The Energy Imperative for Southern Mexico
Seizing the Nearshoring Moment for Southern Mexico
As supply chains and trade relationships the world over return from global to regional, Mexico stands poised to reap major gains. However, seizing this ongoing nearshoring moment requires an alignment in the priorities of two key players that are not always in perfect agreement. First, companies need to find new zones for investment based on their assessment of the risks associated with the fragility of global supply chains and the desire to reduce the costs of production, manufacturing, and labor. Second, the governments of countries on the receiving end of nearshoring need to design new policies to absorb these incoming investments, develop their human capital, and ensure the protection of the environment.
Ideally, these two considerations would coincide to achieve a successful realignment of supply chains. In practice, however, capturing the full potential of nearshoring has proven anything but easy.
Nearshoring presents an opportunity but also a massive challenge. In the case of Mexico, economic and social disparities between wealthier central and northern regions and the poorer southern states have historically been a political stress point. States such as Oaxaca, Guerrero, and Chiapas have suffered from continuous underdevelopment, poverty, and violence. For instance, in 2020, Oaxaca’s GDP per capita was just 25 percent that of Nuevo León’s and less than 20 percent that of Mexico City’s. If the policy vision guiding the nearshoring moment is not well designed, and if its benefits fail to be reasonably distributed across the country, what has rightly been understood as an opportunity to enhance economic development could exacerbate inequality and political instability in Mexico—and that would be an unfortunate legacy indeed.
President Andrés Manuel López Obrador (AMLO) hails from the southern state of Tabasco, in an area historically known for its oil industry. An important segment of his political base is still located in his home state and the southern part of Mexico more broadly. Hence, the oil industry and energy policy have been essential political talking points during AMLO’s political career. Today, they represent the building blocks of his national energy policy. Alongside oil and energy, AMLO’s economic strategy has had a distinctly southern orientation, focused mainly on a series of megaprojects intended to transform the region. Indeed, three of the four main infrastructure projects of this federal administration are located in southern Mexico: the Tren Maya railroad in the Yucatán peninsula, the Dos Bocas oil refinery in Tabasco, and the Interoceanic Corridor across Oaxaca and Veracruz. According to AMLO, these projects, working as an ensemble, represent the necessary investment that southern Mexico so desperately needs.
Of these megaprojects, the Interoceanic Corridor in the Tehuantepec Isthmus (CIIT) pertains most directly to nearshoring. Connecting the Pacific and the Atlantic Oceans through the states of Oaxaca and Veracruz, the project consists of the restoration of 300 km of railway line, the construction and modernization of 10 industrial parks along the corridor, and the modernization of the Salina Cruz port in Oaxaca and the Coatzacoalcos port in Veracruz. The government is attempting to attract foreign investment to this region, mainly by offering subsidies for companies that invest in the industrial parks, as an attempt to balance the penchant of companies to establish themselves as close to the U.S. border as possible. Yet even with these financial incentives, some business owners still believe the increase in logistics prices associated with more complex transportation costs will remain too high, making southern states incapable of competing with the north in the long term. To be sure, the south is at a disadvantage vis-à-vis the north in most industries and economic sectors, but with well-designed policies to compensate for some of the shortcomings, there are distinct opportunities that have thus far been overlooked: opening new supply routes to the East Coast of the United States through the Gulf of Mexico and overland to Central America.
Finally, Mexico needs to seize not only the economic window of opportunity for nearshoring but also the political one. The alignment of presidential elections in Mexico and the United States happens only once every 12 years. It should thus be expected that nearshoring will feature in the policy conversations in the presidential elections in 2024 that will unfold nearly simultaneously in both countries. This represents an opportunity to mobilize publics on both sides of the border in support of policies that incentivize nearshoring, increase cooperation, and outline the future of North America.
Barriers to Progress in the South
A combination of historical inequalities, geographic obstacles, and contemporary policy has left southern Mexico’s economy trailing northern and central regions. One recent study from the Mexican Institute for Competitiveness (IMCO) found three states in southern Mexico—Guerrero, Oaxaca, and Veracruz—to be the least competitive at attracting companies looking to nearshore operations. Some of the reasons stated in the study include the lack of a skilled workforce, poorer labor regulations, shortage of access to housing and other basic public services, and the relatively high price of electricity. Particularly, Guerrero and Oaxaca stood out as the “least attractive” for reallocating supply chains. The price of electricity reaches 850 Mexican pesos (about $49) per megawatt hour, ranking among the highest in the country.
