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August 2017
By Jeff Stagl, Managing Editor
Shortly after President Donald Trump took office in January, he warned that the United States would exit the North American Free Trade Agreement (NAFTA) if the pact wasn’t renegotiated in the nation’s favor.
The leaders of hundreds of U.S. companies that generate business in Canada and Mexico — including the Class Is — grew anxious that a renegotiated pact with high tariffs and other unfavorable demands might greatly disrupt rather than expand trade flows.
They were concerned that millions of jobs and billions of dollars worth of U.S. investments associated with NAFTA would be in jeopardy. They also fretted if there would be trilateral uniformity to border-crossing procedures to improve freight fluidity and security, and if potential political reactions in Canada and Mexico would undermine U.S. exporters.
Most leaders agree the 23-year-old pact needs to be modernized and improved, but not at the expense of the growing trade between the three nations, which each year exceeds $1 trillion in value. In late May, 32 chief executive officers of large U.S. corporations — including Union Pacific Railroad Chairman, President and CEO Lance Fritz, and Kansas City Southern President and CEO Patrick Ottensmeyer — sent a letter to the Trump administration asking for sensible NAFTA changes that would promote free and fair trade.
Fast forward to last month. U.S. Trade Representative Robert Lighthizer unveiled the Trump administration’s NAFTA priorities on July 17, and then something rather unexpected happened: the anxiety eased — at least for the moment. The 18-page list of U.S. renegotiation objectives emphasize e-commerce, telecommunications, intellectual property, labor laws, dispute resolution mechanisms and custom process automation rather than tariff hikes and new trade barriers. Negotiations among the three partners are slated to begin Aug. 16.
While the turn of events was encouraging for all U.S. companies involved in NAFTA trade, it was highly energizing for railroads. An Association of American Railroads study released in late March showed 42 percent of carloads and intermodal units, and more than 35 percent of annual rail revenue, are directly associated with international trade. Moreover, 50,000 domestic rail jobs, accounting for more than $5.5 billion in wages and benefits annually, directly depend on it.
The NAFTA news was particularly uplifting for the Class Is that generate a lot of traffic moving into and out of burgeoning trade partner Mexico, namely UP, KCS and BNSF Railway Co.
Likewise, it was more reassuring for Ferrocarril Mexicano S.A. de C.V. (Ferromex) and Ferrosur S.A. de C.V., the large Mexican railroads that help move freight to and from the United States. Since NAFTA was implemented in 1994, trade between the United States and Mexico has nearly quadrupled while their agricultural trade has quintupled.
KCS’ Ottensmeyer is encouraged by the U.S. trade representative’s renegotiation priorities, which likely would continue to support the Class I’s current and future initiatives for cross-border traffic. Through subsidiary Kansas City Southern de Mexico S.A. de C.V. (KCSM), KCS generates 40 percent of its annual traffic from cross-border business, with the remainder movements within either the United States or Mexico.
“I don’t see any significant concerns with that document,” Ottensmeyer said during the Class I’s second-quarter earnings conference on July 21.
He also chairs the U.S.-Mexico CEO Dialogue Strategic Trade Initiative Working Group, which includes business leaders from both nations who seek to enhance trade flows and economic collaboration.
“The reaction in Mexico appears to have been positive, as well,” said Ottensmeyer.
UP’s Fritz is buoyed by the latest objectives, too. They are reasonable and in line with what the Trump administration had promised of late, he said in a July 20 Reuters article. UP generates about 40 percent of its annual volume from international trade — including 12 percent from cross-border trade with Mexico — and owns a 26 percent stake in Ferromex.
“From our perspective, [it] hit all of the elements that we’ve heard from the administration and they make sense,” said Fritz. “What makes the most sense to us is the elements focusing on the streamlining of freight across the border.”
On top of the NAFTA news, there are other recent developments favoring trade and driving Class Is’ cross-border business. Among them: Mexico’s energy reform and a significant appreciation of the Mexican peso since the beginning of the year that’s aiding several markets.
