On August 18th the Federal Reserve Bank of Philadelphia released its monthly Business Outlook Survey Index of Mid Atlantic regional manufacturing activity and the results shocked the market. The survey showed a drop from a positive +3.2 for July to a negative -30.7 for August, its lowest level since March ‘09. This survey was consistent with recent trends in other regional indexes such as NY Fed and the Richmond Fed as well as the national ISM report which had shown signs of a slowdown on a national basis.
The Philadelphia Fed Index is a broad survey of manufacturing activity comprising such categories as employment, hours worked, new orders, inventories as well as prices paid and received. As the chart shows below it has been an indicator of a decline in economic activity when it has recorded a reading below zero for several months in a row, going back to the recessions of 2001 & 2008-09. When comparing the activity of the Philly Fed and the S&P 500 on a quarterly basis, a decline averaging 5% or more in both indexes typically occurred during or closest to a recession.
What degree of decline in Industrial power sales could we see if the Philadelphia Fed index remains at a negative reading for the next several months? One indicator would be to look at PA Industrial Power Sales as tracked by the EIA in Electric Power Monthly. The chart below tracks the percentage change in industrial power sales in PA against the percentage change in the Philly Fed Index. Recent industrial production figures for July recorded an increase of .9%, but this was largely driven by increased utility output. As weather moderates in September we may get a clearer picture of industrial demand and power sales.
While the economy has rebounded from a demand perspective, from its 2009 lows, it has not returned to pre-recession levels of 2007. This has resulted in excess capacity of power generation and has raised reserve margins of generation that an Independent System Operator (ISO) could call on. If the economy were to falter in the second half of 2011, industrial demand would be a segment of the economy to be impacted more notably than the residential or commercial sectors.
While demand may not return to 2009 levels, it may fall somewhere between those seen in 2009 and 2010. This would further increase coal/gas competition as all the new supply of gas coming from shale fields would be either injected into underground storage or burned for power generation as gas plants seek to displace coal units when the cost of gas is low enough to compete on cost.