Attendees at this year’s workshop Aug. 8-9 in San Diego received mostly positive reports from speakers who agreed that, while the nation is in recovery, the road forward is filled with more than a few bumps. While abundance and availability of natural gas is definitely a major influence, speakers said North America’s economic future will also be affected by the upswing in tight oil production. Those two factors could lead to energy self-sufficiency on the continent by the end of this decade and fuel a resurgence in the domestic petrochemical and manufacturing industries thanks to low feedstock prices and relatively inexpensive electricity.
Mark Peters of the Oil and Gas Financial Journal said the boom in shale gas production is leading the growth in hydrocarbon processing and the valve industry in the U.S. “Gas has great potential that we know how to use,” he said, “and it has the capability to impact everything in the U.S. in manufacturing and in the petrochemical industry.”
His remarks were backed up by several other speakers, including Mark Eramo, vice president of IHS, who added that abundance and low price are encouraging petrochemical companies to bring production back to the U.S.
But natural gas is just one driver. Many factors are affecting the current economic situation, including consumer and business attitudes.
Alan Beaulieu of the Institute for Trend Research said one of bumps for the immediate future is a mild recession that may occur at the end of 2014. However, he also said that, rather than considering the slight downturn a negative, smart business people should use the time between now and the expected boom years beginning in 2015 to prepare their companies.
DOMETIC ECONOMY: Happy Stresses
According to Alan Beaulieu, ITR Economics, the nation is not in the recession that 40% of America still believes is occurring. In fact, Beaulieu said the economy is at record high levels and this year will be seen as a good year. He went so far as to say that if a company has not made money this year, something may be wrong with its business model.
At the same time, Beaulieu conceded that all is not smooth in this country. He said that by 2015, the nation will be “happy stressed” with increased demands on most sectors and inflationary pressures weighing in and that companies should use 2014 to prepare.
Meanwhile, Beaulieu pointed out that more Americans than ever are currently collecting food stamps—38% of Americans receive some form of assistance, which means a significant cash outflow that may translate into taxes.
Other good news/bad news from Beaulieu:
Because the U.S. is a major producer of energy, firms are leaving other nations, including China and Europe, to come to the U.S. This is creating jobs and will continue until other countries in Europe decide to explore more options. The U.S. has a stimulative monetary policy for now with the Fed pumping $85 billion a month into the economy. However, he pointed out that the Federal Reserve is expected to wind down on that easing by the end of 2013. When the agency has done so in the past, the market sags. Without the flow of Fed money many have come to expect, the market will have a negative reaction and pull back. He also said that any massive amount of stimulus spending adds to inflation, which may show up in increased wages.
The Healthcare Reform Act is scheduled to come into effect in January 2014, which will raise costs for businesses and employees. When money drains from businesses and consumers, that means less spending so the economy will slow. In the long run, the economy will adjust, he said; but uncertainty and shock will make for a tough 2014.
Beaulieu is certain that interest rates are going up 400 basis points next year, which means today’s mortgage rate would go up from 3.5-7.5%. He also pointed out that, depending on how quickly the new Fed chair raises interest rates, inflation could get a stronger hold on the economy. He predicted a mild recession in 2014.
Employment is rising, but it probably won’t continue at this pace because there is gross uncertainty coming into 2014 so executives will slow down on hiring. Europe is recovering and will do well until about the middle of 2014, but because of the U.S. recession in 2014, Europe will have a mild recession that will be psychologically damaging for its nations. He also pointed out that manufacturing is improving in the western part of Europe, which helps the U.S. export market.
Trends for the future include:
- An aging, sick population: The U.S. government spends more per person as a percentage of GDP than any other nation, he said. There will be double the number of people over 65 in the next 25 years, with more people over 55 than under 18 for the first time. Taxes could be raised on young workers, but that won’t be popular. An alternative to raising taxes would be to increase the working population through immigration, but that may not happen in this country in the current climate, Beaulieu said.