In 2013, Mexico enacted legislation that opened its energy markets to foreign investments and imports of refined energy products, including gasoline and diesel. The energy reform is propelling southbound shipments of refined petroleum products and liquified petroleum gas (LPG).
But the developments of late don’t suggest it’s time for the Class Is to relax and keep mounting their cross-border carloads unencumbered. On the contrary, there are reasons to believe politics on both sides of the U.S. southern border will continue to be a source of concern for railroads.
For one, Mexico’s Comision Federal de Competencia Economica (COFECE) in March issued a preliminary finding that a lack of freight-rail competition in the nation has resulted in higher rates. Grupo Mexico — which owns Ferromex and Ferrosur — and KCS control more than 72 percent of the nation’s railways and exploit that dominance to restrict access to their tracks and drive up prices, the commission found. COFECE’s anti-trust investigation is ongoing.
For another, the NAFTA renegotiation roller coaster still is a long way from returning to the station.
“We are not completely out of the woods yet,” said KCS’ Ottensmeyer during the Q2 earnings conference.
Although the Class Is’ anxiety level about NAFTA renegotiations is lower than it was earlier this year, the United States hasn’t closed the door on tough negotiations with its partners and the trade fight is far from over, says independent rail industry analyst and Progressive Railroading columnist Tony Hatch.
Fear of a trade war with China and other global trade developments could spill into the NAFTA talks, he believes.
“They will look at other international trade,” says Hatch.
Yet, in the end, it’s likely NAFTA will only be tweaked, Stifel Financial Corp. analyst John Larkin believes.
“I don’t think we’ll see massive adjustments,” he says.
For now, KCS will take any developments that favorably impact U.S.-Mexico trade. The Class I’s North American network hinges on a north-south freight corridor that connects key commercial and industrial markets in the central United States with major industrial centers in Mexico. KCSM — which serves most of Mexico’s principal industrial cities and three of its major ports — provides the shortest and most direct rail route between Mexico City and the U.S.-Mexico border crossing at Laredo, Texas, and Nuevo Laredo, Mexico.
About 60 percent of KCS’ cross- border traffic moves southbound, including shipments of auto parts, grain, food products, steel, paper and industrial machinery. Northbound traffic predominantly is intermodal freight and finished vehicles.
KCS and KCSM currently are focusing on ways to make it easier for customers to do business in Mexico, said spokeswoman Doniele Carlson in an email. For example, KCS, Watco Cos. LLC and WTC Industrial partnered in January to aid and expand the exportation of liquid fuels from the United States to Mexico.
The partners recently completed a unit-train liquid fuels terminal in the WTC Industrial Park in San Luis Potosi, Mexico, that will be served only by KCSM.
Shippers can obtain easy access to the terminal and fast rail-car cycle times via the railroad’s mainline, KCS officials said. In addition, since the terminal is located in a free trade zone, there’s an economic advantage, they said.
KCS officials believe there are significant opportunities to increase U.S. exports of agricultural, energy, petrochemical and plastic products to Mexico. Surging petroleum, refined petroleum and natural gas product exports to Mexico have turned a previous U.S. trade deficit involving that freight into a trade surplus. There also is an opportunity for export growth from the substantial investments in new ethylene and plastics plants that are being built in the U.S. Gulf Coast, KCS officials said.
Such customer- and market-focused efforts are helping to propel KCSM’s volumes, which have increased so far in 2017. The railroad’s carload gains primarily have been driven by motor vehicle and parts, and chemicals and petroleum shipments.
In Q2, KCS’ total automotive traffic climbed 23 percent to 37,900 units and total automotive revenue soared 29 percent to $57.5 million compared with the same 2016 period. KCSM is registering automotive traffic growth from new plants, increased automotive production at existing plants and volumes from facilities that were shut down in 2016’s first half for retooling, said Carlson.
