Mexico’s stalking railway horse impacting KCS

Written by William C. Vantuono, Editor-in-Chief

A railway reform bill that has been approved by the lower house of Mexico’s Congress and that would impose a form of open access has had a major impact on Kansas City Southern’s share price, according to analysts. KCS derives close to 50% of its revenue from its Mexican operation, KCSM; the company’s share price has declined about 15% in recent weeks, despite record revenues in 2013 and an improved operating ratio.

The Mexican legislation would give third-party companies access to the country’s existing rail networks, which were privatized in the late 1990s. The largest are KCSM and Ferromex, in which Union Pacific has a 26% stake. These two railroads combined move about 90% of Mexico’s rail traffic. The legislation is currently with the Mexican Senate for further discussion and a vote. Unlike Mexico’s current railway concession structure, the proposed legislation states that new concessions will be granted only to private companies that develop new infrastructure.

The bill has seven main objectives: Confirm that the nation will maintain ownership of the railway system. Guarantee the interconnection between railways and establish an appropriate reimbursement method between users (however the bill does not specify what reimbursement mechanism is to be used). Develop additional point-to-point railways and branches that require neither government permits nor concession status to be constructed and operated. Revise the reasons under which a concession may be canceled. Create an inter-system substitution mechanism among concessionaires. Change concessionaires’ social (including noise regulation) responsibilities. Maintain the free-tariff fixation mechanism, except where competition does not exist.

Two new types of railway concessions are envisioned: Construction and operation of railway infrastructure by one company; and freight service provided by a third party, which would own the locomotives and rolling stock and pay the infrastructure concessionaire for access. This effectively is open access.

“We believe the proposed reform is ambiguous and includes a number of flaws regarding historical investments and prices,” says one analyst. “It also does not include technical details. Mexican legislators have stated that current concessionaires have not invested in railroad infrastructure, an argument based only on track expansion. However, we know that the current concessionaires have invested billions of dollars in the existing infrastructure since privatization.” Said another analyst, “If material changes are made to the existing exclusive concessions, there is potential for it to be disruptive to rail activity in Mexico and to cross-border activity more broadly.”

According to sources in the Mexican Senate, the reform bill will be analyzed in detail in the coming weeks. One analyst says it does not expect a fast-track approval, as is what happened in Mexico’s lower chamber, where the bill was introduced in early December 2013 and approved February 4, 2014. “Our analysis, including conversations with consultants, suggests that the Senate is likely to change the lower chamber’s proposal to correct what legislators see as excessive price increases and under-investment,” says the analyst. “Moreover, affected companies could take legal action to reduce the impact of the reform bill or to block it altogether.”

KCSM and Grupo México, principal stakeholder in Ferromex, have gone on record as opposing the reform bill. KCSM says it has a constitutional concession in Mexico that cannot be changed through legislative action, and is exploring the use of an arbitration panel set up under provisions of NAFTA (North American Free Trade Agreement) to protect its interests. KCSM’s concession runs through 2027. Grupo México said the bill violates its concession agreement and would void its exclusivity rights, which run another 14 years.

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