- Huge debt: The Europeans and Canadians will have balanced budgets by 2020 and soon will begin paying down debt. The U.S. debt, however, continues to increase because of aging, health care and federal spending. The debt will continue to incur interest, and since interest rates will be going up, this nation will continue to pile on debt.
In the second half of 2014, the U.S. economy will go negative on GDP and industrial production. Inflation could rise 3.5-4% in 2015 to 2016.
The economy in 2015 will heat up; there will be more demand for gas and oil and just about everything, but there will be inflationary pressures as well. Beaulieu predicted growth will continue from 2015 until the middle of 2018. Then in 2019, it all unravels—there are both high interest and high inflation rates ahead, and when that happens, the nation will know it’s getting close to the cliff that will lead into the great depression of 2030.
WALL STREET: Added Value, Right Sizing Are Keys
According to Michael Halloran, Baird and Company, the uncertain macro environment continues to challenge both U.S. and global industrial production growth. There are pockets of strength in oil and gas; however, demand in most markets remains challenged and choppy, he said.
Coming out of the downturn, companies who aggressively cut costs and right-size traditionally improve margins by finding money internally vs. externally, Halloran said. While some employees might lose jobs because of this, most margin improvement comes from better efficiency, which results in stronger balance sheets even though returns are on a smaller scale, Halloran said.
Overall, U.S. industrial production growth decelerated through the second half of 2012 and the first half of 2013. Short-cycle U.S. industrial trends remain volatile amid the uncertain macro environment, and companies remain conservative with respect to near-term industrial outlook given limited visibility into inventory levels, customer/channel demand and new order expectations.
While industrial stocks remain soft currently, he sees improvements in the last six months in the European and U.S. markets. Halloran said people are expecting modest growth in the mature markets as they work off the bottom.
In terms of specific industries, Halloran said end markets with soft demand trends entering the second half of 2013 include mining, commercial construction, municipal infrastructure, power infrastructure, and upstream oil and gas. Later-cycle infrastructure projects continue to be pressured by macro uncertainty and limited visibility, but bidding and quoting activity remain positive (particularly in downstream oil and gas, and chemical), which implies improved order progression through year-end. Agriculture and commercial aerospace remain stable, and they are seeing gradual improvement in demand trends driven by stricter environmental regulations and upward shift in energy efficiency (i.e., HVAC, power, municipal water/wastewater, general industrial applications).
- Upstream Oil and Gas: Rig counts appear to have stabilized and still remain at healthy absolute levels. The U.S. Energy Information Administration (EIA) is projecting output to reach an average of 7.3 million barrels/per day (mbpd) in 2013 and 7.9 mbpd in 2014. Though oil production is forecast to decline after 2019, output is likely to remain above 6 mbpd through 2040. Halloran expects high oil prices will contribute to the sustained drilling trend, with oil prices above $80 typically offering attractive project investment.
- Midstream Oil & Gas: The long-term outlook for refining and production across the board is very healthy although the near-term outlook is somewhat softer. Projects are going out of feed and into the quoting phase. While that trend is not a guarantee, manufacturers of valves, pumps and seals should see these projects starting to come into quoting stages by the end of 2013, which could continue in 2014 and 2015.
- Downstream Oil and Gas: Global downstream capital expenditures are expected to increase 4% in 2013/2014 and 5% in 2015. North America and emerging markets are expected to be the main drivers of project activity for the second half of 2013 and beyond. Continued strength in shale activity and persistent use of natural gas from shale plays as a low-cost feedstock, along with potential for LNG export infrastructure, likely will drive more meaningful refinery capacity additions in North America.
- Chemical: Low production costs thanks to low feedstock prices are likely to remain, providing a strong incentive to invest in the U.S. chemical industry. However, capacity utilization remains pressured as project orders continue to be pushed along, and maintenance, repair and operations (MRO) activity slows. Quoting/bidding activity for larger projects remains strong, and many industry participants are confident larger project orders will be released later in 2013.
- General Manufacturing: While investors are excited about the opportunities, many are maintaining a wait and see attitude. Companies are moving manufacturing out of China, and manufacturing jobs are growing faster in the U.S. than other job sectors; however, those jobs are not so much in standard manufacturing but in tougher positions such as those in oil and gas.
