News: Analysis & Commentary: Energy
Trying to Break the Energy Choke Hold
Companies are taking drastic steps as soaring costs savage one industry after another
Winter is normally a busy time for fertilizer producers as they gear up for spring planting. But not this year. As natural-gas prices have spiked as high as $10 per thousand cubic feet, quadruple year-ago levels, producers have had to shut down nearly half their capacity. No wonder: The raw material accounts for over 70% of the fertilizer's cost. "Many companies are not even covering their cash costs at these prices," says Betty-Ann L. Heggie, senior vice-president of Potash Corp. of Saskatchewan Inc., North America's No. 2 producer.
But fertilizer is only one sign of a spreading energy crisis. Soaring energy prices coupled with supply disruptions--especially in California--have become obstacles for every company. Sure, energy-intensive industries from airlines to steel have endured dramatically higher costs for over a year now. But the effects are now taking their pound of flesh from most other companies as well. The average corporate energy bill rose 20% in the year ended last November, according to the Bureau of Labor Statistics. "That has devastated some parts of manufacturing and slowed down capital investment in many others," says Jerry J. Jasinowski, president of the National Association of Manufacturers.
While companies are doing everything from dusting off conservation handbooks to closing plants, there's little relief in sight. While crude oil, at $25 a barrel, is down 29% from its Sept. 8 high, OPEC is set to cut production to ensure continued tight supply. "There is no reason for oil prices to weaken much in 2001," predicts Dave Costello, a forecaster with the Energy Information Administration. Similarly, while natural-gas prices will fall once winter ends, the EIA predicts prices will still average over $5 per thousand cubic feet this year--well over twice the 1999 level.
The rising energy costs have pummeled earnings throughout the economy. First Call Corp. now expects operating earnings for the Standard & Poor's 500-stock index--excluding energy companies--to fall 1.5% in the fourth quarter, vs. an increase of 21.3% a year ago. "Energy has been a big factor in that decline, accounting for several percentage points at least," says Charles L. Hill, First Call's director of research. Moreover, the Federal Reserve Board cited the problem of "high energy prices sapping household and business purchasing power" as a key reason for its half-point cut in interest rates on Jan. 3.WEST COAST FEVER. The pain is especially intense for energy-dependent manufacturers. Last year at chemical giant DuPont, soaring fuel prices pushed up its raw-material bill by $1.5 billion. In response, DuPont shifted its mix from commodity to more value-added products "while aggressively raising prices wherever we could," says Chief Financial Officer Gary Pfeiffer. Similarly, Nucor Corp., which makes steel by melting scrap in electric-arc furnaces, has seen its costs rise by $2 to $3 per ton. "In this business, you're fighting over nickels and dimes per ton," says Nucor CEO Daniel R. DiMicco.
Regionally, problems are most acute in California and the western states tied into its power grid. Take Chicago-based Smurfit-Stone Container Corp., the nation's largest maker of cardboard boxes. In December, as rocketing California prices inflated prices across the entire West, the cost for the electricity at its paper mill in Missoula, Mont., shot from $4 per megawatt-hour all the way up to $3,000. In response, Smurfit closed down most of the mill.
Within California, the uncertainty about electricity has combined with stunning spikes in the price of natural gas. The state's 850 textile mills, for example, are reeling from natural-gas bills that in some cases have quintupled. "Many industries are facing a one-two punch," says Jack Kyser, chief economist of the Los Angeles County Economic Development Corp. There are other penalties as well. Despite a reputation for conservation, Boeing Co.'s military-aircraft plant in Long Beach was fined several times in December for failing to cut consumption during statewide brown-outs. Given such problems, there's "not a chance" Intel Corp. will expand in Silicon Valley anytime soon, CEO Craig R. Barrett recently declared at the Consumer Electronics Show in Las Vegas.
Skyrocketing natural-gas bills are also hurting many small businesses around the nation. It's a "big problem," says William C. Niegsch Jr., CFO of Max & Erma's Restaurants Inc., a 59-location chain based in Columbus, Ohio. So far, Max & Erma's utility costs are running about $500,000 ahead of last year on an annual basis. That's a big hit for a chain that posted $124 million in revenues last year. In Ceredo, W.Va., Ken Futter, general manager of Pilgrim Glass Corp., a specialty glassmaker, extended Pilgrim's normal holiday shutdown by more than two weeks, until Jan. 22. Futter figures the move helped him avoid incurring a natural-gas bill of $103,000--more than what he paid in the entire fourth quarter of 1999. And in Chatham, Mass., fisherman John Pappalardo, 29, says he has been told his fuel prices may hit $2.25 a gallon, nearly equaling the peak of $2.40 they hit last summer. "If that happens, we'll have to tie up our boats," he says.
Of course, not every company is hurting. Take Jamcracker Inc., a Silicon Valley software outfit. CEO K.B. Chandrasekhar says "energy costs don't amount to more than a tiny slice" of his costs. Regardless, many more companies will be hurt as fuel-price increases eat into consumer demand. On Jan. 8, the Energy Information Administration predicted the average home heating oil bill will rise 40% this winter, while homes heated with natural gas will pay 70% more. These bills "are from another planet," warns Robert Barbera, chief economist at Hoenig & Co., who predicts they'll end up "hurting everything from cars and computers to entertainment."
For many of those who've felt the pinch, hedging initially insulated them from the worst of the price hikes. "In the near term, we have hedged over 75% of our natural-gas needs," says Stan Riemann, executive vice- president of Farmland Industries Inc., the nation's largest producer of nitrogen fertilizer. "But in long-lasting runups like this, there are limits to what you can do."
Nor does raising prices provide much of a solution. Many companies simply can't pull them off. "With demand already softening, it is hard for companies to pass higher costs on," says Tom Robinson, managing director of Cambridge Energy Research Associates. Demand isn't the only problem: Many U.S. manufacturers haven't been able to hike prices because they have to compete with rivals from Europe and Asia, where less-stringent environmental regs have let natural-gas prices stay lower.SHUNTED OFF. And even such companies as the airlines, truckers, FedEx Corp. and United Parcel Service Inc., and the major railroads that have imposed surcharges or hiked prices have seen their limits. Often, the hikes haven't been enough to keep up. Although Norfolk Southern Corp. imposed surcharges last May, for instance, the railroad recently said earnings would stall in the fourth quarter. It plans to push 870 workers into early retirement.
Instead, many companies are pursuing energy conservation with a renewed zeal. On Jan. 5, Home Depot Inc. unveiled a program in 80 stores in the Northwest that includes basics like turning down the thermostat. At its Long Beach plant, Boeing is now shutting off the air conditioning at 4 p.m. and asking workers to "do whatever else you can to help." And Wyndham International Inc. is spending $1.4 million to install energy-efficient lightbulbs in its 27,000 hotel rooms. That's expected to save $5 million over the next three years.
But until energy prices drop, executives aren't optimistic about relief. "I hope that something will improve the situation," says Pilgrim Glass's Futter. But he adds: "I haven't the vaguest idea of what that something may be." It's a stark contrast to just two years ago when a barrel of crude traded in the low teens and the price of natural gas was about one fifth of what it is today. Then, an energy crisis seemed to be a distant memory. This year, for every company, it's all too real.By William C. Symonds in Boston with Michael Arndt and Ann Therese Palmer in Chicago, Arlene Weintraub in Los Angeles, Stanley Holmes in Seattle, and Bureau ReportsReturn to top