PVF sector rides crest of energy cycle

By Morris Beschloss,

Economic analyst

With 52 years of involvement in the pipe-valve-fitting sector under my belt, I have never experienced a cycle more propitious to the growth and expansion of PVF manufacturers, distributors, installers, users and specifiers actively involved in this current happening.

Although historically dependent on mechanical contractor activity, chemical, petrochemical, pulp and paper, and other derivative industries, this cycle is driven by two factors -- hydrocarbon development, refining and transmission and power generation.

This factor alone guarantees a lengthy tenure, likely spanning many years. To amplify this conclusion, I focus on the two driving forces:

1. Hydrocarbons. Although the United States is now dependent on two-thirds of its oil supplies from foreign sources, there are increasing opportunities for domestic development that are sure to come into play --, especially with the recognition of the biofuel failure. The discovery of the Bakken Belt oil shale, drilling in Anwar, and greater offshore activity offer potential options.
2. Power Generation. Catch-up in power supply is even more urgent than the energy shortage. With the phony shortages and price manipulation perpetrated by Enron earlier in the decade, ongoing development projects were either put on hold or mothballed. The Unites States is now faced with an oncoming shortage that has doubled demand over supply.

Although no new nuclear generators are in the cards in the forthcoming time period, the current 104 stations are in the process of expanding their capacity.

With coal, America’s most prolific power resource condemned by the “Greenies,” natural gas is increasingly becoming the element of choice for our lighting, heating and air conditioning requirements. But huge domestic natural gas “bubbles” in the Rocky Mountains are out of bounds because of the influence of conservationists. Further natural gas supplies await the building of liquid natural gas terminals to receive foreign ING shipments.

If there is any doubt about the energy sector’s impact on America’s economy, visit the Houston area, which represents 30% of the manufacturing, distribution, installation and specification aspect of the PVF sector. This geographical base is not only teeming with almost indescribable work activity, but it is hard just to find unskilled workers to do justice to the many project opportunities and maintenance contracts coming down the pike.

Our industry is at the heart of the bi-polar U.S. economy and is offsetting the deep recessionary trends bedeviling housing construction and sales, automotive production shrinkage and continued disruption in the banking and overall financial sector.

PVF is also a major contributor to the unprecedented expansion of exports, which have now reached 14% of our $13.5 trillion gross domestic product of goods and services.

Within the overall plumbing-heating-cooling-piping segment, PVF is growing twice as fast as its PHC cousins. At distributor price levels, the industry as a whole is estimated to be over $75 billion, with PVF comprising one-third of that amount.

Within the next year, expect PHC to slowly make up its recent losses, but expect the PVF sector to grow by at least 20%.

First quarter gross domestic product looks flat

In analyzing the preliminary 2008 first quarter results, it’s become apparent that the bipolar economic sectors are almost in a dead heat. Despite the slight 0.6% positive growth, the same as 2007’s fourth quarter, final results for the first three months of 2008 will likely indicate a nominal standoff.

Even if a sliver of growth emerges, any sustained period of gross domestic product below 2.5% is a certain recipe for rising unemployment and sluggish wage growth.

Almost every indicator (except federal government spending and inventory changes) deteriorated relative to the already weak results of the previous quarter. Declines in consumption spending, investment in equipment and software, residential and non-residential construction, exports/imports -- all combined to a deceleration in overall growth; residential sales and construction, as well as automotive sales amounted to downright contraction.

Residential investment fell for the 9th straight quarter, and its 26.7% drop was the largest quarterly change since the decline began. Given that the recent data on 20 of the largest metropolitan areas show home prices falling at an annual rate of 23% in the last three months, it seems that there is more fallout to come in the residential investment market.

Non-residential investment, as predicted, finally followed residential investment and shrank this quarter as well, falling by 6.2%. Investment in equipment and software fell for the first time in over a year, posting a 0.7% decline.

This broad weakness can be seen most clearly in final sales (GDP excluding the effects of inventories), which shrank by 0.2% after rising 2.4% in the previous quarter. Given the volatility of inventory investment, the final sales number is often thought of as a clearer measure of the underlying strength of the U.S. economy. Domestic demand growth (final sales to purchasers located within the United States) shrank even more, falling 0.4%.

