America has a competitive advantage in energy compared to the rest of the world. We have some of the most advantageous natural gas prices, resulting from the growth of shale gas production. This wasn’t always the case. In the mid-2000s, energy intensive industries reduced production and closed facilities. Manufacturing companies looked for opportunities to move facilities to regions of the world with more favorable energy costs. Today, shale oil and gas has changed the outlook for “Made in America.” Fifty new major industrial projects have been announced, including petrochemical, steel, and fertilizer manufacturing.
The American Chemistry Council estimates that growth in manufacturing will entail $72 billion in capital investment and construction activity and a 7.3% manufacturing expansion. This growth will contribute 662 thousand direct and indirect jobs and contribute $342 billion to the economy.
Several studies look at the direct economic benefit of energy production. The economic benefit of abundant energy goes far beyond the immediate benefit of production and beyond the political rhetoric of energy independence. Energy abundance offers real opportunity to renew America’s manufacturing base.
Energy in Manufacturing
Manufacturers use energy in a variety of ways. Energy intensive manufacturers use energy products as feedstock or have significant heating or cooling applications critical to the manufacturing process. Less energy intensive manufacturers use energy for machinery, transportation, and operating facilities.
Energy intensive industries include petroleum refining, chemicals, steel, aluminum, paper, glass, and fertilizer manufacturing. Many of these industries require energy in the form of heat to transform a raw material, such as iron ore, into a finished product, such as steel. For others, such as fertilizer, chemical, and oil refining manufacturers, the energy products supply both raw materials and heat to create their products.
In energy intensive industries, energy is a critical component of the variable production costs. The more products made, the greater the energy and raw materials used in the process. A competitive advantage in energy cost is a game changer for these industries.
Even for less energy-intensive manufacturers, energy can have an important impact on the bottom line. The recent shale gas discoveries have lowered prices both for natural gas and for electricity, since natural gas is a growing fuel for power generation. As energy is a fixed cost for small manufacturers, any reduction in the cost directly increases the bottom line. If their energy expense is 5% of operations, then a 40% decrease in energy expense reduces total costs by 2%, which is a very real addition to profitability. Increasing company performance directly facilitates business growth.
Petroleum refining is an energy intensive process and manufacturing gasoline, diesel, and other products provides an example of the impact of competitive energy supply and prices. The input is a raw material—crude oil—and the output is gasoline, diesel, specialty chemicals, and other products. The process to convert crude oil to usable products requires energy to distill the various products and hydrogen to change the chemistry of some hydrocarbons into other useable products. The energy and the hydrogen come primarily from natural gas. To make each barrel of refined product requires 500 to 800 cubic feet of natural gas per barrel of crude oil, depending on the quality of the oil.
U.S. refining businesses have a significant competitive advantage over foreign refiners because of natural gas prices. If we assume a natural gas price of $4.00 per thousand cubic feet (MCF), then each barrel of crude oil requires $2.00 to $3.20 of natural gas for a refinery in the United States. If the refinery is in Rotterdam, where gas prices are about $11.00 per MCF, then the cost of natural gas required per barrel is $5.50 to $8.80. In Asian countries relying on Liquefied Natural Gas (LNG) imports, a natural gas cost of $16.00 results in the cost per barrel of $8.00 to $12.80. To understand the extent of the advantage, it is useful to note that the margin per barrel of refined product has historically been around $3.00 a barrel. Current natural gas prices have greatly improved the global competiveness of U.S. refineries compared to those in Europe and Asia.
While the above analysis is a simple review of one component of a complex business involving many more variables, it illustrates the impact of energy abundance on one industry. It is not just about making oil refineries—an industry with historically thin margins—more profitable. The refiner’s competitive advantage results in running their manufacturing facilities at greater capacity, which increases domestic fuel supplies. The excess production can be exported, increasing economic output for the country. In 2011, the United States became a net exporter of refined products, reversing decades of being a refined-product importer.
Energy and Manufacturing Future
Current North American energy abundance is the result of innovation and private sector investment. Government policies that restrict development or prevent the market from working effectively may reduce the benefits this energy competitive advantage offers to Americans and to our manufacturing industries. The best way to ensure the highest value for our economy is to allow the market to work in the manufacturing and energy sectors.
For energy, markets will effectively allocate energy production, particularly natural gas and oil, to uses that generate the highest return for their owners. Oil is a global commodity, so any restrictions on trade will not provide long-term price benefits to consumers. Restrictions can have an adverse effect if the result is decreased investment and production. Furthermore, North America has a structural competitive advantage in natural gas because of the high cost to liquefy and ship natural gas. The cost of liquefying and shipping natural gas to Asia is approximately $6.00 per MCF, almost two times the current gas price. This incremental cost will limit the amount of LNG exports and continue the U.S. comparative natural gas price advantage for the foreseeable future. The more energy we produce, the better our competitive advantage. Polices that discourage supply or restrict demand potentially reduce energy investment.
For manufacturers, the best energy policy encourages long-term productive energy development. At present, abundant energy supplies mean exceptional opportunities for energy intensive industries. If the United States can maintain its energy advantage over the coming years, the projected $72 billion in manufacturing investment and construction referenced earlier will be only the beginning of a long-term trend resulting in greater job growth. While we don’t know what the future holds, relying on markets, while sometimes resulting in higher prices, will provide the price signals necessary to usher in entire new resource opportunities.
The shale oil and gas resources are an example of markets and innovation working together. These new resources offer energy supplies for the next 50 to 100 years. Innovation will change our energy future, although when and how is unknown. With history as a guide, we can maximize the value of these resources now, and trust markets and innovation to find our next energy breakthrough.