Monday, January 19, 2015

A Crude Explanation Of Oil And Trucking

Back in October I correctly predicted crude oil prices would fall to $76/barrel, which it did, for about a day. It then keep falling, due to OPEC no longer being able to control the supply, which I also correctly pointed out it that post.Now crude is around $48/barrel and questions are being asked about how this impacts the economy and the trucking industry.

How low will crude prices go?

The lowest prediction I have seen is $20/barrel.  Some very reputable economists are predicting a bottom in the low-to-mid $30s, still others say we have already bottomed out. Word is that supplies are building around the world and OPEC keeps pumping away.  At some point production has to slow and rationality in the markets prevail.  If you split the difference between the bears and bulls in this market, expect around $40/barrel as the bottom.  

When will prices start to rise?

Expect a steady, measured, rise back to a more stable equilibrium point.  The industry experts say this should be $70-$80 a barrel.  There is disagreement on how long it will take to get back up there.  Some economists say as early as six months from now, while others as long as mid-2016.

Why haven’t diesel prices fallen as fast as gasoline prices?

Diesel prices were subjected to some very odd circumstance during the last quarter of 2014.  Diesel prices were around $4/gallon when the fun started.  Some major disruptions at refineries in the Midwest allowed diesel inventories to plunge to near record lows.  If the price of crude had stayed around $100/barrel, diesel prices would have spiked to $5/gallon as the demand for heating oil
(similar to diesel in composition) started to rise.  But just as this inventory crisis was occurring, crude prices started to plunge.  Therefore you had this “tug-of-war” on price.  At first diesel prices didn’t budge, then started to fall slowly.  Refineries are still trying to build inventories back to normal levels, so diesel prices will keep falling gradually.  If crude is still cheap in March (when heating oil demand drops) and inventories are fully restocked, then you will see the full, expected, bottom in diesel prices.

What impact will the lower crude prices have on the economy?

Some economists predict a huge economic boost, while others say the impact is negligible.   A few experts have tried to calculate the impact of low crude prices on GDP.  This is a difficult endeavor because of the sheer mass of the data and the fact that while some industries thrive due to low crude prices, others, especially fracking and other oil related activities, are hammered. These estimates indicate GDP will only be 40 to 80 basis points higher in 2015 due to lower priced crude.  This is certainly a positive factor, but not a boom.  However, these calculations cannot measure the positive psychological boost provided by lower gas prices.  This factor is probably more impactful than normal because most consumers have been in a fearful funk since the Great Recession.

How do lower diesel prices impact truck freight?

Again you have a tradeoff between markets. Oil and exploration related freight will suffer, however other freight markets will grow due to increased consumer spending.  Therefore it is a net plus, but not a big change.  Fleets profits will grow due to lower operating costs, however this is also tempered by the use of fuel surcharges which were implementing when fuel prices greatly fluctuated in the past.  Freight rates should not drop because industry capacity is tight and driver pay is increasing due to labor shortages.

Word on the street is that two large fleets just signed 3-year diesel supply agreements at around $3.50/gallon.   This shows that fleets value price stability over getting the absolute lowest price. It also indicates the fuel industry expects crude prices to stabilize around $80/barrel in the mid-term.

How will lower diesel prices impact the need for new trucks and trailers?

The number of fleets buying new trucks to take advantage of the improved mileage of the new engines could slow.  But you would have to assume that crude prices would stay low throughout the life of the truck, which is unlikely. 

Conversely, higher fleet profits means there is more money available to buy new equipment.  Increased freight due to economic growth would support more expansion demand. 

New trailer demand would but subject to the same trade-offs as the economy.  Trailers used in the energy sector, tanks for example, will suffer.  While the other segments should benefit moderately.
Demand for Class 8 natural gas powered vehicles will slow because the payback period for buying a more expensive natural gas truck is now much longer than it was six months ago.  Sales should increase when crude stabilizes later this year.