- Power and Water/Wastewater: There is little order activity in either sector right now but recovery could occur later in 2014 or in 2015. Near-term power trends remain constrained by global economic uncertainty and government fiscal issues and delays. Halloran says that, for any kind of meaningful growth, water and wastewater need debt and government stability. However, year over year growth should start to happen at the end of 2013, partially because tax receipts and residential building are getting better.
The anticipated recovery in U.S. industrial demand continues to get pushed out to later in 2013 and maybe early 2014.
WATER/WASTEWATER: Rocky but Full of Potential
Thomas Decker, PE, BCEE, Brown and Caldwell, walked the red carpet with market outlook attendees this year, extending his tradition of linking a presentation to popular culture by using a movie theme. For example, Decker began by saying “The Best Years of our Lives” were 2005/2006 when the industry experienced 12-14% growth, but that turned into “The Sting” in 2011 when the recession finally hit this industry dropping off 4-5%. The industry then remained in “The Hurt Locker” in 2012 and 2013, and is still in a “Rocky” situation going into 2014.
The 2-3% decline experienced in 2012 carried over into 2013 at the time of the workshop. However, while the market saw double-digit declines in January and February of 2013, an uptick occurred each month after that. By the end of May, the water construction part of the market was up by about 1% over 2012. Also, at the time of the workshop, there were 35 projects covering over $100 million in engineering design, which Decker says is a “stunning” number and signs of a comeback.
The water and wastewater markets worldwide can’t help but grow because of sheer need. More than $1 trillion needs to be invested in the next 25 years in the water side of the business in this nation. America will be using 65% more water by 2025, not because of population growth but because of the growing energy business, which consumes 49% of the water produced, treated and generated.
Decker said macroeconomic factors are improving for water markets. For example, while the population growth in the U.S. is expected to slow down, it will still grow 7.3% between 2010 and 2020. Meanwhile, residential construction is up 28% in 2013 over 2012, and utilities are inching toward full cost pricing, which means more money for improvements and repairs.
But Decker also said surveys show the public supports water and wastewater work. Meanwhile, the American Society of Civil Engineers’ annual report card gives water and wastewater a grade “D” for its condition, and the Environmental Protection Agency (EPA) says 55% of stream and river miles in the U.S. are still in poor condition while a $500 billion funding gap exists. Decker said $384 billion will be needed for the next 20 years to keep drinking water infrastructure up to pace.
Drivers of Opportunity
In the western U.S., the issue is supply—76% of the western U.S. is abnormally dry with serious drought conditions in many places. Several large water schemes such as The Bay Delta Program in Northern California and multi-billion dollar pipelines for Colorado and Nevada attempt to address these needs.
In the east, infrastructure breakdown is the big issue—more than 700 pipe breaks occur every day in the U.S. and many of those are on the east coast. Even without the breaks, the systems are in such bad shape that one out of every six gallons treated and sent out is lost to leaks.
Meanwhile, Decker pointed out that only 0.5% of pipelines are replaced yearly, which means it takes 200 years to go through an entire replacement cycle, far longer than the life of a piece of pipe.
The regulatory environment for water and wastewater continues to be a main concern of the industry. Currently, more than 65% of the largest wastewater utilities in the U.S. are either operating under a consent decree or in talks about a consent decree, which means tremendous dollars are needed for upgrades. New developments include:
- EPA’s new stormwater rule: This rule would apply to runoff and discharges from all new developments after they are up and in operation—requiring them to meet certain levels of water quality that are often pre-construction. For equipment companies, this creates more opportunity for infrastructure work.
- Integrated planning: EPA came out with a new framework in June 2012 that allows utilities/agencies to plan the storm water and wastewater sides together. This would allow utilities to better balance improvements and incorporate green infrastructure.
- Energy conservation/generation: President Obama issued an executive order for an additional 40 gigawatts of energy to be derived from cogeneration—combined heat and power—by 2020. Water and wastewater will be a big part of the system.