States in the south, such as Oaxaca and Chiapas, have important natural resources, including some of the largest water reserves in the country, yet these cannot be exploited due to the lack of infrastructure investment over the last several decades. In the case of the CIIT, it is unclear if the fiscal stimulus by the federal government will be enough to attract new investments and outweigh the risks of the industrial parks not having sustained access to water and electricity. By contrast, Aguascalientes was the best-positioned state in the IMCO study, followed by Nuevo Leon and Coahuila. Northern states are in a clearly advantageous position due to their more diversified economy, skilled workforce, and robust infrastructure.
However, there are success stories that the south could emulate. These stories demonstrate how distance from the U.S. border is not the only relevant factor to seizing the nearshoring moment. In the Index of Local Competitiveness 2023, the states of Queretaro and Jalisco (not located near the border) were among the top six states for competitiveness, while the southern state of Quintana Roo jumped from 19th to 13th place in just a single year. Such improvements can be attributed to these states’ efforts to create enabling environments for business through accountability mechanisms, streamlined regulatory processes, and the use of more efficient electronic mechanisms for participation in government procurements. Geography is a strong pull, but it is not destiny. Despite all the challenges, nearshoring is a unique opportunity to remedy some of the historical divisions in Mexico.
Another important challenge for nearshoring in the south of Mexico will be negotiations with local indigenous communities. Under the Mexican federal constitution, infrastructure projects within protected areas must follow a consultation process with indigenous peoples. Oaxaca and Chiapas, for example, are some of the most ethnically diverse states in Mexico, with dozens of indigenous groups with diverging interests, some of which have already expressed concerns about these development projects or presented collective lawsuits in federal tribunals to halt their advancement. Negotiations between indigenous communities and the federal government will therefore add another element to be navigated for nearshoring projects in the region.
Energy policy is another historically sensitive and critical issue in Mexico. Thus, nearshoring will likely generate both technical and ideological backlash. Southern states are historical strongholds of left-wing political parties, which tend to favor nationalist energy policies and the management of state-owned energy companies in the energy sector. A more friendly stance for private investment from the top down is necessary to drive the kinds of private sector-led investments and development which will be truly transformative for southern Mexico.
Energizing the Nearshoring Push
Fortunately, Mexico has at its disposal today the tools needed to jump-start the nearshoring movement in the south. Chief among these is a wealth of energy resources that will prove critical for attracting companies looking to relocate or open new operations. While AMLO has sought to position oil as the crux of Mexican energy sovereignty, natural gas may be perhaps a worthier bearer of that mantle, representing a plentiful, low-emission fuel source with an impressive array of industrial applications. Unfortunately, Mexico’s energy reality has not kept pace with its energy potential, especially in southern states, where generation and distribution infrastructure sorely lag the north.
One important contributor to this is the mismatch between Mexico’s natural resources and production. While Mexico possesses an estimated 17 trillion cubic feet of natural gas, and demand has steadily increased to represent nearly half of the country’s energy basket, natural gas production in Mexico has steadily declined over the past decade. In 2021, Mexican domestic production of natural gas was less than half of 2010 levels, while consumption grew by roughly 33 percent over the same period. Today, Mexico imports 70 percent of its natural gas needs, 96 percent of which comes from the United States, where it has thus far benefited from its northern neighbor’s cheap and plentiful exports and preexisting pipelines for export.
However, this dependency systematically disadvantages southern Mexico, which faces a paucity of pipeline and terminal infrastructure needed to meet growing demand. The Mayakán pipeline, for instance, is the only major conduit carrying natural gas to the states of Yucatán and Campeche, while no major pipeline at the moment reaches Quintana Roo (albeit one is being planned). This is especially troublesome and threatens to undercut the potential of a state that was recognized as making one of the largest strides in improving its competitiveness and innovation. The presence of a pipeline itself is no sure guarantee of satisfactory energy access: Mayakán is capable of transporting just 250 million cubic feet per day (cf/d), but the energy demand of the Yucatán peninsula is estimated to reach as high as 900 million cf/d. Overreliance on U.S. suppliers will also need to be corrected by stepping up Mexico’s domestic production, especially in the south. Given the long timelines associated with pipeline construction, by the time sufficient transport capacity can be built to satisfy energy demand in southern Mexico with U.S. natural gas, the bulk of nearshoring opportunities will have already passed.