Regardless, crude prices fell throughout Q4 as Class 8 trucks set a record for number of orders in a quarter.  So be assured, the market is not being slowed in any way by cheaper crude and it may be helping lead the charge.

Monday, December 29, 2014

Will This Boom Be Followed By A Bust?

Class 8 truck orders were the second highest ever in October (45,639 N.A.) and trailer orders (46,267 U.S.) set a record, shattering the old mark by thousands. Class 8 orders for November are 40,608 and 39,356 for trailers. While these numbers are huge, they are significantly inflated due to sales strategies recently employed by some of the OEMs.                                         
Equipment orders are booming!
Order Inflation
Trailer OEMs and at least one truck OEM have motivated the larger fleets to place orders for most of their anticipated equipment requirements through the second quarter of next year. In other words, they pulled purchase orders forward into October and November which would have normally been received in December 2014 through April 2015. So, although the order numbers are record setting, they are not truly reflective of the current equipment market.
What are the Real Order Numbers?
It is estimated (using previous market share data and statistical software) that approximately 22,000 truck orders and 22,000 trailer orders were “pulled ahead” in October and November.  This means the market is still strong, but not as strong as the raw numbers imply.
Why Did the Fleets Place the Big Orders Now?
Production capacity is very tight in both the truck and trailer markets.  In trucks, capacity was reduced due to plant closures due to the Great Recession.  Those plants will not reopen.  And both the truck and trailer markets, OEMs have been reluctant to invest to increase capacity.
Hot or Not?
Even though the humongous orders and flat-out production give the impression of an over-heated Class 8 market, it really isn’t. Even after the tremendous October and November orders, there were still some build slots open in the short-term. November retail sales were down 2% versus October on a per day basis. This means fleets are not rushing to put new units into service. While this market appears smoking hot overall, it is currently functioning fairly normal for a growing market.
What Now?
The Great Recession devastated the heavy-duty equipment market. When the recovery began it was so weak that everyone was very cautious and minimizing risk was the prominent strategy. This created significant pent-up demand and now that a real recovery is happening, the industry is playing catch-up.
The heavy-duty truck and trailer market is a good example of the impact the Great Recession had on industrial manufacturing in the United States.  The trucking industry was walloped during the downturn.  After the smoke cleared, the recovery was slow and measured.  Industry was overly cautious and risk averse, not knowing if the economy would plunge into another recession.  This created the pent-up demand and when a real recovery started, many businesses were not prepared for it.

What is happening in the trucking industry also shows that the economy is functioning far from normally.  The numbers that the industry typically relies on are now very skewed due to unusual market factors.  In the general economy, the some of the usually reliable economic indicators are still broken.

Now the economy is playing catch-up and this is leading to a boom cycle.  Unfortunately boom cycles are often followed by busts.  This means that by being too cautious at the beginning of the recovery cycle, we may have created bigger problems at the end of it.

Tuesday, December 9, 2014

What Is Really Driving This Economy?

Since the Great Recession officially ended in mid-2009, there have been many questions about the speed, strength, and consistency of the economic recovery. Such as:

-        Why has the recovery been so slow?
-        Why has the recovery been so weak?
-        Why doesn’t it look like previous recoveries?
-        How can the economy recover if housing and consumer spending remain weak?
-        Is this even really an economic recovery?

Economists have debated and analyzed these issues over the past five years, but now there may be an answer. A growing number of experts now believe that this is an “industrial-based” economic recovery the likes of which we have not seen in over 50 years.

Transportation industry analyst Donald Broughton of Avondale Partners said in a recent interview, “We are all confused because we are witnessing the first industrial led recovery in the U.S. since 1961.” He added that, unfortunately, no one is still around who remembers what that recovery was like.

I agree with this line of thinking. At FTR (Freight Transportation Research), our data has indicated the industrial, freight-generating, portion of the economy has been out-performing the other sectors for almost two years. We recognized this was an odd occurrence and couldn’t offer a logical explanation. We didn’t think this situation would last very long and expected the industrial sector to weaken at some point. It really hasn’t, although our 2015 forecast is for the industrial sector to slow down a little while the consumer sector picks up. Mix it together and you get a much more balanced economy growing at a more typical 3% rate.

