PVF sector continues to maintain relative stability

 

BY MORRIS R. BESCHLOSS,

PVF & economic analyst emeritus

 

Although the pipe-valve-fittings sector continues to maintain relative stability, this set of circumstances is primarily due to continued strength in power generation, maintenance of oil refineries, transmission line activities, and limited commercial and industrial construction, such as health and retirement facilities and continuation of ongoing projects necessary to pump oil in Alaska’s North Slope, as well as the Gulf of Mexico.

 

Even with the severe cutbacks in drilling rigs, which are now at the mid-1990s level, one-half of those working a bare two years ago, further reductions may be in the offing, as crude oil demand lags.

 

Refineries, which had been operating at a level of a high nineties percentage rate only a little over a year ago, have now cut their output to a bare 80%, even with the driving season having started effectively after Memorial Day. However, these installations have used the additional downtime to bring their highly modernized installations up to snuff. This has been a boon for pvf manufacturers, distributors, and maintenance specialists, who have continued to manufacture and install the components necessary in fulfilling such maintenance requirements.

 

I continue to express little confidence in so-called renewable energies such as ethanol, wind and solar, and yet to be developed renewable energy ideas to supplant fossil fuels (the bane of the environmentalists). Outstanding experts will tell you that oil, natural gas and nuclear power will be the overwhelming element that will generate electric power utilities and move our cars and trucks for many years to come.

 

Unfortunately, America’s current Administration does not buy this reality and has all but killed the possibility of offshore drilling or developing billions of oil barrels encased in the shale available in profusion within Rocky Mountain sediment.

Coal has been effectively demonized by the triumphant environmentalists within the Obama Administration. This has forced a buoyant coal industry to ship their production to China and India, who thumb their noses at environmental restrictions while they push their burgeoning industries to the limit by fouling the air indiscriminately.

 

China has even stated officially that it is the responsibility of the “rich” developed nations to protect the environment. These developing nations would be happy to let the U.S. and the old “rich” nations of Europe and Japan commit ‘industrial suicide’ in signing the upcoming “Stockholm Protocols,” while they continue to capture an increasing segment of the world markets without environmental inhibition.

 

A telling indication of future oil prices made itself felt on June 9, as the price per barrel of oil crossed $70 for the first time in more than six months. Although this was at the beginning of the driving season, U.S. gasoline demand has not yet picked up perceptibly. The major push seems to have come from China, the dollar’s weakness, and the anticipation of inflation influences later in the year.

 

Gold, oil square off in battle of inflation hedges

 

With optimism of a global economic recovery growing more forcefully by the day, concern of future inflation is heading to the top of the list of worries by inflation-wary investors.

 

Whereas deflation is very much a current reality, the fear of roaring inflation coming down the pike has been kindled by the Obama Administration’s amassing trillions of dollars in debt for universal healthcare, renewable energy experiments, environmental and climatological commitments, as well as ongoing bailouts.

 

With a drumbeat of daily advertisements appearing on radio and TV, the fascination with gold is becoming the hedge of choice by increasing believers, sensing that the glittering metal is the only protection against certain hyper-inflation within the foreseeable future.

 

The problem is that gold is not driven by normal economic supply/demand, but by national treasuries and international banks who control prices by accumulating large hoards when the prices seem propitious, and releasing on the markets when a major profit is in the offing.

 

A wiser choice by those rightfully stressed by the inevitability of future inflation would be oil. Grossly undervalued, even after the current runup, because of the unprecedented crash last summer, the “black gold” is due to increase much more emphatically as the world economy recovers in 2010 and 2011.

 

China has already made its choice by nailing down every oil-producing capability worldwide that Beijing can buy at today’s distressed prices. Although supply appears more than adequate because of demand destruction, supply disintegration is growing much faster as drilling rigs are shut down, old oilfields are taking on water, and new reserves are not being developed because of the costs not being covered by today’s prices.

 

Even more important is the fact that oil is universally dollar-denominated. As inflation drives the greenback increasingly lower, the price of a barrel of oil becomes more expensive when measured in dollar terms. Most global oil experts now expect crude oil to meet and even exceed last year’s $147 a barrel peak, within three years. Despite smaller cars and renewable energy development, world usage of oil, which will reach 83 million barrels this year, is expected to easily top 100 barrels a day by 2020.

 

With China and India alone providing hundreds of millions of new combustion engine aficionados by that time, the recent bargain gasoline prices will soon become a distant memory.

 

Second half consumer spending due to be flat

 

Although consumer confidence points to improved economic conditions in the second half, don't expect much help from the consumer sector. Despite the initial spending from the $800 billion stimulus package, income tax rebates and a 5.8% cost-of-living boost in January for Social Security, plus a special one-time payment to Social Security recipients, the first half consumer activity remained essentially flat.

 

Part of this was due to a 5.7% gain in savings, a 14-year high. This, in effect, absorbed almost all the money that flowed into consumer pockets. But worse may yet come in the third and fourth quarters, with the following factors being faced by the U.S. public.

 

1) Despite a slowdown in May employment losses, these are due to resume their downward trend this summer as the domestic sector continues its hapless slump. A double-digit unemployment rate is practically assured before the bottom is reached by year’s end. Key to this pessimism is domestic automotive disintegration, including component manufacturers and dealers.

