The Industrial Midwest Gets Industrious Again
For nearly 150 years, the region flourished as the epicenter of American growth…
It started with the Erie Canal’s completion in the 1820s. The 363-mile, man-made waterway – which took about eight years to build – connected the Great Lakes to the Atlantic Ocean.
This vital link opened up a world of opportunity for American industry…
Bulk goods could now be shipped faster and cheaper from inland areas to the coastline in New York City. After the canal opened, it only took a week to move flour from Buffalo – instead of three weeks. And the cost to ship a ton of flour plummeted from $120 to $6.
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Towns and farms sprang up all along the canal’s path in New York… as well as in the nearby states of Pennsylvania and Ohio. Hundreds of thousands of folks set out to start new lives.
And it didn’t stop with the Erie Canal… Railroads came next. They brought iron ore, coal, and other raw materials from the surrounding areas. Steel mills and factories were built.
For generations, the region thrived as the hub of America’s industrial revolution…
By 1950, 38% of the U.S. population lived in this region. It included eight different states – New York, Pennsylvania, Ohio, Wisconsin, Illinois, Indiana, Michigan, and West Virginia.
But the boom times didn’t last forever…
As the decades marched on, American manufacturing companies grew more and more complacent with the monopoly over U.S. goods. Plus, the increasing number of job-entitlement obligations and onerous union contracts pushed these companies’ costs higher.
Eventually, overseas competition caught up… Countries like China and Taiwan could exploit cheap labor to produce steel and other goods at lower costs than the U.S. companies.
Even worse for these manufacturers, the Federal Reserve hiked interest rates to 20% in 1979 and 1980 to fight inflation. That meant U.S. products were much more expensive for foreign buyers, and foreign products – like Japanese cars – were cheaper for Americans.
The country’s manufacturing hub soon mutated into its “Rust Belt”…
In the 35 years since Democratic presidential candidate Walter Mondale used that phrase in 1984 to describe the region’s abundance of rusting former factories, there hasn’t been much reason for hope. An era of deindustrialization swept through the region… Hundreds of thousands of employees lost their jobs. Thousands of factories shuttered their doors.
Overall, the number of U.S. manufacturing jobs fell by a third from 1969 to 1996. With no jobs available, people had little choice but to flee the Rust Belt. And they continue to do so… The city of Detroit alone lost nearly 30% of its population from 2000 to 2018. The U.S. opioid epidemic and two generations of hopelessness have taken a tremendous toll, too.
The folks in the Rust Belt so desperately need help that they don’t care which side of the political aisle it comes from… as long as it does.
It’s why Ohio, Pennsylvania, and Michigan are considered “swing states” that often tip presidential elections one way or the other. The folks in the Rust Belt so desperately need help that they don’t care which side of the political aisle it comes from… as long as it does.
But today, parts of the Rust Belt finally have something to look forward to… America’s shale revolution.
‘Hooked Into Just About Every Part of the Economy’
Oil and natural gas deposits are full of “hydrocarbons” – a combination of hydrogen and carbon atoms.
Methane is the smallest and most common hydrocarbon. It contains one carbon atom and four hydrogen atoms. Methane is best known as the primary component in natural gas.
Beyond that, other hydrocarbons are known as “natural gas liquids” (“NGLs”). They include ethane (two carbon atoms), propane (three carbon atoms), and butane (four carbon atoms). These NGLs often get produced alongside both oil and gas in the energy sector.
All these hydrocarbons have one thing in common – a single chemical bond between the carbon atoms. While these single bonds aren’t highly reactive, they can be modified into more useful compounds for everyday use.
Ethylene is one such component, and that can be further processed into polyethylene, the world’s most commonly used plastic.
Polyethylene is found in everything from water bottles and plastic bags to paint additives and construction materials. And as Dave Witte, a senior vice president at global data service IHS Markit, told online news publication InsideClimate News in February…
These materials are hooked into just about every part of the economy, from housing to electronics to packaging… Today, the world needs six of these [processing] plants to be built every year to keep up with demand growth.
In short, experts predict that we’ll soon see a massive boom in global ethylene demand…
The following chart chart from IHS Markit shows historical ethylene consumption, as well as the projected consumption into the 2030s. Notice how it starts to rapidly rise around this year…
The companies that will meet this huge new demand for ethylene in the decades ahead will be the ones that can do it the cheapest. That’s because – unlike the latest tech gadgets, cars, or even foods – the end products in this industry, like all commodities, don’t change from one manufacturer to another. Ethylene is the same no matter where it comes from.
In this industry, a company’s only competitive edge comes from keeping its production costs as low as possible. That’s where America’s shale boom comes into play…
You see, ethane production has more than tripled in the past decade – from roughly 600,000 barrels per day (“bpd”) in 2008 to more than 1.9 million bpd today. Thanks to this abundance of supply, U.S. chemical makers pay some of the lowest costs on the planet…
Before the shale boom, a gallon of ethane typically ranged from $0.80 to $1. But since 2012, the price of ethane has generally stayed between $0.20 and $0.40 per gallon. Today, it costs a little more than $0.20 per gallon – near the lowest level in more than a decade.
These record-low prices have helped chemical makers overcome higher costs for American materials and labor. And those companies have seized this opportunity…
Since the prices of ethane and other NGLs started falling in 2012, roughly $200 billion has been committed to chemical projects in the U.S., according to the American Chemistry Council (“ACC”). U.S. Department of Commerce data show the chemical industry’s share of the country’s total manufacturing sector soared from 18% in 2011 to 45% in 2017.
The shale revolution has upended the balance of power in America’s energy landscape.