Some rare good news was found in reported inflation. The market-based “core” measure (excluding food and energy costs) of price growth in personal consumption rose only 1.7% in the past year, down from 1.9% growth in the previous quarter. While food and energy inflation is every bit the danger to family budgets as other costs, inflation in food and energy is generally driven by the supply-side influences (a rising global price of fuel, for example), and not by overheating in the domestic economy. This tame measure of core inflation gives the Federal Reserve plenty of room to attack the current economic softening without any danger of setting off broader inflationary pressures.

While GDP did not shrink outright this quarter, the economy may well be in recession currently, as the 0.6% growth in the last three months of 2007 was followed by three straight months of negative job growth (totaling 232,000 jobs lost so far in 2008). There is little reason to expect this quarter’s qualitatively worse performance to change this unfortunate trend. Given that employment must rise by roughly 1.1% annually to absorb a growing working-age population, and that productivity in the U.S. economy has grown roughly 1.4% in the very recent past, GDP growth essentially has to exceed 2.5% to keep unemployment from rising and to keep the resulting labor market slack from smothering wage growth.

Evidence on this point could be seen in another simultaneous government release, the Employment Cost Index from the Bureau of Labor Statistics, which showed that wages and salaries for the civilian workforce lagged inflation over the past year; falling 0.7% in inflation-adjusted terms from March 2007 to March 2008 (a period which saw the unemployment rate climb by 0.7%).

All in all, there is little to reassure American families about the economy. Gdp will almost certainly shrink at some point in the ongoing year; and even if it manages to not cross the zero line, it is clear that economic growth sufficient to keep unemployment from rising and wages from falling is neither here nor on the horizon.

Is the falling dollar beneficial?

For months, there has been an increasing outcry for exchange rate intervention, stopping the dollar’s weakening relationship with a basket of the world’s leading currencies. The fear is that the purchasing power of the shrinking dollar, together with ever decreasing interest rates, will instigate a shedding of the greenback by the world’s surplus-rich nations, who have already shown a predisposition to switch to the euro or pound.

Such a run away from the dollar could force the Fed to re-institute higher interest rates once again to hold off further dollar divestiture. A cheaper greenback would also inflate the prices of the ever-growing list of imports that the American consumer depends on. This is especially true of energy that comprises more than 15% of the foreign bill that the American consumer must pay every month.

Furthermore, the thousands of American tourists and commercial travelers that go abroad daily come back with horror stories regarding the staggering bills that must be paid for food, lodging, and incidentals that include these trips’ necessities.

But there is a resounding flip-side to that debate. The increasing competitiveness of American industry has generated increasingly explosive export growth, that resulted in an all-time high of 14% of America’s $13.5 trillion gross domestic product of goods and services in 2007.

And while several sectors of the U.S. titanic gross domestic product are suffering from shrinkage, outward-bound shipments (two-thirds of which are industrial products) are setting consecutive monthly records.

In fact, the industrial component of exports has acted as a stimulant to such major factory-made goods as military and commercial aircraft, heavy machinery, high tech products, various industrial components, armaments and even Harley Davidson motorcycles. This has had the effect of starting to reverse the diminution of America’s industrial base.

During the last five years, the weaker dollar has done its part in shrinking the record trade deficit, which peaked in 2006. While U.S. exports are up 17% in the last two years, the trade gap has narrowed by 11% during that time. This still represents a sizable 5.1% of gross domestic product, aggregating a total $700 billion.

Despite the recent dollar decline over the past five years, U.S. goods have broadened their base in most foreign markets because of their high quality and competitiveness. And this has not impinged on the large trade surpluses of America’s major trading partners. Japan’s surplus with the United States exceeds $100 billion. Even the Eurozone, which has seen its exports evaporate because of their high costs, still generates a $47 billion surplus annually with the United States. China tops all with $250 billion, while Russia and Saudi Arabia are in the black with its U.S. debtors for $140 billion. So the more competitive dollar is not causing fundamental trade problems for these major U.S. trade partners.

A lower U.S. dollar has had the favorable effect of stimulating U.S. net exports, and maintaining the U.S. industrial growth rate at a time of general economic weakness. This has kept the United States from increasing its interest rates to attract foreign investments; the lack of which could have driven the diminishing greenback into freefall.

Investors and policy officials are beginning to realize that the dollar’s current decline is part of a natural process for reducing the U.S. trade deficit. As the U.S. economy is expected to weaken in the coming months, shrinking consumer demand and widening exports will combine to reduce the trade deficit even further. This couldn’t come at a better time.                   

Morris R. Beschloss, a 51-year veteran of the pipe, valve and fitting industry, is PVF and economic analyst for PHC News.