KCS’ chemicals and petroleum traffic rose 6 percent to 71,500 units in Q2, while revenue in that segment climbed 13 percent to $138.8 million. Growing Mexican imports of LPGs and refined products — propelled by energy reform — are helping KCSM build petroleum traffic. In Q2, the railroad’s reform-related volume swelled 223 percent to 5,418 carloads and revenue skyrocketed 255 percent to $14.2 million versus Q1 levels.
Gains in the two commodity sectors partially offset intermodal volume declines caused by continued strong competition from local trucking in Mexico, said Carlson. In Q2, KCS’ intermodal traffic and revenue each dipped 1 percent year over year, to 243,100 units and $90.6 million, respectively.
However, intermodal volume is expected to pick up in the second half due to continued growth in automotive business performed with UP, a growing cross-border service conducted with BNSF and shipments from a new operator at the Port of Lazaro Cardenas.
In December 2016, KCS and BNSF jointly launched a new five-day-per-week intermodal service connecting Chicago, the greater Dallas area and other major markets on BNSF’s lines with consumer and industrial regions on KCSM’s network.
The BNSF-KCSM venture is an example of developing services to better meet customers’ demands, said BNSF Assistant Vice President-Mexico Business Unit Paul Hirsch in an email. Since the value of annual U.S.-Mexico trade is expected to grow $166 billion to $461 billion by 2020’s end, railroads need the network, capacity and expertise to accommodate increasing demand, BNSF officials say.
One of the biggest factors impacting freight transportation in the United States and Mexico is shifting consumerism, said Hirsch.
“Consumers have changed the way they purchase things and their expectations. This is driving different requirements for those of us that are part of the supply chain,” he said. “In this changing world, supply chain partners must work together to make the process more responsive and adaptable.”
The other markets on BNSF’s network targeted by the service include Los Angeles, San Bernardino and Stockton, California; Portland, Oregon; and Seattle. The Mexican markets include Monterrey, San Luis Potosi and Toluca.
“The new joint BNSF-KCSM service is seeing continued growth, and moving forward we will continue to introduce new service products that meet our customers’ demands,” said Hirsch.
BNSF also markets a joint service with Ferromex that targets freight moving between Chicago and Silao.
“As part of [this] joint service we are also moving temperature controlled intermodal (TCI), which is unique to this market,” said Hirsch. “BNSF and Ferromex started offering TCI to this market last year, and have seen some growth as a result.”
Overall, BNSF moves agricultural, industrial and consumer products between the United States and Mexico through five key U.S. gateways: Brownsville, Eagle Pass, El Paso and Laredo, Texas; and San Diego. For ag products, the Class I was a pioneer in the development of shuttle trains pulling at least 110 cars moving into and out of Mexico, said Hirsch. BNSF offers ag shippers more than 300 U.S. origins and 30 Mexican origins.
Cross-border industrial products handled by BNSF include various metals and materials for construction and energy projects, while automotive products include finished vehicles and parts.
The Class I’s Mexico team includes bilingual experts who try to address customers’ needs and provide shippers an in-depth understanding of import and export requirements, said Hirsch.
UP’s Mexico team also includes members who are fluent in both English and Spanish, and have market knowledge and experience working with Mexican railroads. In addition, the railroad’s international customer service center in San Antonio is staffed with customer service professionals who are fluent in the two languages and have expertise in international freight handling, border processes and Mexico’s rail system. Staff members aim to help international customers by proactively monitoring shipments, assisting with border process clearance and acting as a liaison with Mexican railroads.
UP is the only railroad to serve all six U.S./Mexico gateways in Texas’ Brownsville, Eagle Pass, El Paso and Laredo, as well as in Calexico, California, and Nogales, Arizona. The Class I maintains four offices in Mexico’s interior in Guadalajara, Irapuato, Mexico City and Monterrey, and two U.S. border offices in El Paso and Laredo.
UP offers a Border Direct service involving intermodal marketing companies or motor carriers; a Streamline Passport door-to-door and door-to-ramp service to and from Mexico that’s managed by subsidiary Streamline; and a Mexico Direct all-rail service conducted with Ferromex or KCSM that’s designed to bypass congested border crossings.
