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Killing NAFTA Would Hurt the U.S. Economy and American Manufacturers

Several majors could make a play for Permian producer Endeavor Energy

IEA warns of oil supply lagging demand without significant investment

Permian producers prepared for dip in oil prices to last into 2019

Stocks Rocked the House Post Midterm Elections

Killing NAFTA Would Hurt the U.S. Economy and American Manufacturers

If President Donald Trump follows through on his promise to tear up the North American Free Trade Agreement (NAFTA), this could, counterintuitively, hurt U.S. manufacturers and trim billions of dollars a year from the world's biggest economy, according to S&P Global U.S. Economics.

Moreover, ending what the president has called "the worst trade deal" in U.S. history, as part of the administration's broader push toward de-globalization, could disrupt global supply chains and ultimately put pressure on the bottom lines--and thus the credit quality--of import-reliant firms in the U.S. (see "De-Globalization Could Disrupt U.S. Supply Chains," published May 30, 2017).


  • NAFTA has contributed several billion dollars to U.S. economic growth each year, with trade among the U.S., Canada, and Mexico having tripled since NAFTA was signed.
  • In our view, the end of NAFTA would hurt the U.S. manufacturing sector and the U.S. economy, as higher tariffs likely limit trade and investments. New tariffs would mean higher prices for consumer goods, with lower-income households hurt the most. The lost sales at businesses would, in turn, discourage them from hiring new workers and could even lead to layoffs.
  • Without the help from streamlined supply chains, S&P Global believes that more U.S. business would have been lost to competition abroad. Severed supply chains mean diminished production efficiency, higher costs, and, ultimately, lost competition--and less need to hire workers
  • U.S. manufacturing production is near all-time highs, but the sector lost jobs in recent decades, largely because of automation rather than trade. So, even if factories returned to the U.S. with the end of NAFTA, any jobs created will more likely be for robots, not human workers.

It's difficult to isolate the direct effects NAFTA has had on trade and investment from other factors, such as rapid improvements in technology and automation. Indeed, as an April 2015 Congressional Research Service study of the deal noted: NAFTA "may have accelerated the trade liberalization that was already taking place, but many of these changes may have taken place with or without an agreement." What is indisputable, however, is that trade among the U.S., Canada, and Mexico has tripled since the agreement was signed, to over $1.1 trillion in 2016 from just $290 billion in 1993. Cross-border investments among the member countries also grew significantly, to $731.3 billion from $126.8 billion in 1993 (see chart 1). The elimination of many costly tariffs and other trade barriers, particularly with Mexico (Canada was already in a free trade agreement with the U.S.), helps explain why trade between regional partners blossomed.

Source: Congressional Research Service, May 24, 2017; OECD, "Trade in Employment (domestic labor inputs sustained by foreign final demand," September 2016; Wilson Center, "Working Together: Economic Ties between the United States and Mexico, November 2011.

S&P Global agrees with most estimates concluding that NAFTA has had a modest but positive affect on U.S. GDP, adding several billion dollars to economic growth each year. Granted, that represents a drop in the bucket for the $18 trillion U.S. economy but it runs counter to the idea that the deal has been, in a word, a "disaster." Moreover, without the help from streamlined supply chains, S&P Global believes that more U.S. business would have been lost to competition abroad.

The Myth Of Manufacturing's Return

While critics claim that overseas products are squeezing out domestic goods, U.S. manufacturing conditions are, in general, better than they were in the lackluster years leading up to the implementation of NAFTA, when the sector's annualized pace of production slowed. Since the agreement was signed into law on Dec. 8, 1993, manufacturing production picked up dramatically with the Great Recession temporarily slowing, but not ending, what has been a mini-renaissance of sorts.

But in contrast to claims that the sector is in freefall, U.S. manufacturing production overall is near all-time highs. Although the Great Recession brought about a sharp decline in manufacturing production and significant job losses, the country's manufacturing remains on a long-term growth path (in inflation-adjusted dollars). In fact, from 2010-2016, U.S. manufacturing output grew 14%, or roughly 2.3% annually in line with the economy as a whole, which expanded 12%, or 2.1% a year, during that period.

This is not to say that American manufacturers haven't suffered. The sector has lost more than one-third of its jobs, falling to about 12 million today from the peak of 19.6 million in June 1979. Manufacturing jobs, which accounted for 24% of total jobs in 1974, now represent only 8.5% with certain industries faring far worse than others. Hit the hardest from competition abroad was the U.S. apparel industry, which shed 85% of its jobs from 1991-2016, as employment at textile mills tumbled 76%, according to the Bureau of Labor Statistics. So it's no surprise that many Americans see the appeal of tighter trade policies that would help shore up certain industries, primarily through taxes and tariffs that would make imports more expensive.

