035.
The commercial deficit represents about 30% of demand, currently filled by imports, but the domestic industry could meet demand if it operated at capacity. Right now, the Mexican chemical sector only operates at around 60-70% capacity, leaving a big gap in the market. Its underperformance is caused by lack of feedstocks, supplied by the country’s national company, Pemex. For example, Braskem Idesa, a JV between Brazilian petrochemical leader Braskem and one of Mexico’s largest petrochemical companies, Grupo Idesa, can only rely on half of its ethane feedstock needs from Pemex: to produce at its capacity of 1 MT of polyethylene, it requires 64,000 barrels of ethane/day, but it can only source 30,000 bdp from Pemex. For the remaining half, it has developed solutions to import the raw materials from the US.
The lack of feedstocks – and the incumbent shortages in the market, coupled with a strong peso - have opened the way for more imports from Asia. Local players, on the other hand, mostly supply within Mexico, since the market has been big enough (too big, really). “A weaker Chinese economy has left many chemical producers with excess volumes that they are dumping to other places, including Mexico. While volumes imported from Asia remain small, the low prices are harming the industry,” said Miguel Benedetto, general director at ANIQ.
Headed by ANIQ, the Mexican chemical industry went through a national exercise to determine the best way forward in terms of the relationship with Pemex. Benedetto explained the three scenarios taken into account: “One scenario was to start from scratch, without Pemex, but this is not feasible; the second one was to produce exclusively specialty chemicals throwing away the cost competitiveness that Mexico’s own natural resources grants. Therefore the best scenario is to work together with Pemex and with all stakeholders to develop the necessary basic chemicals and feedstocks that the industry requires and that are solely produced by Pemex. The stronger Pemex will be, the stronger Mexico will be in developing the raw materials critical for the development of all manufacturing industries.”
AMLO's legacy
Andrés Manuel López Obrador (AMLO), the country’s president, has made Pemex – and Mexico’s self-sufficiency in energy – an important part of his six-year mandate since 2018. One of his pet projects was the construction of a new refinery in his home state of Tabasco, a project that exceeded its initial budget of US$8 billion by almost half. The Two Bocas refinery was heavily criticized by observers to be a white elephant, stemmed out of political intuition rather than any solid cost-benefit underpinning studies. Meanwhile, Pemex became the world’s most indebted state energy company, with debt ballooning to US$110.5 billion in the second quarter this year, after years of massive losses. The company was saved from bankruptcy repeatedly by the government of AMLO, who directed 42% of the public-investment budget to Pemex and the national electricity company, CFE (Comisión Federal de Electricidad), noted the Economist.
While splurging on Pemex, the new refinery, and a couple of flagship projects like a new railroad (Tren Maya) aimed at boosting tourism in the Yucatan peninsula, AMLO’s government has underinvested in health, education, basic infrastructure, and has taken away funding from institutions critical to democracy, including the independent electoral commission, as well as the energy regulator and an anti-corruption body. Mexico has been notoriously tight-fisted on pandemic spending, being among a small number of countries to have spent less than 2.5% of GDP on Covid-19 measures. AMLO’s frugality was first applied to his own salary, which he self-virtuously cut by 60%, a move not unpopular with voters.
Mexico begins the presidential race for 2024 in a poorer democratic shape, and with higher poverty rates, but in a stronger fiscal position and with brighter economic prospects compared to the last mandate – much driven by the growing trend of nearshoring that has pushed FDI into the country, and higher exports out of the country. Mexico recently marked its seventh consecutive quarter of growth on the back of strong domestic demand and improved employment figures. The peso continues to gain strength against the dollar, and has been called out as one of the best performing currencies in 2023. Inflation has also been coming down, though the central bank warns of upside risks, noted the International Banker, who earmarked Mexico as the “clear winner” in Latin America in 2023. The peso started to outperform other Latam currencies since 2018, the year when the US imposed high tariff rates on Chinese imports.
In 2024, Mexico is almost surely going to have its first female president: either former Mexico City mayor Claudia Sheinbaum, as the chosen candidate for AMLO’s leftist MORENA (National Regeneration Movement) coalition, or former climate scientist Xóchitl Gálvez, the candidate of the main opposition, FAM (Frente Amplio por México) coalition. While Sheinbaum is a close ally and loyalist of AMLO, rival Gálvez presents herself as an outsider, a self-made businesswoman and progressive thinker on social justice issues. AMLO is not eligible to run again.
