“Industry Analysis” is the monthly examination of the developing trends that will influence the automotive aftermarket in the near and long term.

This month’s column is contributed by Prestige Economics LLC, an AASA affiliate member, to share its expertise on two drivers vital to aftermarket suppliers’ business: fuel prices and raw material costs. For forecast accuracy between 2009 and 2011, Prestige Economics has been ranked by Bloomberg News as the No. 1 Industrial Metals price forecaster in the world, the No. 2 precious metals forecaster, the No. 3 aluminum price forecaster, the No. 2 nickel price forecaster, the No. 5 natural gas price forecaster, and the No. 4 WTI oil price forecaster in the world. In 2011, Prestige Economics also worked with the AASA-managed Filter Manufacturers Council to create a forecast model to predict North American filter product demand over the next five years.

Commodity Price Risk and AASA Members

Fuel prices and raw material costs are key drivers of aftermarket supplier costs and market demand. It is vital for aftermarket suppliers to have reliable forecasts of fuel and raw material prices – and understand the risks to those forecasts – for budget planning purposes.

It is also important for strategic planning purposes that suppliers think about how the cost and availability of vital commodities is likely to develop over the next five to 10 years. If the cost or availability of oil, steel, and other key commodities were to shift dramatically, the aftermarket’s size and profitability could change significantly.

Using Prestige Economics’ perspective on the short and long-term outlook for key commodities, AASA and this leading forecasting firm have extrapolated what this forecast may mean for aftermarket suppliers. At a high level, Prestige expects some slight commodity price relief in 2012 compared to 2011. However, automotive executives would be well-advised to retrench before the global economy begins firing on all cylinders in 2013 and beyond. That is when commodity prices and physical supply could become an even greater issue.

Why Fuel and Other Commodity Prices Matter

Gasoline and diesel prices, which are determined in part by oil prices, are the most important variable impacting miles driven for light vehicles. Miles driven has long been considered a key determinant of aftermarket demand, particularly for consumable parts such as filters, chemicals, brake pads and tires. Along with the age of vehicles, it is also a key driver of demand for many other wear parts, like suspension and driveline components. The more a vehicle is driven on rough American roads, the more likely it is to wear out or break its components!

Additionally, higher gasoline prices reduce consumers’ disposable income and hurt their ability to spend on needed maintenance and repairs. For example, a one cent increase or decrease in fuel price adds or takes away almost $1.4 billion from U.S. consumers’ wallets on an annual basis just from gasoline expenses.

Furthermore, increases in oil costs increase shipping and other production and delivery costs by more than $525 million for each one cent increase in diesel costs. With a good view on the fuel price outlook, you would have a big piece of the aftermarket business forecasting puzzle.

Aftermarket supplier members frequently identify raw material prices and availability as the No. 1 business issue in the quarterly AASA Supplier Barometer – for example, the top ranked business issues from the most recent Barometer:

 

High absolute prices and high price volatility have challenged supplier budgets, cash flow and, sometimes, the ability to deliver to customers. As a result, executives from the C-suite to procurement, sales and risk groups all have been forced to address the challenges of a market-imposed commodity mandate.

Almost a quarter of AASA Barometer respondents predicted that commodities prices will remain their biggest concern among exogenous factors in 2012 – even more than economic growth:

 


Unfortunately, the high concern among AASA barometer participants is justified. After all, high commodity prices are not going away. Although Prestige forecasts some potential softness in commodity prices in the first half of 2012, it expects that prices in the second half of 2012 will be higher than year-end 2011 prices.

General Expectations

There are a number of factors that impact commodity and raw materials prices including global growth, product supply, product demand and the value of the dollar (the key pricing mechanism for most commodities). In order to think about where commodity prices are likely to go in 2012, it is important to pin down some reasonable and relevant expectations.

For 2012, Prestige Economics forecasts six fundamental economic and financial market conditions:

1. U.S. growth and jobs are expected to show modest improvements.
2. Growth abroad is decelerating, and additional foreign accommodative monetary policy is likely.
3. The euro will survive, but faces downside risks in the first half of the year.
4. The dollar faces upside risks in the first half of 2012.
5. Most industrial commodity prices are likely to be somewhat lower in 2012 than in 2011.
6. Equity markets are exposed to asymmetric downside risks in the first half of 2012..