The problem with this view is that the number of job losses directly caused by cheap imported goods represents a small fraction of the normal churn in the U.S. labor market. According to a January 2016 research paper by Daron Acemonglu, David H. Autor, David Dorn, Gordon H. Hanson, and Brendan Price, and published in the Journal of Labor Economics, imports (such as apparel) from China displaced as many as 985,000 workers in U.S. manufacturing industries from 1999-2011. But S&P Global U.S. Economics notes that, while the loss of nearly 1 million manufacturing jobs in a dozen years is significant, there are about 1.7 million layoffs the U.S. labor market every month under normal conditions in a jobs market that employs around 150 million people. Additionally, the U.S. economy has added 994,000 manufacturing jobs through September since the figure bottomed out at 11.5 million in early 2010 (see "Automation Marches On: Do Jobs Need To Be Collateral Damage?," published June 7, 2017). China's growing trade strength against U.S. producers gave the U.S. more reason to align with its regional partners in order to keep its competitive edge. Indeed, losing its comparative advantage in a global market may have meant more lost jobs as China's manufacturing power gained strength.

Lost manufacturing jobs are likely more the result of technological updates than trade. Indeed, "The Myth and the Reality of Manufacturing in America" June 2015 study by the Center for Business and Economic Research at Ball State University found that technological change rather than trade was responsible for 85% of that total. It noted that this should be viewed as an example of the impact of productivity growth, not actual lost jobs from productivity.

Overall, it's hard to deny that manufacturers are producing more with fewer people thanks to the help of Mr. Robot. That helps explain why Deloitte found in its 2016 Global Manufacturing Competitiveness Index that U.S. manufacturing is now the second-most competitive in the world, behind China. But not for long. Deloitte expects U.S. manufacturing to surpass China by the end of the decade, largely thanks to increased productivity from advanced technologies.

To A Large Degree, "Hecho En Mexico" Means "Made In America"

In a further sign that blaming trade for sweeping job losses is misguided, consider that many items with tags saying they're made elsewhere include a significant amount of stuff made in the good ol' U.S. of A. In fact, for every dollar spent on Mexican imports, 40 cents goes toward services or products provided or made in America, according to a November 2011 Wilson Center report, with the U.S. exporting twice as much money to Mexico as to China. That figure is a still-significant 25 cents for Canadian products and highlights the unbreakable links between the U.S. economy and those of our neighbors.

Higher prices on imports from Mexico and Canada could crimp U.S. consumer demand, hurting businesses' revenues and resulting in less need to hire workers particularly in low-skilled jobs. Severed supply chains mean diminished production efficiency, higher costs, and, ultimately, lost competition and, again, less need to hire workers. According to a 2017 ImpactEcon report "Reversing NAFTA: A Supply Chain Perspective," the tearing up of NAFTA could lead to the U.S. losing more than 250,000 low-skilled jobs over three to five years. (Mexico would fare far worse, reportedly, losing almost 1 million low-skilled jobs in the same time frame.) Assuming skilled U.S. workers are exposed to a NAFTA withdrawal, the U.S. may loss an additional million jobs.

As trade representatives from the three member countries continue their efforts to rewrite NAFTA, it's worth remembering that American jobs were already heading out the door, or sailing across the oceans, to China and other cheap-labor regions. In fact, NAFTA may have helped keep some jobs in place and may even be responsible for creating employment as the U.S. continued its decades-long march toward being a services-heavy economy, rather than a goods-producing one.

While dismantling NAFTA might protect some jobs in certain segments of the U.S. labor force, other Americans would feel the pain. Many of the millions of jobs that benefit from free trade would be in jeopardy forcing people who transport, stock, and sell these products on U.S. soil to look for other work. The Organization for Economic Cooperation and Development found that 2.8 million U.S. jobs that involve storing or shipping final goods could be lost if NAFTA is unwound. The U.S. Chamber of Commerce said that trade with Canada and Mexico supports nearly 14 million U.S. jobs. They found that nearly 5 million of these net jobs are supported by the increase in trade generated by NAFTA, which would be threatened if NAFTA is reversed. And American consumers would see higher prices at stores, with low-income households suffering the most. In short, it's difficult to see the economic benefits of increasing prices on Mexican and Canadian imports for 45 million low-income Americans (as well as everyone else) in an effort to save just some of the jobs in an industry that accounts for roughly 85 of every 1,000 full-time jobs in the U.S. labor force.

All of this assumes that the unwinding proceeds without any retaliation, and that all actors abide by World Trade Organization rules on tariffs. Either way, it seems clear the U.S. would have continued to bleed manufacturing jobs, even if NAFTA had never succeeded. And succeed for the U.S. economy it has, in our view.

