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Is Low-Cost Energy the New Cheap Labor?

The energy revolution is causing a tectonic shift in where companies choose to locate.

Jonathan M. Berger | ICF International

Jonathan M. Berger

Jonathan M. Berger

We are entering a new economic cycle; call it  Globalization 2.0.

For the past two decades, the driving force behind globalization was the gap in the price of labor between the developed world and emerging markets.

Several events further enabled this labor cost movement: the end of the Cold War, emergence of the Internet, proliferation of free trade agreements such as NAFTA, advanced global communication systems and China’s economic boom.

These shifts prompted many industries to move both manufacturing and aftermarket services to low-cost labor regions.

However, in the latest economic world order, the cost of energy is the main motivator in companies’ location decisions.

This shift is on full display in the United States, where the development of breakthrough technologies such as horizontal drilling and hydraulic fracturing ( fracking) and a combination of risk-taking and private sector investment is spurring an undeniable energy revolution.

As with Globalization 1.0, the 2.0 version brings into play numerous other factors, including state and local tax incentives.

The global financial and geopolitical ramifications of America’s energy revolution cannot be overstated.

While the United States isn’t immune to an oil shock courtesy of continued unrest in the Middle East, it is far better prepared for the effects of a disruption than at any other time in the past few decades.

[Also on Longitudes: Rebooting Globalization]

Traditional labor advantages eroding

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In the latest economic world order, the cost of energy is the main motivator in companies’ location decisions.

The outcome of Globalization 1.0 was the strategic dismantling of traditional supply chain structures for many large corporations. As Globalization 1.0 played out over the past two decades, labor-intensive jobs were outsourced to the low-cost provider and specific aviation and aerospace industry clusters developed.

For example, India specialized in software testing and development, Russia in design engineering and Mexico in manufacturing.  China created its own aircraft OEM (COMAC) to compete with the mighty Boeing and Airbus duopoly.

For the last 15 years, my consulting firm, ICF International, has closely monitored aerospace industry investments. Clearly, if one follows the money trail, Globalization 1.0 was a boon for emerging market economies.

The comparative labor advantage leveraged so effectively by Brazil, Russia and India, among other nations employing similar strategies, has been slowly eroding. Moreover, commercial aircraft maintenance labor rates in the U.S. and Asia continue to converge.

Compounding this impact, productivity continues to grow rapidly in the developed world as companies deploy new automation, robotics and additive manufacturing technologies.

This loss of competitive advantage has significantly changed the calculus for how and where capital is being deployed.

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No one knows how long energy costs will remain low – the potential for further over-supply of oil and gas is real.

In fact, the U.S. now enjoys a significant energy cost advantage over its two historic manufacturing competitors – Germany and Japan. Historically, U.S. natural gas prices have tended to be lower than in Germany and Japan, but the difference has exploded in favor of the U.S. over the past few years.

Now it’s roughly 40 percent less in the United States than in Germany, and American prices are one-fourth of those in Japan.

Not surprisingly, investments for energy-intensive products are migrating to the U.S. Natural gas will provide not only the energy, but also the chemical raw materials.

For example, the Austrian steel company Voestalpine is building a $600 million facility in Texas, where it uses natural gas to power its huge furnaces. Late last year, aerospace aluminum giant Alcoa opened the world’s largest aluminum-lithium plant in Lafayette, Ind.

Meanwhile, the southeastern U.S. has emerged as a magnet for aviation-related investments. The big three aircraft manufacturers have opened major final assembly facilities in Charleston (Boeing), Mobile (Airbus) and Florida (Embraer).

As ICF International research indicates, the U.S. is clearly the current location of choice for aviation and aerospace capital deployment.

[Also on Longitudes: Powering the Next Energy Revolution]

The new winners

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Perhaps cheap energy really is the new cheap labor.

Energy-intensive businesses such as aviation, petro-chemical, aluminum and steel are already reaping the benefits. One reason: the fuel bill for an airline is typically in the range of 30 percent to 40 percent of total costs.

It’s not only aircraft operators that are experiencing record profits. Thanks to low interest rates and the staggering demand growth for air travel in emerging markets, aircraft OEM order books are at all-time highs.

This bodes well not only for the large airframe manufacturers, but also for the plethora of tier one and two aerostructure, engine, systems and component suppliers.

As for geopolitics, those nations whose economies are dependent on high energy prices will suffer the most. Should oil and gas prices remain depressed, expect to see further strife in countries such as Russia and Venezuela.

No one knows how long energy costs will remain low – the potential for further over-supply of oil and gas is real.

This bodeswell for the commercial aviation sector, whose business plans assume oil prices at approximately $100 per barrel. And for any energy-intensive business looking for the ideal location to set up shop, the U.S. is well positioned to be the primary beneficiary of Globalization 2.0.

Perhaps cheap energy really is the new cheap labor. goldbrown2

This article was first published in the May 2015 edition of AviTrader MRO e-magazine.

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Jonathan M. Berger is Vice President, Aerospace & MRO, at ICF International.

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