The results of the elections will have a deep impact on the Mexican chemical industry since they will dictate the future of the highly contested energy reform (the so-called “Energy Sovereignty policy) initiated by AMLO, which aims to reverse the liberalization of the industry achieved by Obrador’s predecessor and grant more power to CFE and Pemex, higher energy costs, and scrapping independent regulators. “Electricity has become a big issue in Mexico. The energy policy stablished by President López Obrador’s limits the participation of private energy suppliers. In this context, investments in power transmission have dwindled. The availability, affordability, and reliability of electricity are a key consideration of foreign manufacturers choosing a nearshoring destination, so we must ensure we are prepared,” said Miguel Benedetto, general director at ANIQ.
So far, the bill has been rejected by legislators, and it will likely be in the hands of the future president.
“Nearshoring-driven investments came to Mexico faster and bigger than anyone anticipated. This suggests a positive outlook for the country, but there remain important caveats about the overall logistics setup, especially when it comes to adding more volumes to ports, airports, or roads.”
Martin Sack, Regional Head Americas, Leschaco
Mexico, the new best friend in the friend-shoring trend
Nearshoring – or the practice of locating or relocating suppliers closer to the end market – is nothing new to Mexico. The country has been a hotspot for the manufacturing of goods destined for US as manufacturers leveraged geographical proximity, trade agreements, and lower labor costs. This has made Mexico one of the largest exporters of automotive (fourth biggest globally), aerospace (sixth largest supplier of aircraft parts to the US), and medical devices (eight largest exporter in the world). However, the pandemic brought a significant impulse to nearshoring, otherwise known also as re-shoring (when it implies a relocation of current supply chains) or friend-shoring (when it is inspired by geopolitical and trade considerations, much accurate for Mexico).
There are at least three differences we can note in the modern use of near & friend shoring within Mexico’s context: first, and likely most important, is Mexico’s repositioning in the middle of the trade between the world’s two biggest powers, the US and China; second, the type of investment, predilected on higher-value and sophisticated manufacturing. And the third aspect, which underscores the first two, is the convergence of geopolitics, supply chain management, and sustainability, all calling for closer-to-home production in a way that is likely to redraw the globalized industrial map built over the past decades.
In many ways, nearshoring is replacing the traditional “outsourcing” philosophy that has allowed producers to make products in offshore locations, predominantly in China, at cheaper costs. The attractiveness of China started to bend in 2018, amidst retaliatory trade tariffs between Washington and Beijing. About 66% of US annual imports remains subject to tariffs averaging at 19%, according to the Peterson Institute for International Economics.
In 2022, the rupture between the two countries materialized at the logistical level, with long delays of critical Chinese supplies putting at risk various sectors in the US. Suddenly, the pandemic changed the rules, and the low-cost of Asian countries lost some appeal. By contrast, Mexico offered the ideal destination; even though labor costs are not as low as in China, Mexico does have a highly skilled and relatively cheap workforce. The higher price paid on labor is made up for by up to 14 times lower shipping costs, not to mention a reduction in the transport time (and associated risks) from about a month to 4 days in transit, according to Reuters. The recent USMCA free trade agreement between the US, Canada, and Mexico, secures a duty of just 0.04% for partners, versus 19% for China, and it has brought a lot of relief to the markets after replacing the previous North American Free Trade Agreement (NAFTA) dating back to 1994. Mexico has 13 other free trade agreements with 48 nations, that includes the equivalent of 1.3 billion consumers, or 60% of the world’s GDP.
Backed by these attributes, Mexico found itself benefiting more and more from investments diverted to its shores but with a final destination in the US. Mexico’s neighbor happens to be the largest importer/exporter in the world. Nearshoring could generate US$35 billion increase in US-bound Mexican exports, according to the Inter-American Development Bank. At the North American Leaders’ Summit at the beginning of this year, Mexico, the US and Canada are alleged to set a goal to replace 25% of Asian imports with products made in North America. According to local news, Canada, the nation with the second largest FDI in Mexico, is to invest up to US$10 billion in Mexico. Meanwhile, the US, which has historically accounted for half of Mexico’s FDI flows, has invested US$15 billion in 2022, according to the Federal Reserve Bank of Dallas.
