Union Pacific May Benefit From Mexico Energy Reform

Union Pacific (NYSE:UNP) generates around 10% of its revenue from shipments to and from Mexico. We believe that with the new energy sector reform in Mexico, this number could go up driven by an increase in Union Pacific’s Mexico shipments of industrial products and chemicals carloads. Recently, the Mexican government passed a law that opens up Mexico’s energy sector to foreign and private domestic energy companies. ^[1] Since 1938, state-owned Petróleos Mexicanos, or Pemex, has been the only company operating in Mexico that produces and refines oil. The new law is expected to bring in billions of dollars in new investment, increase competition, and increase production of oil and gas that will help lower electricity costs in Mexico.

We believe that Union Pacific, with its significant market share and access to cross-border rail freight traffic with Mexico, stands to benefit from the liberalization of the Mexican energy sector.

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Industrial and Chemicals Shipments May Increase

According to the U.S. Energy Information Administration, Mexico has 545 trillion cubic feet of shale gas that is technically recoverable. Most of this is located in the Burgos Basin, which is an extension of the Eagle Ford shale formation in Texas. ^[2] However, the resource has not been properly exploited. While more than 5,400 wells have been dug in the Eagle Ford formation since 2008, less than 25 wells have been dug in the Burgos Basin. ^[3] This may have something to do with the fact that there is just one oil and gas company operating in Mexico. However, because of the energy sector reform, oil and gas companies in Mexico are expected to increase. We believe that this will drive fracking activity in the region and increase shale gas production significantly from the current level of 1.64 trillion cubic feet. ^[2] However, the scarcity of water in the area may prove to be an obstruction.

Fracking is a method of extracting shale gas which requires large amounts of fracking sand, or frac sand, water and pipes. Union Pacific ships frac sand and pipes to Mexico from the Midwest U.S., as part of its industrial products shipments. In 2013, industrial products shipments accounted for 11% of total shipments to and from Mexico. ^[4] Considering the large untapped reserves of shale gas and the lack of wells in Mexico, Union Pacific’s industrial shipments should see strong growth once fracking activity increases in the region. Its chemicals shipments, which include crude oil and liquid petroleum gas, should also see significant growth because of the energy reform.

Driven by an increase in oil and gas companies in Mexico due to the energy reform, Mexican oil production is expected to increase to 3 million barrels per day by 2018. ^[5] Union Pacific’s chemicals shipments from Mexico could see double digit growth because of the increase in oil production. At present, chemicals shipments account for 6% of Union Pacific’s Mexico volumes.

The primary reason for the positive outlook regarding Union Pacific’s potential increase in Mexico shipments comes from the company’s strong network along the U.S-Mexico border. In 2013, the company handled around 65% of rail freight traffic moving between the U.S. and Mexico. ^[4] Its unique network advantage of having access to all six major gateways between the two countries has enabled it to command such a high market share. Its new terminal at Santa Teresa has further enhanced its strength in the region. Therefore, the company stands to benefit significantly from any growth in the energy sector in Mexico.

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1. Mexican president signs landmark energy reform into law, August 11 2014, www.reuters.com [↩]
2. EIA Mexico Country Data, www.eia.gov [↩] [↩]
3. Fracking: Could Mexico’s Water Scarcity Render Its Energy Sector Reforms Self-Defeating?, June 6 2014, www.forbes.com [↩]
4. Union Pacific 2013 Fact Book, www.unp.com [↩] [↩]
5. Mexico Opens Energy Sector to Private Investors, August 2 2014, online.wsj.com [↩]