Ferromex started the service with UP between Chicago and Monterrey about three years ago, and the service with BNSF between Chicago and Silao last year, says Hector Cuevas, the director of Intermodal Mexico for Grupo Mexico, which owns sister railroads Ferromex and Ferrosur.
In 2017’s first half, international, domestic and cross-border intermodal traffic handled by Ferromex and Ferrosur grew 6 percent year over year, he says. One driver was a new terminal that opened in Silao in 2016’s second half. Over the past year, the railroads have invested in intermodal terminals — including those in Guadalajara, Monterrey and Silao — to boost capacity and repair containers faster and more frequently, says Cuevas.
For all of 2017, the two railroads anticipate 6 percent intermodal volume growth compared with 2016’s level.
Finding ways to improve customer service is helping to drive traffic, says Cuevas. So is showing new and existing customers that the railroads’ owner Grupo Mexico is an environmentally responsible company, he adds.
In May, Centro Mexicano para la Filantropia, or the Mexican Center for Philanthropy, recognized Ferromex, Ferrosur and Intermodal Mexico as a Socially Responsible Enterprise (SRE). Ferromex attained the designation for the third straight year; Ferrosur, for the second consecutive year; and Intermodal Mexico, for the first year.
Companies earn the SRE designation by providing safer, more reliable and more sustainable services through efforts to reduce carbon emissions, use renewable resources, and foster an environment that favors better health and work balance for employees.
In addition to intermodal gains, Ferromex and Ferrosur posted some first-half automotive traffic growth even though the auto market’s generally flat, says Cuevas. First-half auto sales were down 2.1 percent in the United States but up 2.9 percent in Mexico, he says.
“Eighty-five percent of our auto traffic is exports going northbound,” says Cuevas.
Ferromex serves an Audi plant in Puebla; Chrysler plants in Chihuahua and Encantada; General Motors plants in Silao and Guanajuato-Ramos Arizpe; Ford plants in Hermosillo and Sonora-Cuautitlan; Honda plants in Celaya and Guadalajara; a Kia plant in Monterrey; a Mazda plant in Salamanca; a Nissan plant in Aguascalientes; and Volkswagen plants in Puebla and Silao.
The railroad also will begin serving a new Toyota plant in Guanajuato in 2019. The assembly plant is expected to build 200,000 Corollas per year.
Meanwhile, logistics service provider Schneider continues to offer cross-border intermodal services using several railroads, including BNSF and KCSM.
Five percent of the company’s overall intermodal business is conducted in Mexico, says Schneider Senior VP and General Manager of Intermodal Jim Filter.
In December 2016, the company worked with BNSF to implement all steel-wheel shipments between Chicago and Monterrey. The service’s transit time previously had been inconsistent because of handoffs from motor carriers coming crosstown, says Filter.
“It was 7 days in transit, and now it’s 4.5 days,” he says.
Schneider typically handles nortbound shipments of finished goods, and southbound shipments of raw materials or finished goods.
The challenge the company currently faces is the growing mismatch between northbound and southbound traffic.
Last year, the gap reached 24 percent more northbound versus southbound traffic, nearly tripling the 2013 figure of 8.8 percent, says Filter. A trade imbalance heavily favoring U.S. imports from Mexico is creating the mismatch.
“The number keeps rising. It’s cheaper to manufacture something in Mexico and ship the finished good north,” he says. “We try to reposition [empty] equipment either into or close to Mexico to deal with the mismatch.”
In addition to building traffic, what all the freight-rail players in Mexico desire is a trade agreement that isn’t a mismatch with their volume-growth goals. Which is why they figure to closely monitor the NAFTA negotiations.
As UP’s Frtiz outlined in a letter posted on the Class I’s website in February, elected leaders need to bring NAFTA into the 21st century.
“They should work with our trading partners to strengthen its provisions on the environment and labor and update it to address e-commerce and cross-border data flows — things that didn’t exist when NAFTA was written more than two decades ago,” he wrote. “The best step our government can take is to create a climate in which businesses have the confidence to invest and create jobs.”
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