Practical analysis for investment professionals
03 August 2011

Could Higher Energy Costs Abroad Lead to a Recovery in U.S. Manufacturing?

Posted In: Economics

U.S. manufacturing may be down but don’t count it out. In fact, the U.S. manufacturing sector could be poised for a comeback. The reason? Skyrocketing energy and transport costs now make it far more attractive to produce goods locally, says Pearce W. Hammond, Jr., CFA (pictured, right), director and co-head of exploration and production research at Simmons & Company International, an independent investment bank specializing in the energy industry.

At the CFA Institute Financial Analysts Seminar in Chicago last Friday, Hammond told delegates that higher energy costs are causing many manufacturers and multinationals to reconsider the location of production centers in Asia as they increasingly look for ways to manage costs.

Transportation costs are a significant component of the cost structure of manufactured goods, particularly goods that have a lower value per pound like electronics and general merchandise. In contrast, goods that have a high value per pound like pharmaceuticals and medical devices never moved offshore in the first place, and labor and transportation costs are a smaller component anyway.

Pearce W. Hammond, Jr., CFA

Pearce W. Hammond, Jr., CFA

Hammond, whose session was entitled “Opportunities and Threats for Natural Gas in a Clean Energy World,” rests his prediction of a U.S. manufacturing renaissance on a simple arbitrage of lower natural gas prices in the United States versus the rest of the world. Natural gas in Asia is trading at $13-14 per million BTUs (mmbtu) while in the U.S. natural gas is trading below $4 per mmbtu. Meanwhile, much of the energy used to transport goods is oil based, which is now trading in excess of $100 per barrel with no signs of declining.

At the same time, drilling technology has improved substantially. Through the industry’s new shale fracturing technology, Hammond noted, we are achieving extraordinary efficiency gains and can now access enormous amounts of natural gas in a cost-effective way. This advancement in natural gas sets the stage for a sustained period of low natural gas prices and hence revitalized growth in North America, he contended. The United States, which boasts a productive workforce and the largest consumer market in the world, will thus be an increasingly attractive place to locate manufacturing plants. As Hammond put it, “it’s time to stop being so darn negative on America.”

About the Author(s)
Ron Rimkus, CFA

Ron Rimkus, CFA, was Director of Economics & Alternative Assets at CFA Institute, where he wrote about economics, monetary policy, currencies, global macro, behavioral finance, fixed income and alternative investments, such as gold and bitcoin (among other things). Previously, he served as SVP and Director of Large-cap Equity Products for BB&T Asset Management, where he led a team of research analysts, 300 regional portfolio managers, client service specialists, and marketing staff. He also served as a Senior Vice President and Lead Portfolio Manager of large-cap equity products at Mesirow Financial. Rimkus earned a BA degree in economics from Brown University and his MBA from the Anderson School of Management at UCLA. Topical Expertise: Alternative Investments · Economics

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