These days, when you talk to anyone in the City about the big themes for the year ahead, you’ll hear about the US energy revolution.
Accessible shale gas means cheap energy. That makes the US more competitive in all kinds of ways. Manufacturers are returning to the country. And it no longer needs to import as much oil or gas, which is good news for the dollar.
But what’s the best way to profit from this major shift? And can it continue?
Manufacturing is returning to the US
Most MoneyWeek readers will be familiar with the shale gas and oil revolution by now. For those who aren’t, what it boils down to is this.
Over the last few years, new technology (hydraulic fracturing or ‘fracking’) has enabled drillers in the US to access gas and oil trapped in once hard-to-reach places. As a result, the US now has plenty of gas and is on course to overtake Saudi Arabia in oil production too, according to some estimates.
Other countries have shale too of course. But the US is almost uniquely well-placed to exploit it. That’s partly because of the legal system: landowners have an incentive to find shale gas, because they benefit from it, whereas in most countries this isn’t the case.
It’s also because the US has a lot of water. Fracking is very water-intensive, which is a big problem for a country like China, which is already very water-poor.
Because gas is not a global market yet (it’s quite tricky to transport), it means that US gas prices have plunged, even as those of us stuck here in Britain have to pay through the nose for the stuff. Natural gas is about a third of the price in the US that it is in Europe.
Cheap gas means cheap electricity. That makes it far more attractive for energy-intensive companies – such as manufacturers – to set up factories in the States. Combine that with rising wages in Asia, and the cost of transporting goods to market, and you can see why it starts to make sense to ditch the outsourcing and bring production back to the US.
US financial paper Barron’s has a good piece on the US manufacturing revival in its latest issue. As the writer, Kopin Tan notes, Samsung is planning “a $4bn semiconductor plant in Texas”. Other companies “making more of their goods on American soil again” include Apple, Caterpillar, Ford and Airbus.
How would you profit from this shift? The most interesting-looking stock tip in the Barron’s piece is a company called Dover (NYSE: DOV). It’s a play on the fact that much of America’s manufacturing plant and equipment is old and needs replacing. That’s where Dover comes in – it makes “a vast array of industrial products”.
It’s not desperately cheap on a price/earnings ratio of around 13 times 2013 profits, but it’s trading at a discount to its sector. It’s also a ‘picks and shovels’ stock, which is usually the way I like to play big themes. If the manufacturing comeback genuinely has legs, this looks like a good way to play it.
(In case you’re wondering, the term ‘picks and shovels’ refers to the California gold rush. A tiny minority of gold prospectors got lucky. The guys who sold them their equipment didn’t have to get lucky – they just had to be there. So when you’re investing in a big theme, rather than try to pick individual winners, find the people who supply them.)
The biggest threat to the reshoring revival – a stronger dollar
Of course, this rather assumes that the ‘re-shoring’ trend can keep going. We’re not saying that it can’t. But there are a number of risks that it’s worth bearing in mind.
Re-shoring is built on several key trends. First, cheap gas. Given the amount of natural gas that America has, it should be able to maintain its advantage for a while. But it’s almost inevitable that gas prices will rise.
For one thing, natural gas producers need to be able to make money. There’s only so low the price can go before they rein in production. As my colleague Matthew Partridge recently pointed out, this has already started to happen.
For another, the gap between natural gas prices in the US and elsewhere in the world makes it very worthwhile finding ways to export more. That will also tend to push the price higher.
And of course, the more factories that relocate, the more demand for energy rises. The point is, for as long as gas is cheap, demand for it will only grow. And at some point, that growing demand will force the price higher.
A second – perhaps more immediate – threat is the dollar. One factor boosting US competitiveness is its relatively weak currency. However, that may not last. As measured by the DXY index (which measures the dollar against a basket of currencies), the dollar actually hit its most recent bottom in May 2011. It’s been staggering higher ever since.
Again, this could take a while to cause problems for US competitiveness. But with every other central bank in the world trying to devalue its own currency, it could become a problem more quickly than anyone expects.
So what else could you consider? My colleague James McKeigue looked at the companies best-placed to profit from expanding uses of natural gas in a MoneyWeek magazine cover story a few months ago. You can read his piece here: The shale gas revolution.
We’ll also be looking at the implications of a strengthening dollar in the next issue of MoneyWeek magazine, out on Friday.
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