Outlook for Fuels

Crude Oil Prices are Likely to Remain Strong in 2012

Prestige expects crude oil prices will remain strong in 2012, with downside price risks in the first half of the year and upside price risks in the second half of the year. The prospects of continued (but slowing) global growth are balanced against upside risks to the dollar and the possibility of a more significant global slowdown in the first half of 2012.

While these factors alone are modestly bearish for equities and metals over the next two quarters, crude oil prices are subject to additional dynamics that are more bullish in nature. Significant geopolitical risks – such as recent news out of Iran and OPEC’s ability to constrain global crude oil production – are likely to remain supportive of crude oil prices over the first half of 2012.

That means little relief at the pump for consumers and continued downward pressure on light vehicle miles driven. However, it is worth noting that the rate of decline in miles driven has slowed significantly in recent months, and Americans appear willing to buy mid-sized and larger vehicles again. For heavy vehicles, the story of improving U.S. economic growth may be more important, since diesel demand has risen with growth – despite higher diesel prices.

Gasoline demand is down year over year, and even though some consumers are becoming more accustomed to gasoline prices well above $3 per gallon, demand could remain flat at these levels. Furthermore, a price spike higher would likely cause a further major decline in miles driven. Unfortunately, the Prestige forecast for fuel prices indicates little relief for the market headwinds that consumable aftermarket product segments have faced in recent years.

Natural Gas Prices Could See Lower Average Prices in 2012

Natural gas prices are currently experiencing a race to the bottom. With high inventories, high production levels and soft demand due to mild winter weather, natural gas prices in 2012 could drop to the lowest average price since 1999. There is a risk that producers may actually accelerate production to increase cash flow on a volume basis to compensate for falling margins. This could push prices to levels that are even lower than they are now.

These lower energy prices have been a boon for many manufacturers. They have helped some corporations justify investing in new U.S. facilities. For aftermarket suppliers, this trend should mean lower costs of production, and lower costs for some raw materials linked to natural gas, such as plastics and power.

Despite these very low natural gas prices, do not expect a large portion of the of the U.S. vehicle fleet to be converted to compressed natural gas (CNG) for many, many years. After all, the required buildup of U.S. CNG infrastructure would be massive. Do expect a lot of poorly informed headlines on the trend, and some niche markets or individual companies to migrate to the technology.

Outlook for Metals

Metals Prices Expectations in 2012: Lower than 2011

Throughout 2012, Prestige Economics expects metals prices (except gold) to experience slightly lower average prices than in 2011. However, Prestige expects most metals prices will rise significantly by the second half of the year and will reach new post-recession average highs in 2013.

The global economic softness in the first half of 2012 is likely to create an environment conducive to slightly lower industrial metals prices compared to 2011. After all, equity and commodity prices (especially metals prices) are significantly exposed to downside risks as global growth deceleration becomes more apparent, unresolved European sovereign debt problems reemerge, and additional accommodative foreign central bank monetary policies threaten to drive up the dollar.

Metals prices are likely to behave very differently from oil prices in 2012, which are likely to be supported by OPEC’s ability to constrict global oil supply and significant, pervasive geopolitical risks to supplies. Industrial metals markets do not have a group like OPEC constricting supply or bearish price risks associated with geopolitical disruptions. As such, geopolitical risks that pose upside risks to crude oil prices (e.g. Iranian closure of the Strait of Hormuz, Iraqi Civil War, Arab Spring, etc.) are wildly bearish for growth, and are therefore also significantly bearish for industrial metals prices. As such, metals prices remain exposed on the downside — at least at times and in short spurts – in 2012.

Growth and Long-Term Expectations

At the end of the day, the global economy will still show positive expansion in 2012. Prestige expects average prices for industrial metals to rise throughout 2012 and into 2013. Metals prices are likely to find support from continued global growth — however slow it may be. Nevertheless, the tumult in international sovereign debt markets and global growth deceleration has clearly spilled over. In the medium- and long-term, relatively low amounts of proven reserves as well as rising emerging market growth and per capita demand, pose significant bullish price risks to metals.

