Tuesday, March 25, 2014

The Missing Shale Miracle

The boom in shale gas production in the United States has sparked talk about a U.S. manufacturing renaissance powered by cheap gas. The National Association of Manufacturers notes on its website that “abundant domestic natural gas resources can fuel a renaissance in U.S. manufacturing”; similarly, a 2011 report from PricewaterhouseCoopers found that “shale gas has the potential to spark a US manufacturing renaissance over the next few years, boosting revenue and driving job creation.”

Meanwhile, in Europe and Asia, where energy prices are still high, leaders worry about a coming deficit in competitiveness that will threaten their already fragile economies. Daniel Yergin, the Pulitzer-prize winning author of The Prize, reported that in Davos this year competitiveness was “was calibrated along only one axis -- energy.” Cheaper energy in the United States, he wrote, “puts European industrial production at a heavy cost disadvantage against the United States. The result is a migration of industrial investment from Europe to the United States.” Yet talk of manufacturing renaissances or dark ages is overblown. Natural gas matters far less than either the optimists or the pessimists claim.

Energy competitiveness, the idea that cheap energy can be a source of industrial strength and competitive advantage, is at once intuitively appealing and intuitively suspect. It is appealing because we have been conditioned to believe that energy is terribly important, so big shifts in global energy must cause big shifts in the economy. It has to be a huge deal for the United States -- with profound implications for geopolitics and economics -- if natural gas prices there are a third or a fifth or a tenth of what they are in Europe and Asia.

At the same time, the idea of energy competitiveness is suspect. One rarely associates access to cheap energy with industrial potency (think Saudi Arabia, Russia, and Venezuela). By an accident of geography, the countries with advanced industrial sectors -- Germany, Japan, Korea, Taiwan -- happen to depend on imported and usually expensive energy. If those countries managed to nurture world-class industrial sectors without indigenous sources of cheap energy, there must be more to manufacturing than energy.

Despite low natural gas prices, in other words, spending on energy is hardly out of the historical norm.

The reality is that energy, although very important for some industries, is a marginal driver for industrial activity overall. In 2012, Dow Chemical reported that “expenditures for hydrocarbon feedstocks and energy accounted for 37 percent of the Company’s production costs and operating expenses.” No wonder Dow is the name most often associated with calls to restrict U.S. exports of liquefied natural gas (LNG) from the United States -- energy is a big cost for the company.

But there is more to the U.S. economy than chemicals, which accounted for 2.3 percent of GDP and 0.6 percent of full-time equivalent employment in 2012. The Bureau of Economic Analysis (BEA) estimates that, overall, U.S. businesses spent $790 billion on energy in 2012. Energy represented about 3.7 percent of total costs, similar to the 3.6 percent that companies have spent on average since 1997. (The low was 2.6 percent in 1998 and the high was 4.6 percent in 2008.)

Despite low natural gas prices, in other words, spending on energy is hardly out of the historical norm. In part, the reason is that natural gas made up only about 15 percent of energy spending by industry in 2011, with the rest going to coal, oil, and electricity, some of which generated from gas. Cheap gas has provided only a limited stimulus, on the order of $32.5 billion in savings for American industry -- a paltry sum compared to the $6 trillion in total spending by industry on intermediate inputs and wages.

What about those industries in which energy is a major cost? Among the 69 individual industries for which the BEA reports data, only eight spent more than ten percent of overall costs (energy, materials and services, and compensation of employees). These industries, mostly in the transportation and logistics sectors, made up less than five percent of U.S. GDP in 2012. Adding in industries that use fossil fuels for feedstock would get that total to around ten percent of GDP, of which a significant portion relates to transportation and logistics.

That is why it is hard to argue that investment driven by cheap gas will drive a manufacturing renaissance. In a February 2013 paper that Charles River Associates prepared for Dow Chemical on U.S. manufacturing and LNG exports, it identified over 95 projects in the gas-intensive manufacturing sector that had been announced by various companies since 2010. Together, they comprised some $90 billion in total investment. At the same time, companies spend around $2 trillion a year in other, non-residential investments. Given that not all these gas-intensive projects will materialize and that this investment will be spread over many years, it is hardly transformative.

Of course, shale gas brings other benefits. The Boston Consulting Group, for example, estimates that “the average U.S. household is already saving anywhere from $425 to $725 a year because of lower energy costs that can be attributed to domestically recovered shale gas.” Together with shale oil, shale gas is creating good jobs and yielding tax revenue, and helping shrink the U.S. trade deficit -- all worthwhile goals. But shale gas will not trigger a widespread manufacturing renaissance in the United States, nor will it undermine economies in Europe and Asia by providing the United States with an energy cost advantage. Its effects will be narrower and limited to a few industries. It is time to let go of “energy competitiveness” as a real thing. More


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