Does this mean things have returned to normal? Possibly, but if so, there is still much damage from the
Great Recession left over because we never had a Great Recovery to fix it. The labor markets are still broken, with the real unemployment rate too high, wages stagnant, and a low participation rate. The financial markets are still messed up. Credit availability is inconsistent, and society, especially the stock market, is hooked on 0% interest rates which have lasted oh so long and will be bitterly painful to let go of.

Many economists expected the housing market to lead us out of recession as it usually does. Analysts panicked when housing sputtered. This caused some people to erroneously claim that no recovery was taking place. The housing bubble burst so violently that it will take a few more years before the market returns to “normal.” Or course normal would be the early ‘90s before easier mortgages began inflating the bubble.

No, this recovery could not wait for housing to lead, so heavy industry took the lead. This is the reason freight growth has been so steady and one reason new orders for Class 8 trucks and trailers have been so high.

We can see how this plays out in the real world, by examining the flatbed (platform) trailer market. Flatbed trailers are usually the last segment to recover after a recession. Trucking fleets tend to run these trailers for more miles at the start of a recovery and delay replacing them. This creates pent-up demand and, at some point, flatbed trailer demand becomes very strong. However, flatbed trailers carry most of the materials involved in house construction, so traditionally the housing market is a significant river of flatbed trailer demand.

With housing expected to be slow in 2014, my initial Flatbed Trailer forecast was for no growth this year. The current forecast has 2014 growth coming in at 10%, and this was after a very slow Q1 due to the bad weather. How is this possible with housing starts still sluggish? Because flatbeds carry products connected to the industrial sector, and this industrial sector is running strong and leading this recovery. Can you imagine what would be happening if housing was growing at a faster clip? GDP growth could be at 5%, flatbed trailer production would be up 20%, and it would be the big, snap-back
recovery that we were told to hope for, but never materialized.

The industrial sector was so strong that flatbed freight was the strongest freight segment for most of this year. However, flatbed freight growth peaked in the summer and has dipped noticeably since then. This is not a good sign for an economy being driven by industrial markets. Is this the canary in the economic coal mine? Too soon to tell, but we need to watch this bird carefully.

This post first appeared on the FTR website.  FTR is the leader in analyzing and forecasting the commercial transportation industry.  For more information on FTR reports and services, please click here.)

Wednesday, November 12, 2014

The Humpty Dumpty Housing Market

Almost all of the recent reports on the housing market have been disappointing:

-             Price gains are slowing, signally a slower market. Some price indices are now under 6% year-over-year, the lowest growth since 2012.

-             New Home Sales continue to limp along. Sales year-to-date through September up only 2.4% year-over-year. (yawn)

-             Existing Home Sales (September) down 1.7% year-over-year, with inventory basically flat for the past 18 months.

-             Housing Starts (September) still a boring 1.017 million (Seasonally adjusted annual rate), with building permits very close to that level, up 2.5% year-over-year (more yawning).  The latest 2015 forecasts are only in the 1.16 million range.

-             Mortgage applications down 6.6% in a recent week (Mortgage Bankers Association), to the lowest level since February.

-             The Housing Vacancy Report from the Census Bureau calculates the Home Ownership Rate at 65.2%, the lowest since the 1960’s.

-             The National Association of Home Builder Index is at 54, still in positive territory but down five points from the previous month.

It is no surprise that housing has hit another soft spot.  This economic recovery has featured a series of false starts that has confused economists and frustrated politicians. Most industries, including trucking and truck equipment, have already experienced this pattern.  The housing industry, falling the most and hitting the bottom last, is subsequently the last industry to recover.  Its growth has been painstakingly slow.

