The Role of Capacity Utilization Rates in Launching Industrial and Engineering Construction

When the actual output of total industry or one of its sub-sectors is compared with what could be produced if operations were running full out, the resulting statistic is termed the capacity utilization rate.

Full capacity is usually estimated, by either the Federal Reserve or Statistics Canada, with normal conditions in mind. It doesn’t take into account extreme measures, such as three-shift operations.

Several factors can raise the ‘usage rate’. At any given time, although it’s more prevalent in a downturn, firms can exit a sub-sector and/or close one or more plants. On the flip side, and especially as an economic cycle improves, heightened demand for the goods produced will do the job.

The construction industry’s interest perks up when the capacity utilization rate for an industry sub-sector crosses above a certain threshold, now thought to be in a range of 85% to 90%, since that’s when the firms in the market will begin to think more seriously about their need to build new facilities.

Furthermore, once one company makes the commitment to a capital spending initiative, others in the same sector will feel a pressing need to do so as well, in order to keep up with their competition. Logically enough, this is sometimes referred to as a ‘copycat effect’.

The table accompanying this Economy at a Glance shows capacity utilization rates for the U.S. and Canada according to some of the most important industry and sub-industry groupings. (The Fed’s data is calculated monthly whereas the approach of Ottawa’s statistical agency is quarterly.)

In Canada, both total industry and total manufacturing are on the cusp of reaching the 85% benchmark.

The year-over-year change in the usage rate of the nation’s manufacturing sector, at +2.3 percentage points, is especially noteworthy. It suggests the decline in value of Canada’s currency, the ‘loonie’, versus the U.S. greenback, is having the desired effect of stimulating export shipments from across the border in the north to destinations in the south.

This argument is reinforced by the usage rates for two Canadian manufacturing sub-sectors that are traditionally major suppliers to U.S. customers.

The utilization rate among Canadian wood products manufacturers has soared to 95.3%, or +6.7 percentage points year over year – although, keep in mind that there were deep cuts to overall capacity in this sector from a wave of sawmill closings during and after the Great Recession, at a time when U.S. housing starts nosedived.

The usage rate in Canada’s transportation equipment sector remained above 90% in this year’s Q1, which was a pull-back from 94.1% in the final quarter of last year. While domestic sales of vehicles have recently been at an all-time high, Canadian automakers have also been benefitting from a strong level of demand on the part of American consumers that is being fulfilled by numerous foreign sources (e.g., Mexico, Germany, Japan and South Korea as well.)

At the same time, the capacity utilization rate of American firms making cars and light trucks is an impressive 88.0%, which is +5.0 percentage points when compared with a year ago. The surge has been even more astonishing over the past three months, though, +9.7 percentage points.

The motor vehicle sector notwithstanding, American manufacturers as a whole (77.8%) are still operating with a usage rate that is less than 80.0%.

Maybe that’s not so bad. The second footnote below the table records that the 1972 to 2014 long-term average capacity utilization rate for U.S. manufacturers has been only a little higher, at 78.5%.

And consider that in mid-2009, the level sank to only 63.7%, or less than two-thirds of capacity.

In resources, U.S. producers are operating at higher capacity utilization rates than their Canadian counterparts in two out of three major sub-categories. The disparity is especially notable (16.1 percentage points) in the ‘mining (other than oil and gas)’ category: 77.0% for the U.S. versus 60.9% for Canada.

The U.S. mining-related sector is being led by non-metallic mineral products (clay, gypsum, cement, etc.), at 80.4%; followed by coal, 76.4%; and metal ores, 73.6%.

In oil and gas extraction, and despite the sharp drop in global energy prices, May 2015’s reading for the U.S. sector was 97.2% compared with Canada’s figure of 88.0% for Q1.

While it may seem hard to credit, the current U.S. level of 97.2% does actually capture a decline of more than 3.0 percentage points compared with 11 months ago. A rarely-seen utilization rate above 100.0% was chalked up in June of last year, when hydraulic fracturing of shale rock was at its peak.

In the closely-related sub-sector of ‘petroleum and coal products’, which includes the refining of gasoline, the U.S. is also ahead of Canada, 84.7% to 80.3%.

In electric power generation, however, the utilization rate of utilities in the U.S., at 79.5%, trails the land of Mounties and maple syrup, 87.4%. From an environmental standpoint, Canada has the advantage that much of its electricity is generated from hydroelectric sources, while the U.S. is attempting to shift supply-sources for its grid from coal-fired units to natural gas and renewables.

It’s interesting that while the demand for electricity will assuredly keep rising in the years ahead, necessitating the construction of more power plants, the annual rate of growth – thanks to successful conservation efforts − is expected to decelerate.

Much of today’s electronic gadgetry draws far less wattage than predecessor versions.

If micro generation systems – e.g., homes with solar panels on their roofs and wall-mounted storage batteries – grow in popularity to the degree expected, aided by costs that keep falling, then the demand for large-scale power projects may eventually bump up against a ceiling.

Although they’re not shown in the table, other Canadian manufacturing sub-sectors with high capacity utilization rates in Q1 of this year were: paper (93.7%); primary textile mills (89.9%); computer and electronic products (85.9%); and rubber products (84.6%).

The strength in the first of those four ties in with good forestry and logging activity. The last links to the aforementioned buoyancy in automotive demand.

If anyone is wondering why steel product prices continue to flat-line, guess no more. The usage rate of U.S. firms making iron and steel products is only 67.2%. It’s hard to raise prices when there is that much slack.