May 22, 2018
Greetings/Hola/Allo/How’s it going, eh?
This is a continental railway network! Recent visits to Mexico (Monterrey and the KCS) and Canada (Ottawa and the RAC’s Railway/Government Interface – slides attached) reinforced my understanding of how much there is to lose (or to maintain) in the NAFTA negotiations – see slides cribbed from the RGI presentation on the issue. NAFTA now appears to be well behind the deadline for 2018 resolution (USTA: “nowhere close to a deal”, contradicting Prime Minister Trudeau) amid the larger trade morass (US Treasurer – concerning China, “the trade war is on hold”) and ongoing issues regarding steel/aluminum (temporary deadline for exemption is June 1) and critical supply chain (and otherwise) allies left out (Japan) not to mention issues affecting trade involving with Iran, North Korea, Russia and the EU (did I leave anyone out?)….but the Damocletian Sword, or Swords, is/are still out there….The China truce may bring with it the promise – or hope, anyway - of increased US Ag exports (I have read up to +$10B in corn); the intellectually-challenged shift to focus on the trade deficit (the FT” an economically illiterate brand of extreme mercantilism”!) and within that a resolution to increase US exports rather than US imports, rather than a focus on the rules of the game (intellectual property, ZTE, etc) is - would be- if it lasts – good for railroads. This week I will also be attending an excellent equity conference on rails (“Conferencia del Lobo” in NAFTA-speak) as well as visit a major supplier in the Pittsburgh area (no, not that one – Wabtec sure has grown in importance to the NAFR, haven’t they? #1 in PTC and locomotives!)….
Trade is important to rails! I came away from my travels even more convinced than ever of the latent demand for rail supporting trade growth in industrial and consumer goods – IF we don’t kill this goldish goose through trade disputes and a misguided return to mercantilism. The AAR, in its ongoing stout defense of (retaining) free trade, reports that 42% of 2016 volumes and 35% of that year’s rail revenues were trade related. That’s a big number – but it actually greatly minimizes the importance of trade to rails (and vice versa):
US-centric – ignores traffic within Canada & Mexico
Ignores impact of trade restrictions on the 3 economies (internally); the peso is at a 12-month low, for example
Ignores political impact (Mexican election July 1, US November, Canada 2019)
Ignores “Inputs” – for example, fertilizers into corn-to-Mexico
Is a 2016 snapshot – the trade segment grows 2X faster than the non-trade segment (so what’s the “42-35” for 2020? 2025?)
KSU and Mexico – even as NAFTA appears to have taken a back seat to the China negotiations, it’s still #1 in our thoughts. Some issues to ponder:
The upcoming (July 1) elections, with Lopez Obrador, AKA “Amlo”, still leading with ~44% of the polled voters in now a 4-person race. A recent cover story in BusinessWeek highlighted Amlo’s personal appeal, especially given the Trump rhetoric (this week’s nuggets – “Mexico is a poor ally” that “does nothing for us”, linking immigration into the NAFTA discussion) as contrasted with the distrust of the business community (centered in….Monterrey). Fears of retrograde nationalism have been tamped down, but in a wounded pride nationalistic state one must always remember the importance of the railway and oil to the psyche of Mexico.
Secreatary of Commerce Wilbur Ross made plain what was inferred by all concerned – the metals exemptions are tied to NAFTA negotiations (gulp)
HIS reports that the Mexican near-term economic outlook is “grim”
Despite that, Mexican rail transports are reporting good numbers – we have covered KSU’s Q1 but note that IANA reported that Mexican intermodal led the continent with +14% YOY Q1 growth (followed by Canada +9% and the US – the one with the driver issue – at +7%); container ports grew 12% in 2017, $23r the former came down oiB of refined products headed S/B, KSU reported a 12% increase in cross-border traffic in Q1, etc
The complexity of the auto supply chain was made clear on my visit as I saw auto racks going northbound – and auto frame manufacturing racks as well, for vehicles assembled in the US (along with southbound parts and lots of steel, from scrap to unfinished to greatly value-added coils, etc; the auto issue (and wages as well) join dispute resolution and the 5-year “sunset clause” (Canadian MP, part of a delegation to Washington: “the sunset clause is a stupid idea”) as the sticking points as Canada and Mexico stick together – though the head of CIBC economics called for Canada to cut out Mexico and do a bilateral deal on autos with the US in a Globe & Mail” Op-Ed….