Writer: Joe Maguire

Several majors could make a play for Permian producer Endeavor Energy

Oil majors Exxon Mobil Corp., Chevron Corp., Royal Dutch Shell PLC and ConocoPhillips are all considering making first-round bids for Texas-based oil producer Endeavor Energy Resources LP.

Including debt, Endeavor, which holds more than 300,000 acres in the prolific Permian Basin, could be valued at $12 billion to $15 billion. Core acres are located in Martin, Midland, Upton, Glasscock, Reagan and Howard counties. The company's net production in the second quarter was 64,000 barrels of oil equivalent per day, 75% of which was oil.

Many of the majors have highlighted their renewed interest in the U.S. shale plays. Having announced plans earlier this year to triple its Permian oil production to 600,000 barrels per day by 2025, Exxon is viewed by many as the most logical would-be buyer of Endeavor. Back in 2014, Exxon inked a seven-year deal with the producer to expand its presence in the basin.

Exxon's third-quarter shale oil output from the Permian was up 57% on the year due to the ramp-up to the current 38 rigs in the Midland and Delaware basins. The company's third-quarter Permian production increased 170,000 boe/d, or 11%, on the quarter.

While Chevron could be a contender, the company already has a sizeable position in the Permian, analysts said. "Chevron is another possibility although we think its existing position of 1.7 [million] acres (0.5 million Midland and 1.2 million Delaware) is likely adequate, with the focus likely to be more on acreage swaps and trades to core up its position," RBC analyst Biraj Borkhataria wrote in a Nov. 13 note.

Analysts said ConocoPhillips and Shell are less likely to emerge as bidders.

"Despite the company's positive disposition to the play, we would not expect Shell to bid for such a large package given the company has been clear that inorganic activity is included within its $25 [billion] to $30 [billion] capex framework per annum, meaning limited headroom to execute such a large deal," Borkhataria said.

Should a sale occur, it would follow a rash of Permian-based transactions, including Concho Resources Inc.'s purchase of RSP Permian for $8 billion and Diamondback Energy Inc.'s purchase of Energen Corp. for $9.2 billion. Additionally, on Oct. 31, BP PLC closed on its $10.5 billion acquisition of BHP Billiton Group's U.S. shale oil and natural gas assets.

In emailed requests for additional details on a sale, officials from Endeavor, Exxon, Shell and ConocoPhillips declined to comment. An inquiry to Chevron was not immediately returned.

Endeavor, which is family owned, agreed to explore a sale after receiving inquiries from prospective bidders, although the family reportedly would prefer an IPO next year so it could retain control. JP Morgan Chase & Co. and Goldman Sachs Group Inc. were reportedly selected to arrange the possible transaction.

IEA warns of oil supply lagging demand without significant investment

The International Energy Agency warned in its World Energy Outlook 2018, released Nov. 13, that without sufficient oil production investment, the world faces a possible oil supply gap during the early 2020s.

"Oil and natural gas will be part of the energy system for decades to come — even under ambitious efforts to reduce greenhouse gas emissions in line with the Paris Agreement," the report said.

Under existing and planned policies included in the report's new policies scenario, trucking and aviation demand will drive global oil consumption to 102.4 million barrels per day by 2025. Meanwhile, the IEA projects currently producing oil fields will supply just 68.0 MMbbl/d.

"The level of conventional crude oil resources approved for development in recent years … is only half of the level needed to meet demand growth in the [new policies scenario]," the report said.

"If these approvals do not pick up sharply from today's levels, U.S. tight oil production would need to triple from today's level to over 15 [million barrels per day] by 2025 to satisfy demand," the report said. "With a sufficiently large resource base, this could be possible. But it would require levels of capital investment that would far surpass the previous peaks in 2014."

Among trends to 2040, the IEA outlined a "major shift in the geography of oil demand."

According to the report, developing economies will see oil demand grow by 18 MMbbl/d from 2017 to 2040, offsetting a demand decline of 10 MMbbl/d in developing economies.

The IEA projects global oil demand from trucking will grow by 3.9 MMbbl/d, while global oil demand from petrochemicals grows by 4.8 MMbbl/d.

At the same time, the IEA expects oil use in cars will peak in the mid-2020s. It projects approximately 300 million cars on the road by 2040 will avoid 3.3 MMbbl/d of oil demand that year, while efficiency improvements in nonelectric cars will avoid more than 9 MMbbl/d of oil demand in 2040.

The IEA projects automotive demand for oil will decline by 5 MMbbl/d from 2017 to 2040 in advanced economies, offsetting demand growth of 5.4 MMbbl/d in developing economies.