Due to the severity of the real estate crash it will take years for the market to function normally. Right now the market is very dysfunctional because:

Buyers Don’t Want To Buy

-          The Emotional Reasons

There is still fear left over from the Great Recession.  The massive layoffs meant either your job got wacked or you know somebody whose job got wacked.  People without houses would rather rent than take on risk or debt.  People with houses are not really interested in trading up to more expensive dwellings for the same reason. People are not moving long distances to take new jobs (and buy new homes) as they did in the past.  People are still fearful of taking on more risk.

-          The Logical Reasons

There is just not as much money available to spend on housing.  Many people are making less money than before the Great Recession.  If they lost their home, they don’t have enough money yet to buy another one.  For many others, wages are stagnant which doesn’t encourage first-time buyers and doesn’t promote trading up. And finally there are the Millennials who should be starting households, in of course houses, but are straddled with high student loan debt, low-wage jobs or a no-wage existence.

-             The Cultural Reasons

The Millennials are cohabitating in record numbers.  While this may qualify statistically as a household, it does not immediately involve a long-term commitment.  Because buying a house usually comes with a long-term commitment, known as a mortgage, cohabiters are much more likely to rent than buy.

To Baby Boomers, owning a house was a central part of the “American Dream”. Buying a house was an expected part of your lifestyle and the size of your house a visual representation of your success. This idea has become less prevalent for each successive generation and home ownership is much less important to Millennials.

Sellers Don’t Want To Sell

-             Prices are still depressed. Many homeowners are still underwater, but this condition has improved significantly this year.

-             There are risk factors in making a change and there is limited trading up activity as mentioned previously.

-             People are not relocating much for new jobs.

Bankers Don’t Want To Lend

-             Interest rates may be low, but requirements and standards remain inflated.  If you qualify, you can eventually get a loan, but the process is reported to be onerous, frustrating and lengthy.

Putting It Back Together 

When a bubble bursts it is messy.  As messy as a huge egg falling off a wall.  So call this the Humpty
Dumpty housing market.  It must be put back together again, but oh was a difficult job that is.  Much too difficult for the King’s horses and men.  Getting this market back to “normal” is going to take a long, long, time.

This post first appeared (slightly different version) on the FTR website.  FTR is the leader in analyzing and forecasting the commercial transportation industry.  For more information on FTR reports and services, please click here.)

Tuesday, October 21, 2014

Get Ready For The Return of $3 Diesel (and $2.60 gas)

How low can you go .......?

After several years of stability there is now a major shake up to fuel prices. Crude oil prices are falling like a rock. Currently at $86/Barrel (or down a $1 since I started gathering notes for this post, which means I have to type faster. Original posted 10/15)  This is down from the June average of $105.

The main reason for the drop is falling world demand.  The economies of Germany, China, Japan and Brazil are all experiencing weakness.  The U.S. would seem to be the only economic superpower with any momentum. 

Another big factor is the increase in U.S. crude production.  While natural gas gets all the headlines, fracking has also freed up vast reserves of crude oil.  So you have conditions of decreased demand and increased supply, leading to a large oversupply of oil.  I don’t have to draw you a graph on this one.

The forecasts are for crude to drop to $76/Barrel.  At that point you will see $3/gallon diesel coming soon to a truck stop near you.  This would further pump up the trucking industry and be a positive for carriers and shippers alike. (Industry people claim fuel surcharges don’t recoup all the additional costs)

Gasoline costs have already dipped below $3 in many parts of the country. $76 crude would result in pump prices around $2.60.  This is a big deal because gas prices act like a tax on consumer spending. Cullen Roche of Pragmatic Capitalism estimates that for every $10 change in crude prices, consumer spending is impacted by $25 billion.  So a drop from $105 to $76 would infuse billions of dollars ($70 billion annual rate) into the economy right before the holidays.  Merry Christmas indeed.

And don’t give any credence to those articles claiming that lower crude prices are “not always a good thing”.  Yes there are some negatives, but $70 billion additional spending annually is a great thing, period. 

