Strategic View: What’s next?

lull is likely to persist for a while and assuming that the causes are reversed beginning in 2016, represents an opportunity for capacity expansion investment needed to reduce the risks of congestion that have been an issue in the last two years. 

   Analysts on Wall Street, since Charles Dow (author of the Dow Jones index) in the 19th century, consider the transportation sector to be the canary in the mine. The slowdown in volume growth has coincided with declining short-term economic indicators such as industrial production. This has made financial analysts and the freight movement industry uneasy. Some are concerned that a recession is brewing. 

   The slowdown in freight volumes reflects a combination of technical issues and fundamental economic factors. Some analysts point to technical factors such as the effects of the West Coast stevedore contract negotiation in 2014 and 2015 which coincided with ocean-borne freight volumes shifting to the East Coast and an unusual buildup of imported goods inventories prior to the traditional third quarter peak season. This makes year-on-year growth comparisons difficult to interpret and leads some to speculate that the inventory buildup was unintentional.

   Beyond those temporary factors, there is concern that the unwinding of excess commodity production capacity could sandbag an otherwise improving economy. This is most evident in the oil, gas and coal industries. OPEC is maintaining high levels of production to create excess supply and therefore keep prices low, ostensibly to discourage oil and natural gas production in the United States. However, there could be other reasons such as to thwart efforts to shift fuel demand away from oil and towards alternative fuels by keeping oil prices “irresistibly” low. However, the bottom line for the freight movement industry is that oil production and therefore movement from wells to refineries in the United States has flat-lined and is likely to decline in the near term.

   The public sector in the United States is pushing electricity production away from coal and towards alternative fuels, such as natural gas. While this may be slowing coal demand growth, the more likely reason is that the United States is experiencing a relatively warm winter. This reduces seasonal demand increases for heating oil, natural gas and electricity. There may be very high stockpiles of fuels and therefore less need for railcar shipments.

   China’s economic slowdown has also caused trouble for the freight movement industry on a global basis. Between 2000 and 2014, China became the world’s largest importer of many raw materials. For example, in 2000 China accounted for 17 percent of world iron ore imports and in 2014 its share had increased to 71 percent.  

   Many commodities sectors, such as fuels and industrial metals, made substantial investments in production capacity over the last 15 years. As the production capacity comes on line and demand growth falls below the level expected when the investments were made, companies are reacting. Some of them borrowed substantial amounts of money to make the investments and low commodity prices hurts their ability to service their debts. A review of share price performance by industry shows that oil company share prices have declined, as have those of mining companies and industrial goods manufacturers which sell to the commodity-producing industries. 

   Both economic data and financial markets indicate that the economic recovery has shifted from being led by investments in the commodities industries to being led by consumer spending. Energy and mining companies have been reducing their investments and laying off staff. Those who borrowed a lot of money are issuing shares to pay down their debts to survive financially.

   Economists do not feel that a recession is imminent, mostly because the virtuous cycle of consumer spending driving employment growth, which in turn drives more consumer spending, remains intact. However, there is a risk that the unwinding of the excess investment in the commodities markets accelerates significantly or that the debt default rate in the energy and mining sectors rises enough to start a financial crisis. If so, it is unlikely that another 2008-2009 outcome would occur; however, it is important to be watchful of trends in those struggling sectors.

   Eventually the commodities sectors will be right-sized for market demand and demand itself should pick up as construction trends continue to remain positive. Until that happens, this is a good time to take advantage of relatively low interest rates and raw materials costs and engage in infrastructure investments needed to avoid the congestion issues that have been plaguing the freight movement industry in the last few years.
   Kemmsies is chief economist at Moffatt & Nichol, an infrastructure engineering firm. He can be reached at (212) 768-7454, or email at wkemmsies@moffattnichol.com.