The Financial Picture
Minimal inflation and construction costs that rose only 2.5% in 2012 could help the infrastructure situation. Also, water rates are up an average 6.6% while wastewater is up 7.2%, which is good for potential business.
One point of concern is that municipal bonds, which are the main source of funding for water/wastewater, are in the bull’s eye of the current administration, which is threatening to take away deductions.
Another possible challenge is the move to green infrastructure, which includes porous pavement, rain gardens and other tools for attenuating storm water and keeping it from running off and getting into either combined systems or separate storm water systems. These programs do not use a lot of valves or pipes.
The water and wastewater industry will remain flat for the remainder of this year with the second half more robust than the first and some improvements in 2014.
POWER: New Tools is the Story
Power is a two-sided story involving mature economies and emerging economies. To understand what is going on in those economies requires looking at three major factors: supply, demand and the factors that promise to change the game, according to Kevin Geraghty, vice president, Energy Supply, NV Energy.
Customer needs and behaviors: Demand
In 2010, net generation from non-OECD and OECD areas of the world was equal. However, by 2040, non-OECD demand will be double that of OECD.
Geraghty says that over the next quarter-century, the demand for power in mature economies will stay flat. He pointed out that the recession brought, for the first time ever, contraction in U.S. electricity demand. This contrasts with the EIA’s prediction of a 28% increase in demand from 2012 to 2040. But Geraghty pointed out that in five of the last six years, consumption has fallen, and as energy becomes more costly and more efficient products are created, demand will continue to fall.
Internationally, a different story can be seen. For example, while China’s energy demand is starting to taper off and population growth in that and OECD countries slows down, other parts of the world continue to grow. Africa’s population is growing by 75% over that quarter century and India by 40%. Geraghty said by 2040, three-quarters of the world’s population will reside in Asia Pacific and Africa.
Existing and Future Resource Mix: Supply
No new coal projects are currently underway in the U.S. while the dominant changes in the energy mix are toward natural gas and renewables. Unfortunately, those renewables are mostly wind and some solar, which do not use valves. By 2040, wind and solar capacity will nearly triple from what it is today in the U.S., he said.
Meanwhile, nuclear is at a standstill in the U.S. The big problem there is the economics of building a huge power generating facility, Geraghty said. What’s more, because the price of gas is so low, nuclear will remain challenged on costs alone. Not only will there be no growth, current plants will be shut down because nuclear is so expensive to run, he predicted. Even after a facility is built, it requires many people to operate the plant. Geraghty expects there will be only four nuclear plants in this country, all in the southeast. Neither nuclear nor coal will survive unless the plant is a regulated utility in a non-regional transmission organization (which is mostly in the Southeast).
The energy story in the U.S. is all about natural gas. If the prices stay low, manufacturing should come back, he said. The ability to prove and deliver on natural gas also will determine how much electricity is derived from this resource. He said power operators will proceed with natural gas plants if they are comfortable that $10 (or less) gas will be available.
Policy and Regulatory Drivers: Game Changers
Some of the current game changes are:
- Greenhouse gas (GHG) taxes: All information the EIA releases assumes there will be no GHG taxes. But Obama recently said he is telling the EPA to put in rules for greenhouse gases for existing facilities, Geraghty said. If a tax of $25 per ton is set on GHGs, much of the current 314 gigawatts of coal generation would be retired immediately, and natural gas will not rise to its full potential, he said.
- Renewable energy: The part renewables will play in the U.S. and in the developed world is tied to policymakers. Tax credits, efficiency standards and GHG taxes can dramatically level the playing field for renewables versus gas and nuclear.
- Energy efficiency: Technological advances have greatly reduced consumption of power, and efficiency is the big story with everything from LED lights to smart phone apps that handle the power in a residence. In industry, the use of 3D printers could reduce power use.
- Demand side management: There are ways to interrupt the loads of residential units, big plants and manufacturers by controlling demand, which is now a high tech boom industry for power—new tools are constantly adding flexibility in managing usage.