 

2) A major slowdown in government-led stimulus and other federal gimmicks to reduce taxes and expand after-tax income. Without government bailouts and other artificial stimuli, unleveraged consumption will continue to wallow.

 

3) Rising interest and mortgage rates, inhibiting a housing building and buying comeback, and blocking the reduction of foreclosures may impose serious new costs on a reviving construction industry.

 

An increasing savings rate spurred by familial insecurity is sure to be maintained. Almost certainly, gasoline prices nearing $3 a gallon by the fourth quarter will eliminate the benefits of the $1.90 per gallon prevalent in the depths of the recession earlier in the year.

 

When one squares this circle, it becomes obvious that there will be precious little cumulative spending money left in Americans’ pockets to drive the once massive consumer sector forward.

 

Is stimulus plan’s buy American clause counterproductive?

 

With the domestic manufacturing sector increasingly imperiled, any aid to the stabilization of America’s industrial sector would normally be welcomed.

 

However, the “Buy American” provision may not be all that it’s cracked up to be. First of all, the impetus behind this $800 billion stimulus package amendment, pushed through by Congress with lightning speed, was the labor unions, flexing their newfound muscle, sitting in the Obama Administration’s inner circle. There are three major factors that make this obvious stickler counterproductive.

 

First, what is not known by most observers is that labor gets the benefit of the Davis-Bacon Act, passed during the 1930s Roosevelt years, forcing employers working on government-supported projects to pay the highest prevailing wage offered by organized labor in a particular area, whether such work is unionized or not.

 

Second, foreign and domestic companies employing thousands of workers in the U.S., but not able to guaranty source of origin of all component parts as domestically made, are disqualified from bidding on any stimulus-involved projects.

Third, the most dangerous component of this ill-conceived provision is that it has stirred up a hornet’s nest among our trading partners. This could conceivably lead to loss of jobs among our domestic workforce, and lost revenues for America’s companies who have benefited dramatically from the upshot of America’s No. 2 global export sector.

 

Representatives of a dozen American trading partners are already consulting with each other as to how to respond to what is being called the "United States’ protectionist drive." Our No. 1 trading partner, Canada, which has been barred from bidding for stimulus-oriented American business, is threatening to back a Dominion-wide response, retaliating in kind.

 

An analysis communicated by the Peterson Institute for International Economics, Washington, D.C., estimated that “Buy American” provisions could save 9,000 American jobs vs. 650,000 jobs directly involved in the foreign government procurement of American exports.

 

Taken in the context of what’s good for America, “Buy American” in the stimulus bill could well turn out to be “un-American” due to all its ramifications.

 

Global manufacturing is breaking out all over

One of the most demoralizing aspects of the current global recession has been the simultaneous disintegration of manufacturing in the world’s leading industrial centers.

 

This has not only undermined the economies of major developed nations, but has stopped the emerging, most agrarian nations from developing their economic societies, as imports from the U.S. and other industrialized nations shrank precipitously.

 

The worldwide deep recession has also brought international trade to multi-year lows, which has had the side effect of encouraging a new round of protectionism.

 

But latest statistics from around the world seem to indicate a significant rebound is in the making. In the United Kingdom, the purchasing managers’ index hit its highest level in a year. In the Eurozone, the manufacturing recession seemed to be easing, with indices for Germany, Italy and Spain rising by a record amount. China’s manufacturing sector in May grew for a third month in a row, indicating that the Asian giant’s industry is gathering new momentum.

 

Even the U.S. manufacturing numbers are “less worse” than they have been since the summer of 2008.

 

India and Australia also seem to be well on their way to industrial recovery, with indexes hitting multi-month manufacturing highs.

 

A major reason for this unexpected turn of events is that the U.S., as well as most of the industrialized world have cut their inventories to the bone, while production has been cut back severely. Increasing inventory draws, as demand has started coming back, have created shortages that can only be alleviated by an acceleration of factory activity. Whether this comeback will prove to be spasmodic, rather than long-term, still remains to be seen.

 

U.S. savings rate spikes to 12-year high levels

 

The U.S. savings rate, which had dropped below zero as consumption spiked to its highest level ever in 2007, has reversed course, reaching 5.7% most recently.

 

Although the American savings rate has not taken into account 401ks, IRAs, or other federally-sanctioned savings plans, the spate of leveraged U.S. consumption had reached bubble proportions, creating the scenario that had led to an unprecedented financial crisis, bringing the U.S. to the verge of a liquidity meltdown last summer.

 

Although the current fear-inspired rush to savings safety has severely curbed consumer appetites, it has also solidified an eventual economic recovery.

 

With consumer borrowing, such as home equity and credit card loans increasingly harder to come by, providers of consumer products, both imports and domestically produced, have seen severely reduced demand, impinging drastically on their revenues.

 

Although increasing unemployment has only aggravated consumer buying momentum, a more prudent consumer approach will eventually lead to a balanced equilibrium between demand and supply.

 

This could permanently impact such major manufacturing sectors as housing and automotive once the American economy emerges from its grinding recession sometime in 2010.

 

Morris Beschloss, a 49-year veteran of the pipe, valves and fittings industry, serves as PVF and economic analyst for Phc News and The Wholesaler.