$3/gallon diesel prices would negatively impact the conversion to natural-gas powered vehicles (NGPV).  Sales of NGPV Class 8 trucks had slowed this summer due to the new higher efficiency diesel engines elongating the payback period of NGPV. And this was at $4/gallon diesel.  At $3, who is going to buy one?  Who knows what other industries will be impacted by lower crude prices?  This turn of events may have even fracked up the natural gas market in the short-term.

Crude is how low?!!!!!!!
More importantly, crude prices may not stop at $76/barrel. Reportedly, Saudi Arabia is running around slashing prices to customers like a used car salesman.  Iran and Iraq are also doing the same thing while maintaining production levels.  This is not the Arab Spring, but the Arab Spring-A-Leak.  This could result in the end of OPEC as we know it. 

It was assumed that OPEC’s ability to control prices would diminish over time as U.S. and other countries increased production, but like other world events, it could happen much sooner than expected.  

What is the free market price of a barrel of crude? No one knows because it has been a long time since the market was “free”.  How low can it go? Well, we may get a chance to find out and the price may be ludicrous.

This post first appeared (slightly different version) on the FTR website.  FTR is the leader in analyzing and forecasting the commercial transportation industry.  For more information on FTR reports and services, please click here.)

Tuesday, October 7, 2014

Confidence In The Economy Is Gaining Steam

The Great Recession produced great fear, and this fear generated economic anxiety that has persisted long after the recession ended.  It has taken years for the trauma to fade, but now in the trucking industry confidence is overcoming the anxiety.

The Reasons for This Confidence:

·       The economy is not falling back into recession
·       The economy continues to grow
·       Freight is growing at a steady pace
·       Fleet profits are growing due to freight growth and a manageable cost environment
·       Reduced uncertainty, which includes knowing the impact of Hours-of-Service regulations and the better than expected performance of the new engines.

The increase in confidence in the trucking industry began last December, and it appears this confidence is starting to spread to the general economy as recent GDP forecasts are improving.

Let’s look at what the latest numbers on economic confidence are telling us:

The Conference Board Consumer Confidence Index

Down to 86 from 93.4 in August - this index was at around 110 before the recession and fell to below 30 in 2009.

This index fell significantly after rising four straight months.  This is probably due to geopolitical tensions including the resumption of military action in Iraq. However, part of the decrease is attributed to a perceived mild softening of the job market.

Thomson Reuters/Univ. Michigan Consumer Sentiment Index

Up to 84.6 from 82.5 in August vs. 77.5 in September 2013 – this index peaked at 98 before the recession and bottomed out below 60.

This index rose based on positive outlooks for the economy and expected growth in personal income.  Consumers anticipate modest job growth in the next year.

Bloomberg Consumer Comfort Index

Down to 35.5 from 37.2 last week, but up over 2% from last year. This index was around 50 before the recession and bottomed out at 21. 

This index fell to its lowest point since early June.  It is attributed to “negative views of the national economy,” and that sub-index fell to its lowest point since May.  Since most economic news of late has been positive, it can be assumed the decline was caused by factors in the Middle East. The personal finances and buying climate sub-indexes held up better.

Moody’s Analytics –Survey of Business Confidence (World)
Down to 34.4 from 35.5 last week

This survey found business confidence is very strong in the U.S., near record highs.  There is strong confidence across all industries, especially in real estate and manufacturing.  Expected employment gains in this survey have never been stronger.

The Conference Board Measure of CEO Confidence

Q2 – Down to 62 from 63 (Readings above 50 points reflect positive attitudes.)

CEOs remain positive in their outlook for 2014; however, the strength of their confidence is starting to level off.  A large majority of respondents expect higher profits this year.

National Federation of Independent Business Optimism Index

August index at 96.1 from 95.7, the second highest reading since October 2007.

Small business owners are remaining cautious.  Hiring plans have flattened out, and they do not expect sales to increase much the rest of the year.  They are also not expecting to increase capital spending or increase inventories substantially.

