Issues and Analysis: Analysts fear terrorist attack could delay industrial recovery


By Kate Thomas
OGJ Online Staff

September 17, 2001 — Energy economists just 2 weeks ago expected industrial natural gas and power demand to begin reviving, possibly as early as the fourth quarter of this year.

The right signs were falling into place. “A number of things looked fairly good,” said Dave Meckstroth, senior economist for the Manufacturers Alliance in Arlington, Va. “Manufacturing was beginning to bottom out.”

Roger Phillips, CEO of IPSCO Inc., Lisle, Ill., said the “seeds have been sown” for a recovery in steel plate in remarks prepared for a meeting with steel investors Sept. 11, the day terrorists struck. He said the US manufacturing sector, exclusive of telecommunications and information technology equipment, seemed to have bottomed out. “The squeeze out of excess inventories seems to have run its course.”

But Sept. 11’s terrorist attacks that damaged the Pentagon and disrupted US financial markets in New York City have cast a large shadow over the potential recovery. Economists previously had blamed a sharp 13-month decline in manufacturing for sending gas and power consumption down.

The US government estimated gas consumption in the industrial sector, excluding nonutility power generators, fell 600 bcf in the first half, a 22.5% decline from the first 6 months of 2000. Economists said the decrease in industrial demand accounts for about 20% of the build up in natural gas inventories in storage.

Meanwhile, industrial electricity sales fell 7% to 262 billion kw-hr in May, compared to May 2000. Sales were down 4.9% for the first 5 months of 2001, vs. the comparable year ago period. An upturn in the depressed industrial sector was widely viewed as key to an energy recovery.

When chemicals, petrochemicals, and primary metals come back, “you will see a big upturn,” David Costello, an economist with the US Energy Information Administration, predicted in an interview with OGJ Online.

Manufacturing continued to contract in August, but the National Association of Purchasing Management (NAPM), Tempe, Ariz., reported the rate of decline decelerated, while two components of its overall index rose. The production index was up 5.8% over July. The new orders index was also up 6.8% from July, with 12 of 20 industries reporting a rise.

The National Association of Manufacturers, Washington, DC, in its annual Labor Day report also said it expected manufacturing employment to stabilize by yearend and to improve next year. NAM chief economist David Huether said a “massive” inventory reduction was helping set the stage for an industrial recovery. Other positives for the industrial sector included the decline in natural gas prices from historic highs of $10/Mcf and the series of interest rate cuts engineered by the Federal Reserve, he said.

Positives in petrochemicals
A little over a week ago Kevin Swift, chief economist of the American Chemistry Council, Arlington, Va., said the industry appeared to be nearing a trough with reports from the field showing rising demand for polypropylene, for example.

“The consumer is the Atlas holding up the world,” he said. But, he also warned the economy was relatively fragile and a jolt to consumer confidence could still tip it into recession.

With gas prices down, Midwest fertilizer manufacturers were anticipating bringing plants back on line, said Joe O’Donnell, director of commodity research for Aquila Inc. With natural gas trading at about a $1 discount to No. 6 fuel oil on a btu basis, he said plants have a financial incentive to switch back to gas from oil.

Many energy-intensive industries, never anticipating that natural gas could cost $10/Mcf, failed to hedge their purchases or lock up supplies, O’Donnell said. Their answer to dealing with high energy prices was to shut down production.

O’Donnell expected many to change their mode of operation after the past year’s experience. With the contract for October delivery trading for less than the January 2002 contract, some industrial customers were looking to pick up gas cheap in the spot market, he said, while senior executives appeared to be pressuring their purchasing departments to lock in low prices.

Before Tuesday’s attack, EIA’s Costello was expecting the industrial sector to show a year over year gain in the first quarter of 2002. He predicted a “kind of long haul to get back,” with production not expected to reach May 2000 levels until the end of 2002.

He expected a 2.8% increase in gas-intensive industrial output, excluding nonutility generation gas consumption. One manufacturing economist calculated a return to May 2000 levels of manufacturing activity would boost gas demand 5% and increase prices 30-60-/Mcf to just under $3/Mcf. Prices higher than $4/Mcf were “devastating” to such energy intensive industries as chemicals, fertilizers, metals, glass, and paint drying, he said.

EIA also expected industrial electricity demand to recover next year, after declining this year from 2000 levels. But all bets are off in the aftermath of last week’s terrorist attacks, analysts are now saying. Whether the fragile base for an industrial recovery remains intact remains uncertain.

Many industry economists say the immediate outlook turns on consumer confidence. Swift said the free fall in industrial production appeared to be ending, but judged it too early to tell how consumers will ultimately respond to the tragedy.

Meckstroth said the financial effect of industry, schools, airlines, financial markets, and offices being closed will likely tip the economy into a decline in the third quarter because the economy was barely expected to grow anyway. A nervous consumer response could also tip the economy into a full decline, causing a “double dip” recession in the manufacturing sector, he said.

Meckstroth said new figures for consumer spending and income will not be available from the government for about a month.

The first bombing of the World Trade Center in 1993 and the 1990 Gulf War had a dampening effect on the economy, said Raymond James & Co.’s Houston energy research team. But over time, Raymond James analysts, and Matthew Simmons, CEO of Simmons & Co. International, said it will be easier to solve the demand side of the gas equation than the supply side.

“One of the things that is unfortunate is that energy markets are so volatile. They are totally in the hands or the emotions of speculators on the NYMEX,” Simmons said. “The minute we create any cushion in the market to get through the winter, we collapse the price. We should be applauding the extra bcfs we found for storage.”

The extra gas showing up in the market will serve as a cushion, but that will disappear as supply responds to falling prices, Simmons predicted.

Contact Kate Thomas at katet@ogjonline.com

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