- Distributed generation: The world is learning that large central plant generation of power is no longer the only choice. Rooftop solar, backyard wind and small modular can all contribute to local power generation.
GHG management and energy efficiency will be the story for the power sector in developed economies over the next 25 years. Cheap power will be the story in developed economies and China. But the most fascinating story line to watch is energy efficiency and management tools.
OIL AND GAS: New Opportunities in Both Areas
U.S. producers are well aware they drilled themselves into an over-supply situation with gas, and they don’t want to let the same thing happen with oil, John Spears, Spears & Associates, Inc., told attendees. At the same time, U.S. refineries have restraints about the kinds of crude they can process. Currently, a tremendous level of production of light sweet crude is taking place, but many of the refiners are better suited to processing heavier, sour crudes, which creates a mismatch in this country, he said.
More refiners need to address this imbalance in the types of crudes they can handle, he said. For the individual markets:
While global crude oil use grows about 1% per year, supply from non-OPEC countries is projected to increase to an average of 53.9 million barrels per day (mbpd) per country. Last year, the U.S. produced about 6.5 mbpd, and currently it drills about two-thirds of the oil wells in the entire world. By 2014, the Energy Information Administration predicts the U.S. will produce about 8.25 mbpd, much of it from the Bakken shale in North Dakota and the Permian Basin in west Texas. In 2014, non-OPEC output is expected to increase to an average of 55.5 mbpd.
Changes in U.S. rig and well counts have uncoupled over the past two years as the efficiency with which horizontal and directional wells are drilled has improved by almost 20%, Spears pointed out. Going forward, however, rig count and well count are expected to resume moving in tandem as rig efficiency improvements moderate.
Oil prices should decline 5% in 2014 as new supply additions exceed global demand growth—Spears said prices are likely to reach $90 in 2014. If the price falls below $70, rigs could be retired as those wells would not meet profitability requirements.
Natural gas production in the U.S. has decoupled from rig activity partly because of rig efficiencies, but also because of the significant backlog of gas wells waiting to be tied to pipelines. The cost to drill and complete new wells in the U.S. may continue falling at 2-3% per year through 2014. The one area that has not seen price reduction is the production equipment category (which includes valves) where cost is actually growing about 4% per year, Spears said.
Overall rig efficiency is up about 9% in 2013, offsetting an 8% drop in rig count. Because of a 10% drop in the number of new gas wells drilled (the most valve-intensive segment of the market), Spears estimated that overall valve demand in the upstream sector of the U.S. petroleum industry fell 1.3% in 2013. However, expected recovery in gas well drilling in 2014 will see valve demand rise again in that year.
Midstream and Infrastructure
In the Marcellus shale, pipeline capacity is expected to increase further to about 2.8 billion cubic feet per day (bcfd) in 2013, which would allow gas production to grow almost 40% even though the number of new wells drilled in the Marcellus fell about 30% in 2012. Marcellus is currently benefitting from drilling done a couple of years ago.
An important factor for equipment manufacturers is that midstream companies in the U.S. spend $17-$18 billion per year in capital projects. One-half of that is for facilities, which include gas processing plants, storage caverns and oil terminals. The other half is for pipelines. Companies on both sides will have total revenues of $85-$90 billion per year, and their capital spending is about 20% of their revenue.
In December 2012, the LNG market benefitted from a report concluding that exports of natural gas would be positive for all sectors of the U.S. market. That report has been key to the Department of Energy (DOE) approval of export proposals.
Currently, 20 proposals to build LNG export terminals in the U.S. are in the works; three have been approved by DOE. Each terminal could handle 2 to 3 bcfd. Spears expects that, even if just four or five of the facilities are approved, that would mean 8 to 10 bdfd that currently does not exist in the market. At the same time, Spears pointed out that producers must recognize approval is just the first step in getting a facility built: The first terminal won’t even come on-stream until 2016.
