Industrial Activity Still Rising, but Cautious Consumer Spending Raises Potential for a Double-Dip Recession

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Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--Industrial companies have gradually increased project spending. The federal government has shoveled money into the market. But the U.S. economic recovery likely will remain fragile until consumer confidence firms and consumer spending increases.

By some measures, three consecutive quarters of positive economic growth signals the end of the recession that started in December 2007. The U.S. economy grew 5% during the fourth quarter of 2009, 3.7% during the first quarter of 2010, and 2.4% during the second quarter of 2010.

But it's not that simple. Good economic news on Monday--low inflation or rising levels of inventory restocking--is offset by bad news on Tuesday: continued high unemployment or low consumer confidence.

Over the past 24 months, according to data tracked by Industrial Info, corporations have dramatically reduced their capital investment plans, shed excess capacity, and closed inefficient operations. During that time period, more than 2,100 industrial plant sites have closed, while only 1,400 new ones have opened. In the U.S. and Canada, we saw 1,853 capital projects valued at $176 billion that were scheduled to take place in 2009 placed on hold or cancelled due to the recession. In a much more significant figure, more than 3,900 capital projects valued at $1 trillion were delayed to future years. Corporations rapidly responded to deteriorating economic conditions by postponing or cancelling scheduled project spending.

But there is growing evidence that industrial companies are activating more project spending. Our monthly North American Industrial Spending Index has shown a slow but steady increase in the value of capital and maintenance spending scheduled to kick off in 2010, compared to project spending plans scheduled to kick off in 2009, when the U.S. was deeply mired in a recession.

It's certainly good news to see five consecutive months in which the potential value of spending in North America by industrial companies increases compared to scheduled spending for 2009. This positive growth indicates that plant owners have started to release more project activity this year over last. Each month, we see added data that shows that the pull-back we saw in 2009 is reversing.

Each month, Industrial Info Resources measures the value of active capital and a maintenance projects schedule to start construction in the current year, and then compares it to the rate of the previous year to determine growth or contraction. This index also shows project-spending activity in 12 vertical industries:

• Power Generation
• Petroleum Refining
• Metals & Minerals
• Industrial Manufacturing
• Food & Beverage
• Oil & Gas Production
• Oil & Gas Transmission
• Chemical Processing
• Pharmaceutical & Biotech
• Alternative Fuels
• Terminals (Oil, Gas & Chemical Storage)
• Pulp, Paper & Wood

In addition, detailed breakdowns show each industry's scheduled project spending by region.

Through the end of July, the 12 North American industrial sectors followed by IIR reported a total of 5,837 projects that were scheduled to kick off in 2010, and those projects carried a total investment value (TIV) of $231 billion. By contrast, in July 2009 IIR was tracking a total of 5,243 projects valued at $215 billion that were scheduled to kick off that year.

Click here for a regional summary of industrial project spending for 2010 and 2009..

This is another good sign that companies are more optimistic about investments this year over last. While there are still four months left in 2010 for these projects to play out, higher capacity utilization rates combined with substantial improvements in corporate profits suggest there should be less fallout in capital projects for the remaining months of 2010 compared to last year.

Industrial businesses such as electric utilities, petroleum refiners, oil & gas producers, chemical processors, and mining companies continue to exercise a high level of caution in spending for capital or maintenance projects. Negative data in one month can cause companies to suspend the start of work on big-ticket projects like greenfield construction, expansion of existing plant capacity and maintenance turnarounds.

Moreover, recent increases in North American industrial project spending have been confined to a few sectors. Projected spending in North America by the electric power industry rose nearly $14 billion in July 2010 compared to July 2009 levels. Incentives for renewable energy continue to fuel growth in this sector. We are starting to see the beginning of a natural gas-fired power plant building boom, as we did in the year 2000 and 2001. With gas prices low and stable and coal-fired development constrained by environmental regulations, natural gas is the leading choice for future intermediate and base-load capacity.

Onshore Oil & Gas Production continues to be driven by sharp increases in spending in shale formations as the industry anticipates demand to pick up as the economy improves and power generation relies more on natural gas as a feedstock. Lease owners are required to continue drilling or lose their lease.

In the Chemical Processing Industry, the need to rebuild inventories has pushed companies to more than double their planned investments in capital and maintenance projects this year compared to last year.

But these increases have been largely offset by relatively flat project spending for alternative energy and metals & minerals companies, continued sharp declines among industrial manufacturers, and various degrees of declining spending among pharmaceutical & biotech companies.

Industrial Info sees spending for major plant expansions as being determined by the rate at which inventory levels are reduced and replenished. At this point, companies have worked to restock inventories. However, the key to sustained economic growth will be how quickly those inventories are depleted by rising consumer demand, how rapidly businesses act to restock inventories, and how that cycle translates into rising employment and higher consumer confidence.

If we don't see a pickup in consumer demand, there could be an increased chance for a double-dip recession. Manufacturers have reported sharp increases in profits this year, leading to plans to increase spending for capital and maintenance projects. But consumers are still tight-fisted, and consumer spending accounts for about two-thirds of the overall U.S. economy. A strong recovery depends on consumers feeling confident about their economic livelihoods to the degree that they will begin spending again. The second half of 2010 will be a pivotal period in our nation's economic history.

We know industrial companies and the companies that provide equipment and services to manufacturers are eager to begin celebrating the end of the Great Recession. We believe it's fine to chill the proverbial champagne now, in anticipation of celebrating the end of bad economic times, but our analysis tells us that it is premature to actually pop the cork.

This article is an abridged version of the industrial outlook that appeared in the midyear issue of The NavigatIIR, IIR's monthly industrial forecasting newsletter. Sign up now to begin receiving your complimentary copy.

Industrial Info Resources (IIR) is the leading provider of global market intelligence specializing in the industrial process, heavy manufacturing and energy markets. IIR's quality-assurance philosophy, the Living Forward Reporting Principle™, provides up-to-the-minute intelligence on what's happening now, while constantly keeping track of future opportunities.