Three charts tell a compelling story about the relative cost advantage of U.S. manufacturing.
The first shows the relative prices paid in the U.S., Europe, and Japan for natural gas, in real (inflation-adjusted) dollars:
Data Source: World Bank
Prices can be seen to move in relatively close correlation until the beginning of the U.S. shale gas boom, when U.S. prices decouple. The U.S. now enjoys a significant, and widening, price advantage in energy.
The average energy content of a barrel of oil, though the precise value varies by the type of crude, is approximately 5.6 million BTUs. At per million BTUs, U.S. natural gas is the equivalent of -per-barrel oil. With infrastructure investment, natural gas can substitute for oil in most applications, and the extreme spread in energy cost has already begun to drive such investment, and will drive it further.
(Given the global nature of oil markets, the same magnitude of spread is not visible between, say, Brent and West Texas crude.)
[See: Lassonde: Very Bullish on Natural Gas]
Shale skeptics note the high up-front infrastructure costs in shale exploration and production, and point out that the size of economically recoverable reserves depend on the prices of the commodities. That is, natural gas at .50 greatly reduces reserves that could be recovered if it were .
But we point out the converse of these observations. Gas at or would dramatically expand recoverable reserves. Further, with infrastructure already in place, ongoing technological improvements can continue to drive reserve expansion. Basically, we see much larger upside than downside potential in reserve expansion, for both economic and technological reasons.
Labor Costs
Since the Great Recession, the U.S. has also led many of its peers in the moderate pace of the growth of workers’ hourly compensation. While this adjustment has certainly been painful to workers, it is, in the longer term, going to contribute to making the U.S. a more attractive destination for manufacturing — which will lead to a better employment picture in the future.
Data Source: Bureau of Labor Statistics
A Final Ingredient: Energy Intensity
The last item which suggests a U.S. advantage is energy intensity. This is basically a measurement of how much GDP is generated by a unit of energy, from any source: in short, as you use energy, how much economic growth do you get out of it?
[Must Read: Gary Shilling: Bears Have It Wrong—U.S. Not Stuck With Permanently Slow Growth]
The chart below shows the improvement in energy intensity between 2007 and 2011.
As you can see, while the U.S. has not made as much progress as some of its peers (especially in Europe) it is outpacing some historically inexpensive manufacturing destinations (Mexico, Brazil, Bangladesh, Korea) and keeping up with others — notably China.
Source: Bloomberg
Adding Up to a Competitive U.S.
These factors — very competitive energy costs, increasingly competitive wages, and increasingly competitive energy intensity — together make a bullish macro picture for U.S. manufacturing. In this phase of the cycle, with capital expenditures expanding, and with an uptick in commercial and industrial loan growth reflecting that spending, we are bullish on U.S. industrials. We do not favor large industrial conglomerates, but prefer to be more selective in identifying industrials we see as attractive investments.
For more commentary or information on Guild Investment Management, please go to guildinvestment.com.
