Low Oil Prices Bring Good Fortune to Some Manufacturers, Burdens to Others
By Cathy McNamara
This summer, oil prices hit a six-year low, dipping below $40 per barrel. This marks a substantial decline from prices of $112 per barrel in the U.S. just one year ago. Meanwhile, data from the Institute of Supply Management shows that in September, the manufacturing industry experienced growth for the 33rd month in a row, though at the slowest rate since the spring of 2013. The machinery subsector reported expansion, as well. The ISM reports that despite overall growth among machinery manufacturers, new orders and production fell in the month of September.
Growth in the machinery manufacturing sector, mirroring the U.S. economy as a whole, slowed more than was expected this spring. Now, economic slowdowns in the Asian markets have troubled stock and commodity prices stateside. The persistence of low oil prices has brought about nuanced effects across industry segments, but has particularly affected producers of oil and gas-related machinery and parts. Going forward, we could see some segments benefit, while some could be burdened by the implications of low crude oil prices. At the end of the day, how a company will be impacted largely depends on its product, as well as several other factors.
Lower spending by oil and chemical companies
Oil and chemical companies have been forced to spend less in an effort to turn a profit in the face of a glut of supply, which has caused a dip in production among oil and chemical producers in the Gulf area. Sharp spending cuts could result in challenges for machinery manufacturers who rely on demand from oil and chemical companies, like producers of machinery used in the production of fossil fuels. According to Business Insider, one machinery manufacturing executive noted, “Uncertainty about where the price of oil is headed has everyone on pins and needles.”
However, lower crude oil prices have stimulated global demand for more affordable mineral and energy commodities, and some analysts predict a positive outlook for mining, oil and gas machinery manufacturers. Lower spending and production could result in some stabilization in oil prices in the coming months, as supply lowers to meet lagging demand. To mitigate weakened U.S. demand, oil companies are looking abroad for new business opportunities; however, they continue to be mindful of how the strengthened dollar might impact their work within foreign exchanges. Given the potential for currency fluctuation between the day the deal is signed to when it is completed, manufacturers are looking to hedge against this exposure by locking in forward contracts linked to more stable indexes, like certain commodity prices.
Reduced energy costs could help bring production back to U.S.
Energy costs are at historic lows, and the savings experienced by some manufacturers have helped soften the strain of lost purchasing activity from oil and gas suppliers. While lower energy costs benefit most manufacturers, they slow production and new orders for machinery producers, whose business had been booming in response to energy companies’ high demand before oil prices plummeted.
Lower energy costs result in lower production costs overall, softening the potential blow of a slowdown in new orders. Lower costs also can encourage expansion and increased production in many sectors, particularly among machinery subsectors whose demand is fueled by increases in consumer spending confidence, including producers of commercial and service equipment machinery. Furthermore, lower energy costs have made the U.S. more attractive to manufacturers who may have previously opened factories in other countries in an effort to cut costs. We could see an increase in re-shoring activities, including opening new factories in the U.S. and moving foreign production back stateside if the trend of lower prices continues.
Strong dollar could bring increased consumer spend; threaten U.S. competitiveness
The dollar’s climb to 12-year highs earlier this year has stimulated U.S. production and domestic spending, but has reduced cost-competitiveness of U.S. manufacturers against their Japanese, Brazilian, French and German counterparts, reports Global Trade. While this shift hasn’t been drastic enough to shift the competitive balance – U.S. manufacturers remain more cost effective by about 10 percent overall – we could see international business and exports suffering as foreign buyers pull back slightly. We could also see a more cautious approach to expansion from manufacturers that service international companies.
And increasingly, manufacturers are looking for ways to offset potential financial losses from reduced international activity. In particular, we’ve seen interest in currency-hedged exchange-traded funds and foreign exchange derivatives skyrocket from companies that have a strong business stake in international operations. This investment could help manufacturers mitigate risk while locking in favorable effects of a strong dollar. International companies are also looking to derivatives as a way to stem the impact of the strong dollar, which is translating to lower sales and profits.
However, domestic consumer demand is up, driven by job growth and increased spending power, and could fuel growth in the sector despite export troubles. U.S. consumers are feeling the strength of their dollars, and are capable of purchasing imported goods for less, which builds consumer confidence and frees up additional dollars to be spent on other goods and services. This may help some sectors that produce goods and machinery for the retail, restaurant and travel industries.
Lower oil prices have resulted in a wide array of nuanced effects across the manufacturing industry and even among machinery producers. And if trends continue, low oil prices could contribute to a spur in activity through the remainder of the year. Despite the risk faced by some manufacturers, many forecast that the manufacturing sector will bounce back from slow growth in the first half of the year, as it did in 2014. Overall, we expect that manufacturers across a wide variety of sectors will continue to enjoy the effects of strong demand and low energy costs, while others continue to work to mitigate risks.
Cathy McNamara is an assurance partner in BDO’s Manufacturing & Distribution process, and may be reached at crozanski@bdo.com.
This article originally appeared in BDO USA, LLP's Manufacturing Output newsletter with permission (Fall 2015). Copyright © 2015 BDO USA, LLP. All rights reserved. www.bdo.com