Energy Independence: Reviving U.S. Factories

by Aaron Levitt | June 21, 2012 8:00 am

So far in InvestorPlace’s continuing series on energy independence[1], we’ve focused on energy opportunities. As the advanced-drilling boom continues to sweep the nation, everyone from pipeline operators to exploration and production (E&P) companies are benefiting. For investors, the growing use of these unconventional assets could provide one of the biggest portfolio bumps of the next decade.

What about the end users? We’ve looked at the export potential of liquefied natural gas as well as the possibility of using it as a transportation fuel[2], but the biggest end-user potential of the U.S.’s newfound energy abundance could lie in a revival of the nation’s beaten-down manufacturing sector.

As inventories of both West Texas Intermediate crude and natural gas continue to build, prices for the fuels have plummeted. Electric utilities have been champing at the bit to gain access to the cleaner-burning energy source. And companies that can use natural gas and natural-gas liquids as a feedstock are seeing huge margins. That’s helping to create one of the most robust environments for industrial production since the 1950s.

The shale and unconventional-asset boom in the U.S. could usher in a new era of manufacturing dominance — which means plenty of opportunities for investors.

$11.5 Billion in Annual Savings?

While cities such as Pittsburgh, Milwaukee and Cincinnati can conjure up images of America’s manufacturing past, the shale boom is helping to unleash the heartland’s future. According to PricewaterhouseCoopers, the natural-gas drilling boom could spark a revival in the nation’s industrial production that could lead to more than 1 million new manufacturing jobs by 2025[3].

Just a few years ago, the U.S.  had a shortage of natural gas. Companies such as Cheniere Energy (NYSE:LNG[4]) constructed multibillion-dollar facilities to import the fuel. Today, Cheniere’s Sabine Pass Facility is being reconfigured to export LNG to Asian markets[5].

The extremely high gas prices ($15 per Bcf) of about five years ago led to the shale-gas and fracking boom as E&P players took advantage of the high prices. As that abundance has been tapped at a record pace, the resulting glut of unsold gas has pushed prices down to extremely low levels. Now, those low gas prices are attracting interest in new chemical-processing plants and utilities that operate gas-fired power plants.

PwC estimates that by 2025, manufacturers alone could save $11.6 billion in energy costs. Ultimately, that’s capital that can be plowed back into new businesses[6], employment and the economy.

Petrochemical manufacturers are already feasting on low prices for natural gas and their key feedstock, ethane. With natural-gas prices dropping nearly 50% over the last three years, American chemical companies are enjoying a large cost advantage over their European and Asian rivals, and seeing record margins for their end product, ethylene.

Those juicy margins have prompted a variety of companies to expand operations. Dow Chemical (NYSE:DOW[7]) plans to spend nearly $4 billion over the next five years on new facilities, while Exxon Mobil (NYSE:XOM[8]) has recently filed permit applications to expand its Baytown petrochemical complex[9].

Also benefiting is America’s steel industry. Using natural gas as both as a fuel and a reducing agent to produce iron, input costs for U.S. producers are now  roughly one-third those of their European rivals.

That could shrink even more as steel companies change their production methods to a process called direct-reduction iron (DRI). Producers in the U.S. were slow to adopt DRI because they didn’t have enough low-priced natural gas to make it worthwhile. But now, mini-mill leader Nucor (NYSE:NUE[10]) is building a new DRI facility in Louisiana and has hinted that it plans to build a fully integrated steel mill. That’s something no steelmaker has done in the U.S. in more than 50 years[11].

Finally, electricity prices in the U.S. are the lowest of any industrial nation in the world, thanks to shale gas. These low energy-input costs could be the key to combating the pull of cheap labor in Asia and helping manufacturers bring back lost production. The benefits of on-shoring U.S. manufacturing intensify when you add the cost of shipping goods across the Pacific Ocean.

ETFs Are the Best Long-Term Play Here

While today’s ultra-low natural-gas prices won’t last forever — for many E&P players, including Quicksilver Resources (NYSE:KWK[12]), current prices are under the marginal cost of production — they should remain in a comfortable range for the foreseeable future. That should cut costs all the way down the manufacturing value chain to finished goods.

For investors with a long time frame, the resulting resurgence in manufacturing could lead to portfolio gold.

Still, it makes little sense to pick single stocks now and hope for the best. There’s too much volatility, and it’s too easy to make the wrong bet.

So a pair of low-cost exchange-traded funds from Vanguard could be the best way to play this happy trend. Pairing the Vanguard Materials ETF (NYSE:VAW[13]) with the Vanguard Industrials ETF (NYSE:VIS[14]) provides broad exposure to the wide range of companies that will benefit from continued lower natural-gas prices.

The materials fund’s 137 holdings[15] include a 54% weighting in chemical manufacturers and a nearly 7% weighting in steel producers. The companies in the industrial ETF[16] will gain from lower input costs derived from raw materials. Ultimately, this pair of ETFs represents the best long-term way to participate in the rebirth of U.S. manufacturing.

With expenses for these funds running at a mere 0.19%, it will cost investors little to hold the pair as this decade-long story plays out.

  1. series on energy independence:
  2. the possibility of using it as a transportation fuel:
  3. could lead to more than 1 million new manufacturing jobs by 2025:
  4. LNG:
  5. export LNG to Asian markets:
  6. capital that can be plowed back into new businesses:
  7. DOW:
  8. XOM:
  9. expand its Baytown petrochemical complex:
  10. NUE:
  11. more than 50 years:
  12. KWK:
  13. VAW:
  14. VIS:
  15. The materials fund’s 137 holdings:
  16. companies in the industrial ETF:

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