Will cheap shale gas revitalize manufacturing?

The U.S. has been ramping up shale gas production over the past 10 or so years. It began to achieve scale in 2006 when a multitude of shale plays began production. That year, the U.S. was producing less than 3 billion cubic feet of gas per day (Bcf/d); now they generate over 26 Bcf/d, according to the Energy Information Administration.

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Shale gas has shifted U.S. manufacturing down the global cost curve and is driving investment into the sector. But skeptics contend the recovery in manufacturing is not supported by output data, hiring trends and meaningful investment.

Our view is that low-cost gas has vastly improved the fundamentals for energy intensive manufacturing sectors like plastics, chemicals and metal smelting. The plastics industry has already greatly benefited from cheap feedstock, such as ethylene, which is linked to natural gas prices. From 2006 to 2011, U.S. plastic sales attributable to exports has risen from 28% to 41%, while over the same period U.S. manufacturing exports have risen from 14% to 18%.

A major factor inhibiting further export growth for both plastics and chemicals is the lack of capacity in chemical cracking facilities. Volatile prices in the past have led to under-investment in plants but with the persistent low price environment several firms have made significant capital expenditures and a slew of capacity is set to come online in 2016-2017.

Another beneficiary is the most energy intensive manufacturing sector of them all: metal smelting. Electricity is the single largest cost in producing most metals, outside of the ore itself. As an example, 40% of the cost of aluminum is electricity. Since 2006, U.S. metal imports have fallen from $5 billion to $1 billion in 2012.

We also contend there’s still room to run for U.S. manufacturers. Amid a shaky recovery coupled with persistently weak demand, the manufacturing sector as a whole has lagged the broader economy. The competitive advantage local producers now receive when examining domestic versus international gas prices is undeniable. Global gas prices moved relatively in tandem until 2008 when they tumbled along with the rest of the economy.

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Since then, U.S. prices continued to fall while the rest of the world saw a significant recovery. This leads us to believe that over the near to medium term, U.S. manufacturers are well positioned to regain lost market share from their foreign competitors.

TRADING WEEK AHEAD

In Canada there’ll be a Bank of Canada rate decision (or indecision if you prefer) on December 4, plus just about all the banks are scheduled to report earnings.

There are lots of U.S. data next week that could determine expectations for the timing of the taper for the balance of the year. We’ll see ISM data on Monday with expectations for 55, down a bit from last month’s 56.4, but still expansionary for manufacturing.

Regional data’s been mixed to the softer side, including Dallas, Kansas and New York. There will also be manufacturing PMI (that’s what they call ISM outside the U.S.) data from China over the weekend and for Europe next week. These tend to be leading indicators and have been trending on the positive side over the past few months.

The European Central Bank will also have a rate announcement on the December 5; no change is expected. Likely the biggest equity and bond moving news will come Friday ahead of the market open with non-farm payrolls expected to add 183,000 net new jobs, down a bit from October’s 204,000. This would translate into another tick lower in unemployment for the U.S. from 7.3% to 7.2%.

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Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @Gareth_RGMP