Aftermarket suppliers may get some relief from metals prices and some other production commodity prices in early 2012. However, price volatility risk is high. If prices do drop, customers may try to claw back some of the decrease, even if the price relief is temporary. In the medium- and long-term, the trend toward rising prices will return, along with all the business and pricing model challenges – and opportunities – that entails.

Thinking Beyond 2012

Long-term risks to commodity prices and physical supply are significant. If the first half of 2012 is a softer patch in the global economy, now is the time to be thinking about how to counter future medium- and long-term risks to commodity prices and supply.

Taking an integrated procurement and risk management approach now is one of the best ways to get ahead of the problem. Getting visibility over direct and indirect commodity spend is very important – as is consciously making decisions regarding risk management and procurement strategies and marketing strategies to effectively share commodity price impacts with customers.

If Prestige’s forecasts for 2013 prove correct, commodity prices will be ranking as an even greater concern in AASA’s 2013 Barometer than it did in the 2011 Q4 Barometer. Ignoring future commodity price risks will not make them go away.

Prestige’s view is that we are looking at a long-term bull market for commodities and may face scarcity of some raw materials. This view raises some critical, long-term strategy implications for the aftermarket.

From a production standpoint, challenges could stem from the scarcity of some raw materials as demand from emerging markets mushrooms over the next several decades. Scarcity can lead to the type of commodity availability and volatility issues that have plagued many suppliers over the last five years – and which could get much worse a decade from now.

These concerns are leading some manufacturers to revisit the concept vertical integration to secure their supply chain. Numerous companies have invested in or linked themselves to their commodity sources in recent years, including many Chinese companies, the former GE Plastics (now SABIC Innovative Plastics), and Hyundai, which opened its own steel plant. Short of vertical integration, many analysts have hypothesized that in the future competitive advantage could be driven by access to raw materials, relationships with commodity suppliers, and a competence in agile material substitution in response to price fluctuations.

There have been a lot of policy discussions about increased fuel prices at the pump leading U.S. consumers to reduce miles driven and change their settlement patterns to reduce their reliance on the automobile.

Of course, this argument can be overstated. European gas and diesel prices are more than double prices in the United States, yet Europe remains heavily dependent on the automobile. In addition, increasing government CAFE standards will help lower the long-term fuel costs per mile driven, economically supporting the status quo. At the same time, however, per capita oil consumption in a number of European countries, like Germany and France, is half the level that we have in the United States. This shows that while policies can have an impact on consumption, higher prices also result in significantly lower demand. The implication for the U.S. automotive aftermarket is clear: if the price of gasoline and diesel go up sharply in the future, we could see a further significant reduction in per capita miles driven.

The risk certainly exists in the long term for rising oil prices or oil price spikes to modify the rules of U.S. aftermarket demand. In Prestige’s view, oil prices in 2020 are likely to be significantly higher than they are now. While AASA’s belief is that U.S. infrastructure will remain fundamentally organized around the automobile, it is likely that additional consumer dollars and technology will be applied to increasing fuel economy, which could in turn change the mix of the future aftermarket parts demand. That mix change could bring increased opportunities for some, and threats for others. Considering these risks and potential scenarios sooner rather than later is a solid strategy for long-term success.

Jason Schenker, Prestige Economics
Paul McCarthy, AASA

Information on our guest contributor:
Jason Schenker ChFC®, ERP®, CFP®
jasonschenker@prestigeeconomics.com

• President and Chief Economist of Prestige Economics, LLC, an AASA Affiliate Member
• Author of the Forthcoming Book Conquering Commodity Prices: The Executive Roadmap to Effective Commodity Risk Management (February 2012)
• The World’s Leading Independent Commodity Price Forecaster: www.prestigeeconomics.com/top

For more information on AASA’s industry analysis, please contact:
Paul McCarthy
Vice President
Industry Analysis, Planning & Member Services
pmccarthy@aasa.mema.org

Disclaimer: All commentary provided by Prestige Economics LLC or any of its employees is commentary intended for general information use only and is not investment advice. Prestige Economics LLC does not make recommendations on any specific or general investments, investment types, asset classes, non-regulated markets (e.g. FX, commodities), specific equities, bonds, or other investment vehicles. Opinions do not represent a solicitation or offer of financial or advisory services or products, and are market commentary intended and written for general information use only.