How Energy Could Spoil Nearshoring

Mexico is the talk of the town. As US and Western companies seek to disentangle their supply chains away from China, they’ve started to look for alternatives to trade. In this search, Mexico has emerged as a clear favorite due to its close proximity to the US and its already large industrial economy (more on Bloomberg). The practice itself has earned a popular nickname: nearshoring—ie, placing factories in countries closer to their desired market (both in terms of geography and ideology). Just ask any investor about Mexico and the word is likely to emerge.

The question, then, is not whether nearshoring will happen. As we will soon show, data does seem to suggest that such is the case. The real problem is whether Mexico will be able to withstand this increased growth from nearshoring. More specifically, if Mexico has the resources to enable such levels of increased interest and manufacturing.

At Nido, we firmly believe that nearshoring will be a transformative force in Mexico, capable of significantly increasing GDP and expanding the well being of millions of citizens. But the story isn't so simple and, as we’ve now found, nearshoring could soon meet one of its biggest challenges in the country: an inability to meet rising demand for electricity.

Let’s start with the facts. Mexico is indeed gathering an increasing amount of interest from financial circles. In 2023, the country registered a historic high in Foreign Direct Investment of over $36 bn (more from Mexico’s Government). Nowhere is this clearer than in the amount of industrial space occupied across the country. In 2018, industrial space occupied roughly 72.8 million square meters in Mexico; by 2022, that number had reached 82.7 million—that is a 13.6% growth in just four years (more on Deloitte). If we assume that, given nearshoring, growth rates will continue to increase at similar levels in the coming years, this could result in a total industrial space occupied of 141 million square meters.?

These new factories, however, will result in an increase to overall energy consumption—as shown by the red line in the figure above. How much? We can estimate it based on past data. Knowing, for instance, that the entire large industry sector consumed 23.7% of Mexico’s electricity in 2021, and that, in that same year, the country produced some 284 Gigawatts of electricity per hour, we can estimate that every million square meters of industrial space added, on average, will increase electrical consumption by 0.86 gigawatts per hour (more on SENER and Datos Macro). This means that, by 2030, Mexico will need to produce an additional 50.2 Gigawatts of energy every hour to meet increasing demand from industrial facilities alone. Considering, once more, that in 2021, the country produced just 284 GWH worth of electricity, it would need to grow 17.6% in the next six years.

Now, thus far, we have focused just on the increased demand from electricity that might result from building new factories. But this accounts to just a small fraction of Mexico’s electricity consumption. Due to nearshoring, we are likely to see increases elsewhere—more houses being built, more infrastructure projects being pursued. It would be difficult to account for such growth in a simple manner. Yet, current data on electricity consumption and production does give an initial suggestion of a worrisome pattern.

In recent years, Mexico has managed to increase both its consumption of electricity and its total production, keeping production well above consumption for the last thirty years. In fact, the gap between the two has grown from 6.9 GWH in 1980 to 36.1 GWH in 2022 (more on Datos Macro). However, recently, that gap is threatening to tighten. Broadly speaking, for most of recent history, the growth rate in electricity generation has been higher than that of consumption. But that pattern shifted in 2022. That year, electricity production grew by a considerable 2.92%, yet consumption grew by an even higher 4.33%.?

This pattern is likely to continue in coming years due to the demand of nearshoring. Let’s assume that the pattern observed in 2022 will become the new norm. By projecting a GWh generation CAGR of 3.12% and a GWh consumption CAGR of 4.61%, and maintaining the same growth ratio as in 2022, we can see that by 2030—the end of the upcoming presidential administration in Mexico—total consumption would surpass nationwide production.

The problem is further aggravated when considering the current geography of Mexico’s electricity production (more on SENER). As of now, the bulk of the country’s electrical power comes from a handful of states in the Gulf Coast (Veracruz and Tamaulipas) as well as the north (Chihuahua, Durango, and Sonora). Some of these states (mostly those in the north) are also those most likely to benefit from nearshoring due to their proximity to the US. But some crucial states like Nuevo León and Coahuila—also in the border—are strategically underperforming when it comes to electricity generation (more in El Economista).?

All the above will likely put Mexico at a crossroads. If the country wishes to take full advantage of nearshoring, it will have to increase energy production. As of writing, the most common means to produce electricity in Mexico remain polluting sources of electricity which, in turn, could likely become an easy solution to power nearshoring (more on SENER). But, in doing so, the country would be sacrificing its environmental stability to gain economic momentum. Although, it is worth noting that Mexico’s newly elected president, Claudia Sehinbaum, has vowed to make renewable energies a priority of her administration, likely shifting this pattern (more in El Financiero).

So, it's not just that Mexico will have more industrial areas due to nearshoring. The logical consequence is that these new factories will result in increased electrical consumption for the country. If Mexico wants to take advantage of nearshoring, it will have to invest heavily on electricity as a whole. This will be the country’s true challenge. To attain nearshoring, it must first become better equipped to handle rising energy demands.

There is much that could be done to change this system. For most of the nation’s history, energy has been regulated by the state through a federally-owned agency, the Federal Electricity Commission (CFE). During the administration of President Enrique Pe?a Nieto, Mexico attempted to open the door to private investment in electricity infrastructure, which remains to this day. However, during the López Obrador administration, Mexico’s government has taken a state-centered strategy, opposing further investment. As things stand, Mexico’s CFE accounts for 36% of all electricity produced, while private industry represents a shockingly high 64%.

If Mexico desires to radically increase the amount of electricity being produced, there are two alternatives readily available. The country can drastically increase its government spending to meet rising energy demands. However, given the already historically high investment in massive infrastructure projects and increased spending in social programs during the Lopez Obrador administration, it might be difficult for Mexico to increase government expenditures even further. Alternatively, the government could open the doors to private investment further to meet rising demand which has already provided a meaningful amount of energy for the country little over a decade after President Pe?a Nieto’s reforms were first enacted. Not to mention that, thus far, private industry accounts for 97% of the nation's renewable energy capabilities—a majority that the CFE has been unable to defeat in recent years.

So, it’s not just about the increased industrial areas due to nearshoring. The inevitable surge in new factories will substantially escalate Mexico’s electrical consumption. To fully capitalize on nearshoring, Mexico must make significant investments in its electricity infrastructure. This represents the country’s paramount challenge: to sustain and benefit from nearshoring, it must first enhance its capacity to meet the burgeoning energy demands. Without this, the promise of nearshoring transforming Mexico’s economic landscape could be undermined by an electricity supply shortfall, jeopardizing the very growth and prosperity it aims to achieve.

Written by José Luis S.

-- Amended calculation mistake.