Merchandise traffic may end up being the “hot sauce” for the Mexican-American rail feast– nothing against intermodal which will always be the growth leader, but merchandise is already 40% of the intra-Mexican business now with big growth prospects in steel, plastics and, of course refined products. My visit to the KCSM HQ was eye-opening – the level of technical proficiency (all of the KCS telecommunications etc are run from Monterrey), most evidenced by my visit to the security monitoring segment which would make Homeland Security proud. Security is one thing that gives KCS a competitive advantage over Ferromex (among others) as commodities like plastic pellets are actually valuable criminal targets; KCS has gained share because of their ability to protect plastics in SIT (storage in transit) placements. I was able to see the developing transload network (already 16% of in-country revenues and growing at 6-7% CAGR) as well as the huge new Logistics Park Interpuerto Monterry, highlighted in the BW “Amlo” article and site of the Oreo production that made POTUS switch brands. Steel growth will come 2 big ($1B +) plants announced (since the US election, mind you) including a big Arcelor Mittal project at Lazaro Cardenas which would supply the auto industry in Mexico - and possibly in the US west, according the country’s head with whom I had the opportunity to speak at the (oops!) ballgame. But it is refined products that is the unsung, or relatively unsung star (and that carries similar political risk as the auto supply chain). Gasoline and related products imported into Mexico have, er, exploded, from practically nothing before Mexican Energy Reform - a run rate in excess of $60-70mm in revenues (revenues up fully 275% in Q1/18 on carloads up 287%!) – and that should quintuple in the next 3-5 years – in a free market.
Canada – Crisis of Confidence in the Endgame? Not by the railways, to be sure – in fact CNI has reported that they are ahead of their recovery schedule and are looking to a terrific H2 and, especially, 2019 (ditto for CP, less vocal in these labour (sic) negotiation days). But as a nation, Canada doesn’t seem to share its railways brio, at the present. Not only were their hints that I heard of abandoning their partner in rationality (Mexico), but Ottawa and the RGI conference seemed obsessed with US Tax reform as a competitive edge. In fact, the nature of Canadian Competitiveness was everywhere – the RGI, the business press, the CBC, the man on the street; this was related to questions concerning the very nature of their federation in light of (the latest example) the inter-Provincial trade war between BC and Alberta over the KinderMorgan (“Trans Mountain”) pipeline – and the inability of a strong national government (or an interstate commerce clause) to prevent it. As I was in Ottawa, the Alberta government threatened to cut off BC’s oil supply, the federal government offered to backstop KM’s losses on the project, and Maclean’s, the Time magazine of Canada, lamented that “Canada is not a country”! I see great similarities between the two major Commonwealth nations, Canada and Australia – at least the “Last Spike” for the former came down on standard gauge!
Carriers talk up trade – CN, as noted, stated that it was ahead of their plan to regain full fluidity – they also told their national press that they saw no rail consolidation in the future save for some selected smaller tagets (as yet not for sale), the opposite of the eastern US approach to short lines, it seems. Meanwhile. CN continues to show great trade-related growth but still sees minimal impact from NAFTA renegotiation; I appreciate the former and am not so sanguine about the latter. Janet Drysdale, CN’s strategist, noted that in the time period 2010-17, growth in CN’s trade-related units was more than double that of Canadian domestic (9% to 4%). She reiterated the company position that, for the commodities they carry, if the nations chuck NAFTA and revert to the WTO rules, there would be minimal impact (after all, lumber is doing fine). But that pre-supposes that the USA would continue with the WTO, a body with which the US is in a heating cold war. And Jante also noted that the Chinese trade war potential would have a major, noticeable impact on their BC-ports inbound IM business (over 50% of which are Asian goods heading to the USA). For CP, 2/3 of their business is “global” or cross-border; the remaining third split between intra-Canada and intra-US. Both expected the so-called rail reform act C-49 to pass into las, soon - thereby liberalizing the regulatory regime in the grain provinces (and allowing for a much needed wave of capex – CP says $400mm in grain cars alone) – but at the cost of much longer – 1200km! – interswitching rules. One step forward, half a step back? As doe the NAFTA negotiations, Canada is the one country that doesn’t have a looming election, but is still frustrated (the afore-mentioned G&M accused the US of “ragging the puck” in the talks).
Anthony B. Hatch