Much more important in the near term is how much gas this nation can send to Mexico, Spears said. Mexico has the fourth largest shale reserves in the world, but has done almost nothing to take advantage of this resource. The country has a gas shortfall at the same time its power sector is growing, so the short-term strategy is to build pipelines to the border and import gas from the U.S. Currently Mexico buys 1.7 bcfd, and they are building 5 bcfd of pipeline capacity over the next couple of years to handle imports from the U.S.
Spears predicts U.S. gas exports will increase first to Mexico via pipelines, then by LNG terminals to the rest of the world. This could bring the price up to $5 or $6 at the wellhead here, which is still below the trigger price of $10 (the break-even price between gas and nuclear). If gas goes up to $5 or $6, it also could also extend the lives of some of the older coal plants.
There probably will be another year of spending in the midstream sector to build pipelines and storage for new gas. Based on the expected recovery in gas well drilling in 2014, overall valve demand will rise 2.3% in 2014.
PETROCHEMICALS: A Bright Future for North America
The North American petrochemical industry took about a decade off, but the situation has changed dramatically in the last half decade, according to Mark Eramo, vice president, Chemical Insights, IHS Chemicals. Growth in natural gas and hydrocarbon processing, which feeds into the chemical industry, has created this huge shift, and the big spread between the price of oil and natural gas is fueling the growth.
Also, with the economy growing again, demand is increasing, so Eramo says the North American chemicals and plastics industry is moving into a sustained period of expansion limited only by feedstock capacity and capital.
The capital flowing into North America is roughly 50% foreign and 50% domestic, Eramo pointed out. Investors who used to look elsewhere are now happy to look here again because of increased resources.
New assets in petrochemicals take multi-billion dollars of investments and four to five years to show up as facilities and production, but these trends began about 2010, so projects were starting to come about in 2011-2012. Currently, companies are making plans, doing the engineering and ordering equipment. By 2016-2018, the investments will begin to come into play.
Eramo pointed out that investments are driven by cost advantage or proximity to demand centers. At the same time North America is experiencing advantages, massive investments still are occurring across Asia partially because that area continues to be the manufacturing floor of the world. Demand growth is also accelerating in developing regions such as India and China.
Hydrocarbon energy, crude oil and natural gas account for 65-70% of the cost of producing petrochemical products, which is why petrochemical investment goes where the feedstock is least expensive, Eramo said.
What is important for the North American petrochemical industry is the ratio between oil and gas prices. In the early 2000s, when crude and gas were trading at the same level, plants were shutting down. Current investments in petrochemical are higher because natural gas liquids left over from the natural gas that goes to fuel are very competitive now in comparison to the price of crude oil feedstock.
While abundant shale gas now available on this side of the ocean is also available all over the world, the question is whether it can be developed. North America currently has a head start of 10 to 15 years before even the most aggressive plants in places such as China can bring the gas to the market.
All discussion about the economy around the world ultimately is based on the value chain and the demand for plastics and petrochemicals, Eramo pointed out. Demand for basic chemicals is driven by end-user demand. While opportunities from good feedstock supplies and processing knowledge in North America make the future bright, the question is whether the makers of durable goods will want to bring manufacturing back here, which is not a certainty. North America currently has a stagnant market for chemicals and plastics, but as capacity ramps up, there will be opportunities to get the plastics offshore. Eramo said tomorrow’s chemical market will be more globally interconnected.
Accelerating demand growth in developing regions will outpace capacity growth, which means those regions will increase imports. Eramo said that by 2020, 50% of the world’s ethylene products will have to be put on a boat and shipped elsewhere to be turned into products. Polyethylene and vinyls will be pushed offshore in the form of plastic pellets and powders.
He said the message to producers (and manufacturers supplying to them) is clear: Do not ignore the absolute size of the North American and European markets, but for rapid growth, look to the emerging world.
North American spending on new ethylene plants from 2013 to 2017 is projected at $48 billion to 2017. It will peak early in capacity at 16 million megatons in 2018, but that level is sustainable. Investment could be $68 billion by 2030. Comparing this to growth around the world over the next decade, Europe will be flat, but there will continue to be investment in the Middle East and Asia.