The Impending End of "Stagnation"?: Implications for U.S. Railroads
Perhaps radically, I am prepared to state as a thesis right now that the U.S. national economy is on the verge of a period of very strong economic growth.
1. The global supply of cheap and accessible labor has been exhausted. Wage inflation in China and even Bangladesh is the best evidence of this. However, an even stronger notion in my mind also works. Although there are still many countries were one can employ cheap labor at abysmally low wages, these countries are also subject to political insecurity or simply do not have the infrastructure necessary to allow for rapid industrialization. Furthermore, and most importantly these other places simply do not have sufficient volume of available labor to meet demand
. China and India both were the world's last great reserves of inexpensive labor that was accessible for rapid industrialization. While neither country is by any means completely industrialized yet, a great deal of new industrial capacity in both China and India will be used for domestic consumption, leaving export oriented production effectively competing for the same labor pool. The remaining available locations for industrialization or re-industrialization (outside the United States) are marginal at best.
2. The United States as described in the "North Dakota Bakken Crude Oil"
thread via linked CNBC article is now a net exporter of distillates for the first time since records started being kept in the 1970's and by some estimates since WWII. In short this points to unnecessary imports of crude oil from foreign countries. Within the context of this data there is actually a double trend
. The net export of distillates is not taking place solely because of an increase in production within the domestic United States. In reality these production increases have barely begun to affect the U.S. market. It is occurring because of a substantial reduction in demand from U.S. consumers
. As the expected increases in production of crude oil begin to make their way through the domestic distillate market two things will happen. Imports of far more expensive crude oil will decrease substantially, as has already been documented elsewhere and prices for domestic distillates will likely slowly decrease as well. The additional production that will then consequently pour onto the global market, instead of the U.S. market will then have a depressing effect on the global price of crude, which will ultimately place downward pressure on all crude prices. This will finally result in a substantial price decrease in U.S. distillate prices. Short of a major global crisis of production (war with Iran) I expect to see this trend materialize over the course of 2012. Given the enormous amounts of new production coming out of North Dakota it is now only a matter of time for this cycle to begin. There is literally no stopping it. Stockpiling of crude oil reserves will prove nearly impossible for two reasons, current high inventories in private stock and current near capacity levels in the U.S. Strategic Petroleum Reserve (eliminates the possibility of the government being pushed to step in and absorb a systemic oversupply).
There is another trend, as indicated in the distillate exports. Even once crude becomes cheaper domestic refineries will be pressured to drop price levels to a point where domestic consumption can finally again begin to balance with refinery capacity. In short refiners must
drop prices along with crude oil prices due to low utilization rates for refiners. Failure to do so would result in continuing declines in demand along with concurrent pressures on refiners. Thus, due to lower domestic demand for distillates, refiners will be under enormous pressure to drop distillate prices in step with crude oil prices in order to stimulate demand for distillates to a point where refiners can generate sufficient volume to make a profit. The confluence of low or declining distillate demand along with new domestic production (that is substantially cheaper than imported alternatives) is a highly unusual circumstance rarely seen in the past 30 years.
3. The U.S. has the only large pool of available comparatively cheap labor, good infrastructure, light(er) regulation, and political stability anywhere in the world. Furthermore a great deal of U.S. industrial infrastructure is relatively new having been abandoned or off-shored within the last 10-20 years. Many properties have yet to be redeveloped, leaving a glut of industrial property in the United States that is prepared for nearly immediate redevelopment. In top of all this discovery and new production of extremely
abundant sources of natural gas will help bring energy prices in the United States down substantially. This runs counter to trends elsewhere in the world which will see continued increases in energy costs due to import requirements and the cost of building or improving energy infrastructure.
4. China's continued economic expansion will eventually make the Chinese Central Bank's currency peg for the Renminbi (Yuan) fiscally impossible to defend. In order to continue to peg the Chinese currency against the dollar China is forced to export capital inflow in large volumes. The only safe means to do so is through the purchase of U.S. Treasury securities and through the availability of inexpensive domestic Chinese credit. Due to the credit contraction now underway in China, the expected reduction in sales of U.S. government debt and the continued expansion of the Chinese economy the Chinese Central Bank will be unable to maintain the currency peg of the Renminbi against the U.S. Dollar. Continued accumulations of foreign capital in sovereign reserve accounts without the ability to buy large quantities of bulk U.S. government secured debt will make it largely impossible for China to hold the Renminbi peg against the U.S. Dollar. The alternative, removing the Renminbi from foreign currency exchange trading would essentially sever China's banking sector from world financial markets. This would be catastrophic to the Chinese economy and therefore as such does not represent a viable option.
5. Additional Miscellaneous Geo-Political Developments:
a. Continued growth of Iraqi oil production, now at close to 3.0 million BOPD, past Saddam era peak of 2.4 million BOPD. Production in Iraq is expected to grow well past 5.0 million BOPD before 2020.
b. Light damage to Libyan oil production facilities during 2011 civil war. Production in Libya has already recovered to 1.0 million BOPD and is expected to come back online to 100% of Qaddafi era capacity within the next 6 months. Much as with Iraq, exploration in Libya has not been seriously undertaken during the Qaddafi era. This means additional exploration, discoveries, and production are likely to come online over the next 10 years, to include gains in efficiency from current production which is mostly done using outdated facilities.
c. Possible retrenchment by the Chinese government in their economic liberalization policies.
What are the Implications for U.S. Railroads ("The Future of Rail")?
1. Moderate improvements in the U.S. industrial sector yield incremental traffic gains.
2. Lower energy prices improve overall profitability.
3. Broad based domestic economic recovery leads to increased consumption, meaning a potentially significant increase in intermodal traffic. This development may be tempered substantially by the expansion of the Panama canal and subsequent changes to international maritime traffic patterns.
Beyond these three basic conclusions it is very hard to see what the implications are for U.S. railroads of a domestic economic recovery due in part to the potentially sector-specific economic trends that may develop.
While it may not seem to be a reasonable thesis at this point, recent trends are impossible to ignore. Changes to the energy source composition for the United States have enormous implications for the U.S. economy. It is impossible to treat as insignificant the developing surge in new production of both oil and gas within the United States. Additionally other global trends, specifically wage inflation in China and India mean that the U.S. is suddenly very attractive again for development, where it wasn't the last time energy was really cheap (in the mid to late 1990s).
When I see Chinese factory workers successfully agitating for higher wages (and receving 50%+) across the board raises at the mere hint of a strike things have changed. That is exactly what happened in 2011 and I think it is an incredibly important indicator of the state of the global labor market.