To be sure, access to natural gas is only one piece of the puzzle. A competitive, innovative, and future-oriented economy in southern Mexico will depend upon a diversified energy matrix, including significant investments in renewables, notably coastal wind and solar. However, the need for cheap, reliable, and increasingly green power is an argument in favor of expanding domestic natural gas production and distribution, not paring it back. Natural gas is an important transition fuel source, is cleaner than oil, and is more competitive on price for many light industries such as textile manufacturing. As companies increasingly make environmental, social, and corporate governance principles core elements of their business plans, investments that prioritize natural gas may hold even more appeal for businesses than the Dos Bocas refinery in Tabasco state, which continues to be pitched as the flagship energy megaproject for the south despite budget overruns and environmental hazards.
Key manufacturing inputs, including steel, glass, and plastics, are highly energy intensive and especially gas intensive. Emerging opportunities in the fields of automation, the digital economy, and telecommunications also hold potential for southern Mexico but will be no less exacting in their energy demands. Thus, for southern Mexico to become a larger player in North American supply chains, and attract new and potentially transformative industries, there are precious few substitutes to natural gas.
(Re)setting the Table
Both the White House and Palacio Nacional have important reasons to focus on accelerating the nearshoring movement in southern Mexico. The approaching presidential elections in both countries also present unique opportunities as well as risks. A careful calibration of the bilateral relationship is therefore necessary to ensure conversations around nearshoring, energy, and southern Mexico continue to move in a productive direction. There is cause to be optimistic in this regard, as Mexico and the United States have a multitude of tools at their disposal, from government channels such as the High-Level Economic Dialogue (HLED) and North American Leaders Summit to private sector convenings such as the U.S.-Mexico CEO Dialogue.
In this respect, the private sector stands out as a key player. In the energy production and distribution space, state-owned companies, most notably PEMEX, still dominate in Mexico. However, especially in the natural gas industry, private sector actors have been instrumental in making investments to expand pipeline access as well as processing and storage hubs. The struggles PEMEX already faces in meeting its oil refining goals further underscore that the energy giant will not be able to meet rising natural gas demand on its own. The government of Mexico can encourage this trend by entering into more public-private partnerships to deliver power to underserviced states and municipalities. Also critical are the companies looking to nearshore their operations to North America, which will be important to engage to promote a view of opportunities in Mexico that looks beyond merely the northern border states. The United States can encourage this by leading trade missions to southern Mexico to educate business leaders about the unique opportunities and comparative advantages of basing their operations in these states.
Any conversation about energy in Mexico is bound to run up against the third rail of the United States-Mexico-Canada Agreement (USMCA) consultations, as the United States and Canada continue to dispute AMLO’s domestic energy reforms. While these consultations will undoubtedly cast a shadow over all discussions on energy, a focus on southern Mexico carries the potential to reset the conversation in a more positive direction. Indeed, bolstering energy security in the south plays to AMLO’s rhetoric around Mexican energy sovereignty as well as the U.S. desire to tamp down on the root causes of migration. The upcoming U.S.-Mexico 2023 HLED presents one important opportunity to elevate such conversations and perhaps remove the albatross of USMCA consultations, to a degree.
Policymakers in both the United States and Mexico should also endeavor to leverage the window provided by discussions about expanding natural gas access to revitalize the renewable energy space in Mexico as well. While Mexico saw a spike in renewables investment, with $6.2 billion invested in 2017 alone, this has trailed off in recent years. A second wave of investment in renewables could create major opportunities for southern states.
Expanding energy access in southern Mexico promises to pay dividends not only for residents there, but potentially for Central American countries grappling with their own challenges in the realm of energy security. If Mexico is capable of better integrating its grid with that of the Northern Triangle countries, it would markedly increase the entire region’s nearshoring appeal, delivering knock-on effects in its ability to address the root causes of irregular migration. Mexico and Guatemala have already seen progress in easing cross-border flows for workers employed in southern states. A productive next step could be to expand the conversation to include energy transmission as well.
Ryan C. Berg is director of the Americas Program and head of the Future of Venezuela Initiative at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Emiliano Polo is an intern with the CSIS Americas Program. Henry Ziemer is a program coordinator and research assistant with the CSIS Americas Program.