What It Means

Consumers continue to feel better about economic conditions.  You can see the impact of the recent military actions on the data.  It can be assumed the Reuters/ U Michigan data was collected before the other two indexes and was not influenced by the geopolitical news.  This means the October readings should be more positive.  In general, growing consumer confidence translates into future retail sales.  Therefore, we can expect the consumer segment of the economy to remain healthy.
Rail freight is also very strong right now!

The business sector also looks to be in good shape.  Spending and hiring should continue to improve.  Because pullbacks in this sector are often the first signs of recession, there is little chance of a significant dip in the next 12 months.    

However, it is interesting to note that small businesses are much more cautious and less optimistic than big businesses.  This is consistent with what we have seen in the commercial vehicle markets.  The large fleets started buying early and more aggressively.  Then the medium-sized fleets joined the party, and finally, the smaller fleets are buying more trucks and trailers.  Likewise, the medium-duty trucks, which are used primarily by small business, are still not seeing the sales increases you would expect in this economic recovery.

This post first appeared (slightly different version) on the FTR website.  FTR is the leader in analyzing and forecasting the commercial transportation industry.  For more information on FTR reports and services, please click here.)

Friday, September 5, 2014

The Economy Could Use A Visit From Dr. Phil

A realtor friend told me the current housing market in Stark County (Canton, OH) is very frustrating for him.  He has many interested buyers, but there are not enough attractive homes for sale to meet this need.

Under normal conditions, this would be considered a “sellers” market because demand exceeds supply.  However, there is not enough selling going on because people are still reluctant to sell their houses.  The perceived value of the properties is still low, and people do not want to sell at a loss.  Under these conditions prices should be rising, but that means sellers would have to have the confidence to list their homes at higher prices.

I don’t believe that is happening yet.  Two homes in my neighborhood recently sold very soon after going on the market.  I doubt if either one were priced nearly high enough based on market conditions (please ignore my bias).

Economists would call this an “inefficient market,” but I call it a “dysfunctional market.”  People coming out of the Great Recession were filled with fear.  Some of this fear was rational and some was irrational.  Some of it quickly faded and some of it stuck around.

And this irrational fear which endures is messing up the housing market and the economy.  People keep asking whether the current economic conditions are the “new normal.”  I would contend that it is the “new abnormal” which will exist until the fear of the Great Recession is past and “normal” levels of rationality returns. 

This could take a while in housing.  Inventories of existing homes are at 2.3 million.  This is up 6.5% y/y, but 35% below where it should be, and still 43% below peak.  Housing prices are also rising, up nearly 8% y/y (Truvia) in July, but pricing growth has slowed recently.  Things are moving in the right direction, but at an excruciating slow pace.

Could be what the economy needs!
This market dysfunctionality has to be present in other industries as well.  Where fear is greater than confidence things are growing, but not as fast as they should.  When you add it all up, you get an economy moving forward at a very cautious pace and careful to jump back at the slightest scare.  Maybe the economy doesn’t need more economists telling it what to do; maybe it needs a visit from Dr. Phil!

Fortunately the trucking industry seems to have shed its fear and regained its confidence.  The Class 8 truck orders and commercial trailer orders started to surge in December and haven’t really backed off when you factor in seasonality.  The 29,500 preliminary Class 8 orders in July were the second highest total for that month ever.  June trailer orders were up a solid 35% y/y. There are other factors driving the market, but I do believe “buyer confidence” remains a significant influence.  

Because people talk and interact much in the trucking industry, this confidence can become contagious and provide strong market momentum.  Growing confidence and scarcity of open build slots may have been a big driver for the huge order volume in July.  It will be interesting to see how orders placed now are converted into shipments going into 2015.

Because the trucking industry can lead the general economy, it will also be interesting to see if other industries can break out of their funk and start growing strong again in 2015.  If this happens, GDP could exceed the forecast (2.9%) next year.

This post first appeared (slightly different version) on the FTR website.  FTR is the leader in analyzing and forecasting the commercial transportation industry.  For more information on FTR reports and services, please click here.)