As a key contributor to GDP (about 20%) and closely entrenched in all manufacturing sectors in the country, the Mexican chemical industry has much to be hopeful about in the nearshoring trend. In a recent survey conducted by S&P Global with 350 manufacturers in the country, it was found that the chemical and pharmaceuticals sector is the third largest in the country that expects to benefit from nearshoring opportunities. “A reliable supply of raw materials is key for any manufacturer establishing itself in Mexico, which makes the chemical industry a key condition for the concretization of nearshoring opportunities,” said Miguel Benedetto, general director at ANIQ.
The industries set to benefit most from nearshoring are automotives, electrical equipment, semiconductors, plastics, and logistics, according to recent growth markers from Deloitte. The auto production has been in the spotlight especially after Tesla announced it will build its next gigafactory in Nuevo León, an investment worth US$5 billion (though local authorities pointed to a figure triple the size, cumulating investments from Tesla suppliers). Other car makers like BMW, General Motors and Ford have also made announcements about ramping up or starting plants.
Though Mexico’s chemical industry is mostly concentrated in basic agrochemicals and petrochemicals, the development of higher-value industries will bring about more opportunities for specialty chemicals production. While in aromatics, solvents, ammonia, fertilizers, and urea, as well as other petrochemicals and agrochemicals, the country’s production volume has consistently decreased in the last 10 years or so, in specialty chemicals, the opposite has been noted. ANIQ data suggests a (positive) +31% trade surplus in specialty local production in 2021.
“For many years, Tier 1 and Tier 2 companies especially in the automotive and aerospace sectors established a presence in Mexico. The difference now is the level of sophistication and tech-driven facilities being built across a wider range of industries,” said Martín Toscano, president at Evonik Mexico, a specialty chemicals producer with a presence in 15 verticals in the country, including automotive, aerospace, healthcare, personal care, construction, feed to food, and others.
Asked whether Mexico is ready for the new investments, Toscano added: “Mexico will need significant investments in the areas of security and transport infrastructure to be able to keep up with the growth we expect to see in manufacturing and exports. Sooner or later, we may also see issues in terms of talent availability. We also need more industrial parks and warehousing capacity to support the distribution of products within and out of Mexico, mostly in the northern and central parts of the country,” he concluded.
No free lunch with nearshoring
The biggest challenge on Mexico’s plate will be feedstocks, said Patricio Gutieres, CEO of Grupo Idesa, “No company will build a new plant if they cannot secure feedstocks at reliable and competitive prices.”
While the north of the country can rely on imports, Mexico and the US having become closely integrated especially in the gas market, the south continues to depend on Pemex. This will only exacerbate a north-south divide, whereby the Gulf Coast (Nuevo León, San Luis Potosí, Tamaulipas and Veracruz) and the North of Mexico (Baja California, Baja California Sur, Chihuahua, Coahuila, Durango, Sinaloa and Sonora) have seen the highest growth owing to nearshoring, according to S&P Global, while the south struggles with underemployment and poverty.
Mexico will need to step up investing in logistics infrastructure, as well as in technology and education. According to the Economist, AMLO’s government cut spending on roads maintenance by 28% between 2018 and 2021. When Mexico reopened schools in 2022, the education budget was the lowest since 2010, informed the same source. Mexico’s demographics are highly attractive, but it is not enough without the right education and training: “Mexico has the classic social pyramid of emerging economies, with a large share of its 120 million population being of working age. This offers a broad talent pool and a strong pipeline for the future. However, we need more educational and training programs because the skills required in the future may not be the same as those required today,” said Martín Toscano, Evonik’s president in the country.
Finally, it is important to note that other countries in Central America are also in the spotlight for nearshoring, competing with Mexico. That competition is only going to become fiercer with the US economy decelerating, which will temper FDI outflows, as well as demand. Spillovers from a US GDP growth of under 1% (as predicted for 2024) will reach the entire world, but especially US’s main southern neighbor. Mexico’s soft landing is not guaranteed.
Image by Chris Tomassen at Pexels