Permian producers prepared for dip in oil prices to last into 2019

Mindful of the lessons learned during the 2014-2016 oil and gas price collapse, large independent producers in the Permian Basin are shielded from the current U.S. oil price slide, thanks to conservative budgeting, new access to Brent crude pricing at the Houston Ship Channel and greater efficiency.

The price of West Texas Intermediate crude oil bounced back above $60 per barrel on the morning of Nov. 12, a slight improvement over the end of the previous week but still well below the $76.40/bbl reached in early October. If prices remain near $60/bbl, that will be more than enough for most producers to see healthy returns, as many have budgeted for prices at $50/bbl or below. Even though prices spiked more than $20/bbl above anticipated levels for several months, Permian producers largely made only slight increases to budgets as they looked to the long term.

"The industry has been conservative in oil price assumptions," Williams Capital Group LP analyst Gabriele Sorbara said. "I would say a majority of 2018/2019 budgets are contemplated on $50-$60/bbl WTI."

EOG Resources Inc., one of the largest producers in the region, assembled a capital budget for 2018 assuming oil prices at $40/bbl and gas prices at $2.50/Mcf, and the company intends to take a similar approach in 2019.

"We're not going to increase capital at the expense of efficiencies and returns. We will develop our assets and spend capital at a pace that will optimize our learning curve and allow sustainable improvement to our well productivity and cost structure," EOG CEO William Thomas said. "Any production growth is strictly the result of disciplined capital allocation to high-return assets. … We are continuously resetting the company to deliver strong returns, even in a low to moderate oil price environment."

When capital budgets for 2018 were assembled, most Permian producers assumed that WTI would hover around the $50/bbl level for much of the year. Even though they recognized far more revenue during the second and third quarters than initially anticipated, they seem content to stay the course at similar levels for 2019.

"What matters for companies is the long-term expectation," said Raymond James & Associates analyst Pavel Molchanov, who anticipates that most companies will continue to build budgets based on prices near $50/bbl. "The futures pricing for 2019 is pretty close to what it was a year ago."

Unlike the situation facing Permian producers during much of the price collapse, many independents have a new advantage, in spite of pipeline constraints: exports to Europe and Asia through the Houston Ship Channel. The exposure to offshore markets and Brent crude prices has allowed them to increase their revenues, as Brent crude was trading at more than $71/bbl on Nov. 12.

Pioneer Natural Resources Co. CEO Timothy Dove said during the third-quarter earnings call that his company would stick to its $3.4 billion budget for 2018 and is likely to take a similar course in 2019. But Dove said Pioneer is now able to avoid the consequences of a WTI price drop due to large amounts of its Permian crude being exported.

"We are now essentially a Brent-priced company if you talk about our oil sales," he said.

Another lesson learned from the price collapse was a continued push for efficiency, with producers using new technologies and methods to cut costs while increasing production. During Anadarko Petroleum Corp.'s third-quarter earnings call, executives said the company's more efficient operations would allow it to recognize "double-digit" production growth while maintaining a budget anticipating $50/bbl prices.

Apache Corp., which is increasing its Permian operations with the development of the Alpine High play, said it would operate in 2019 with a capital budget of $3 billion, lower than in 2018. "If changes in expected cash flow dictate, we have the flexibility to reduce our activity levels accordingly," CEO John Christmann said. The move by Apache and other producers to follow long-term price expectations and not become overly exuberant over higher prices earlier this year may have allowed companies to hold steady heading into 2019.

"Capital spending should be either stable from what it is this year or modestly higher, but no one should expect cuts in capital spending from recent levels because this year's capital programs always lagged behind the uplift we saw in prices we saw in the summer months," Molchanov said.

Stocks Rocked the House Post Midterm Elections

After the S&P 500 logged its 9th worst Oct. on record, losing 6.9%, it has bounced back 2.6% month-to-date through Nov. 9, 2018. Though the monthly returns for the eight Novembers following the historically bad Octobers were only positive twice – in 1978 (President Jimmy Carter midterm year) and 1933 – the fact there was a midterm election this year may help the chance of a solid rally if history repeats itself. Historically, the S&P 500 has been positive in most periods after the midterm elections.

In the months of Nov. and Dec. during historical midterm election years, the S&P 500 gained 14 of 22 times in Nov. and in 15 of 22 times in Dec. with a combined 2-month gain in 17 of the 22 midterm election year-ends. In percentage terms, the S&P 500 gained in 64% of midterm election Nov. months and 68% of the following month that when combined into a 2-month return resulted in gains 77% of the time. Also, the magnitude of the average gains in the 2-month period was 6.1%, more than the magnitude of the average loss of 4.1%.