By Tom Runiewicz
One year ago, crude oil prices were $30/barrel, well below the $70/barrel they are now. US average gasoline prices were still below $2.00/gallon; now they have exceeded $3.00. Natural gas prices were $5.30/million British thermal unit (mmBtu) 12 months ago; now they are above $12.00/mmBtu. Furthermore, in September 2004, the general expectation was that energy prices were peaking and that they would slowly erode through much of 2005 and 2006. What a difference a year makes! Hurricane Katrina, continuing problems in the Middle East, heavy energy purchases by China, and refinery shortfalls have forced most energy analysts to take a strong dose of reality. High energy prices are here to stay, and if they do start to decline, they will only fall moderately over the next year or two.
With manufacturing still in a recovery stage after suffering through three difficult years (2001-03), will this new perspective on energy prices jeopardize the growth in industrial output? The recovery in manufacturing is not expected to be derailed and a recession in manufacturing should not return in the near term, but, slower growth is definitely in the cards. A year ago, with energy prices at least 50% lower than what they are now, manufacturing output was projected to increase by 6.0% this year and 4.7% in 2006, but these rates have become unlikely. Instead, US manufacturing growth is expected to be 3.5% this year and easily below 3.0% in 2006, with the increasing likelihood that these projections will be revised down. This is a significant slowdown from the 4.8% growth seen in 2004 and a major downward revision from the outlook a year ago. Regardless, there is still too much momentum within the industrial sector for the plug to be suddenly pulled.
With higher prices for gasoline and heating fuels, will consumers still remain manufacturing's backbone? Tax cuts and strong housing prices supported the purchases of consumer goods such as appliances, carpeting and rugs, and furniture. Furthermore, the auto industry has benefited tremendously from the "You Pay What We Pay" programs, and it looks like the program will be extended into the fall. However, current spending rates relative to income are unsustainable. Global Insight estimates a payback is due. The first half of 2005 saw real spending on durable goods increase nearly 6.0% from year-earlier levels. The second half of the year is likely to see increases less than half that. By 2006, durable goods consumption is expected to slow to well below 3.0%. As a result, manufacturers of light vehicles, appliances, and other big-ticket consumer items are likely to face a significant downshift in output growth next year. Look at this as a slowing down from 65 mph in fifth gear to 35 mph in third. Adjustments will need to be made, but there is still forward progress.
However, over the next two years, do not look for the consumer to be the primary driver behind manufacturing growth. Instead, business equipment investment will take on that role. For more than two years, spending on computers and high-tech equipment has been leading the growth in investment. Last year, investment in computers advanced 16%; this year, over 12% growth is projected. In 2006, we expect at least 10% growth. Investment in traditional capital goods has also been doing well, clocking 5% in 2004. This year, look for a somewhat smaller gain. Next year, at least 5% growth is anticipated. This will be good news for the producers of equipment such as construction, industrial, metalworking, and service industry machinery. HVAC equipment and engine, turbine, and power transmission equipment are also likely to see business remain solid over the next 18 months.
In order for manufacturing growth to maintain its forward momentum in 2006, new consumers must continue to come into stores and dealerships. That said, both high-tech and traditional equipment investment remain the key to keeping manufacturing growth well above 2.0% over the next two years in spite of high energy prices.