In other words, a significant chunk of U.S. manufacturing can now be traced to the shale revolution. And with so much supply, this trend shows no signs of slowing down…
By the end of next year, the U.S. plans to add 8.7 million metric tons of petrochemical production capacity. Ethylene plants will make up more than two-thirds of this new capacity. Based on U.S. Department of Energy estimates, ethane-based petrochemical investments will generate $716 billion in revenue growth for the U.S. economy between 2018 and 2040.
A massive, multidecade American manufacturing boom…
Chemical makers gain an edge with lower costs, so they want to build processing plants near the cheapest source of ethane.
Historically, that led these companies to the Gulf Coast because of all the oil and gas in states like Texas, Louisiana, and Oklahoma. From 2004 to 2016, every new ethylene plant was built in either Louisiana or Texas. Today, the Gulf Coast is home to more than 95% of U.S. ethylene capacity.
But the shale revolution has upended the balance of power in America’s energy landscape. And now, the hard-hit Rust Belt section of the country is getting another chance to thrive.
If you’re looking for a steady supply of NGLs, the Rust Belt is a good place to start…
Thanks to the prolific Marcellus and Utica shale formation, the Appalachian Basin – spanning Pennsylvania, Ohio, West Virginia, and Kentucky – has become one of America’s largest sources of low-cost NGLs. Since 2010, production of NGLs in this region has grown sixfold – from roughly 100,000 bpd to more than 600,000 bpd today.
Going forward, the U.S. Energy Information Administration (“EIA”) expects this torrid pace of growth to continue… In the following chart from the EIA, you can see that the eastern U.S. states are expected to be the leading source of production growth through 2050…
The Appalachian Basin’s fast-growing supply of NGLs is one reason that, in 2017, Shell Chemical Appalachia – a subsidiary of oil and gas giant Royal Dutch Shell – began constructing the Rust Belt’s first ethylene plant on the Ohio River.
This $6 billion facility is about 30 miles northwest of Pittsburgh. It will consume up to 96,000 barrels of ethane per day to churn out 1.6 million metric tons of ethylene per year.
But Shell’s reason for building in the Rust Belt region instead of along the Gulf Coast goes beyond just the cheap input costs. As Shell spokesman Ray Fisher told the construction trade publication Engineering News-Record back in November…
The top two reasons Shell decided on Pennsylvania were proximity and abundance of [ethane], and proximity to customer base. Seventy-five percent of all the polyethylene demand is within a 700-mile radius of our facility.
In other words, the Rust Belt region is also where many chemical makers are located…
The Department of Energy lists more than 7,500 chemical makers in this region. These companies account for more than $300 billion in annual revenue and employ 900,000 workers. Appalachian Basin chemical makers total nearly a third of all U.S. petrochemical industries – the primary consumers of ethylene.
According to a 2018 study from IHS Markit, a hypothetical $3 billion ethylene plant in the Appalachian Basin would lead to hundreds of millions of dollars in additional earnings for chemical plants versus a facility along the Gulf Coast. With lower-cost inputs and closer location to consumers, the region delivered better returns under every scenario.
In the base-case scenario, the study showed the Appalachian Basin plant would create a net present value of $700 million in EBITDA (earnings before interest, taxes, depreciation, and amortization) in 2020. A Gulf Coast plant would only bring in $217 million in EBITDA in 2020. This economic advantage is why Shell is building its ethylene plant in the Rust Belt.
It’s only a matter of time before other companies follow Shell’s lead…
Two additional ethylene plants are in the planning stages for potential construction in the Rust Belt region – a facility in West Virginia with a capacity of 1 million metric tons per year and one in Ohio with a capacity of 1.5 million metric tons per year. The Department of Energy expects these plants could start operating sometime in the early 2020s.
And that would be just the beginning… A 2017 study from the ACC suggested the Appalachian Basin could support at least six “world-scale petrochemical complexes, in addition to a number of smaller facilities.” The ACC believes these plants could create roughly 100,000 jobs and nearly $30 billion in direct economic output for the region.
If these plants were created, they would also create billions in ancillary economic activity. That could include a multibillion-dollar ethane-storage facility and trading hub…
In late 2018, the Department of Energy – at the request of Congress – released a 91-page report, “Ethane Storage and Distribution Hub in the United States.” As the name implies, the report studied the potential economic impact of creating infrastructure for large-scale storage and distribution of ethane feedstock. Specifically, it looked at the Appalachian Basin.
Among the many findings, the report concluded that establishing this infrastructure in the Appalachian Basin would reduce the current risks of the highly concentrated petrochemical industry along the Gulf Coast. Remember, just a couple of years ago, Hurricane Harvey showed that one bad weather event can cripple the U.S. chemical sector for weeks.
Both President Donald Trump and Department of Energy Secretary Rick Perry have voiced strong approval for building out an ethane and petrochemical hub in the Appalachian Basin. At a recent meeting of the National Petroleum Council, Rick Perry commented…
There is an incredible opportunity to establish an ethane storage and distribution hub in the Appalachian region and build a robust petrochemical industry in Appalachia. As our report shows, there is sufficient global need and enough regional resources to help the U.S. gain a significant share of the global petrochemical market. The Trump administration would also support an Appalachia hub to strengthen our energy and manufacturing security by increasing our geographic production diversity.
The bottom line… All signs point toward a coming chemical boom in the Rust Belt.
In the decades to come, this manufacturing renaissance will create tens of billions of dollars in economic activity and at least 100,000 jobs for folks who’ve been down on their luck.
And yet, almost no one is paying attention… at least not yet.
Bill Shaw travels the globe searching for the best investment ideas in the commodities and natural resource space… As editor of two natural resource-focused newsletters, Commodity Supercycles and Stansberry Gold & Silver Investor, he focuses on oil & gas, base and precious metals, agriculture equities, and gold bullion.