Oil hurting the pillars of free trade

You just knew this was going to happen eventually.  The skyrocketing price of petroleum soon reaching the $200 level as the astute Jerome a Paris of the European Tribune  noted, has not only caused pain at the pump.  It has also started to hit the foundations of the whole way manufacturing done.  The whole mad free trade system is starting to buckle.

Please take a gander at these news clippings from the past 72 hours, and you may start to get the idea of what is happening.

TOKYO -- Rising crude-oil prices caused Japan's trade surplus to shrink for a third straight month in May and contributed to the 22nd straight month of rises in the prices that businesses charge each other for their services, Japanese government data showed Wednesday.

Although the trade surplus was bigger than expected, shrinking export gains, combined with energy-fueled inflation and weakening demand for Japanese products in advanced countries, continue to pressure the world's second-largest economy.

- excerpt from Japan's Trade Surplus Shrinks Again As Crude's Rise Pushes Prices Higher, Wall Street Journal.

Not exactly good news, considering that the Japanese are one of the largest buyers of our debt.  Some will say "fine good, we won't owe them squat" but keep in mind, demand for our debt is dropping.  And until we start running budget surpluses again, Uncle Sam will continue to borrow.  But wait, this gets even more interesting!

This excerpt was originally broadcasted on ABC's World News Tonight on June 24th this year.

While I'm not getting my hopes up that all those manufacturers that left this country over the decades will suddenly return, this is an interesting turn of events.  Indeed, I wonder, if this really is the start of  new trend?  The cover story for this issue of Businessweek hit on this very topic.  

Rising costs are starting to eat into what American managers fearfully call the China Price, the once-formidable 40% to 50% cost advantage enjoyed by Chinese manufacturers--and demanded by customers. "Fuel prices just shot up so fast that everyone was caught flat-footed," says Allen J. Delattre, who heads Accenture's (ACN) global supply chain practice. "Now logistics costs are an overarching priority." Richard Sinkin, a San Diego consultant who scouts manufacturing sites in the U.S., Mexico, and China for multinationals, also senses a major strategic shift. "A lot of clients who were thinking about going to China are now saying, Not at these prices,'" says Sinkin. "The high cost of fuel is going to radically transform the way people look at the geography of their manufacturing."

- exerpt from Can the U.S. Bring Jobs Back from China?, Businessweek

Just In Time slowing down and facing a possible halt

One of the keys to our modern day "free" trade system is a process known as Just In Time Manufacturing (JITM) or sometimes also known as Just In Time Inventory (JITI).  Essentially, the entire process from the extraction of natural resources to getting the product in your hands is streamlined as much as possible.  The main goal is to get it to you quicker and cheaper.  Businesses bought into this, especially for their high growth potentials in their enterprise.  

JITI/JITM worked for the business concern so long as several variables were managed or known.  When things "worked", companies are able to boost their productivity numbers and eventually their earnings; higher earnings meant better Earnings Per Share forecasts and thus a better share price if the company was publicly traded.  The origins of this whole thing came from basically two sources, Henry Ford's book "My Life and Work" (out of print, since 1930, as far as I can tell) and the writings of consultants suck as Peter Drucker and W. Edwards Deming and Dr. William Ouichi.  It should be noted that the bulk of what is considered in these procedures was written up by the latter three.  Ironically, American businesses ignored the latter three in the 1950s through 1970s, but their ideas found popular reception in Japan which quickly implemented them.  We all sorta know how that turned out.

In light of how efficient and cost saving Just-In-Time is, it is also very fragile.  As noted, if the inputs that went into the product or service are managed or at least the costs known and prepared for in advance, the thing quickly stalls or falls apart.  A hickup in any part of the process for an extended period beyond what a manager plans could shut the whole operation down.  Simply look at what happens when an auto company's supplier faces labor issues. Other variables (for the sake of space, I will not include them all) include of course labor costs, quality control, design process, material costs, shipping.  You could include shipping in material costs, but I subtracted it because it should also be a reflection of shipping the final good.  Now for services, obviously there would be different variables.  But if you'll indulge me, I would like to focus on the goods side and material costs.

Three such materials that comes into mind is petroleum, gold, and ore. The price of oil is fast approaching $200, and I would dare say that would be all the major brands of crude!  Looking at my computer screen, the benchmark West Texas Intermediate just crossed $141 mark (by the way, if you're interested, I am thinking of posting a primer on oil trading, you folks interested?).  Petroleum is a major component to manufactures beyond being used as fuel.  Plastics and other resins go into everything from toothbrushes to iPods.  Fuel prices, when volitile, can kryptonite to Just-In-Time procedures.  Below is an interesting article on how JIT simply breaks down when fuel goes up.

Soaring energy prices are forcing Procter & Gamble to rethink how it distributes its products, with the world's biggest consumer goods company shifting manufacturing sites closer to consumers to cut its transport bill.

Keith Harrison, head of global supply at P&G, the maker of Tide detergent, Crest toothpaste and Pampers, said the era of high oil prices was forcing P&G to change.

"A lot of our supply chain design work was really developed and implemented in the 1980s and 1990s, when our capital spending was fairly high as a cost of capacity and oil was 10 bucks a barrel," said Mr Harrison in an interview with the Financial Times.

"I could say that the supply chain design is now upside down. The environment has changed. Transportation cost is going to create an even more distributed sourcing network than we would have had otherwise."

- excerpt from Oil costs force P&G to rethink supply network

gold
(Gold chart courtesy Futuresource.com, 2008)

Gold (and its sister precious metal, silver) are used for industrial goods besides looking nice and shiny in some piece of jewelery.  Gold is applied on semiconductor products like circuit boards.  Many wire products also use gold for conductivity.  The list goes on and on, but you get the idea. The chart above shows the monthly prices for gold going back a quarter of a century.  As one can see, prices have gone just nuts.

Last, but not least, is the price of ore.  Ore can be everything from aluminum, to coal to iron to tungsten.  Its the stuff that goes into metal or metal-like products.  Cars, computers, houses, you name it, chances are that metal is in it or was used to make that good or provide that service.  And like the other two, prices have been on an upward spiral.  Two things I want to share with you, one is a chart from the London Metals Exchange showing the benchmark index for Aluminum industrial good products for the North American market.  The second thing is a news piece from the Financial Times.

NASAAC
(NASAAC chart provided by the London Metals Exchange, 2008)

Global inflation fears deepened as Chinese steelmakers agreed to a record increase in annual iron ore prices in a move likely to boost the cost of cars, machinery and other products.

Chinese millers agreed to pay Anglo-Australian miner Rio Tinto up to 96.5 per cent more for their ore supplies this year, the largest ever annual increase and well above the 9.5 per cent increase paid last year.

The rise suggests that demand for commodities from emerging economies remains strong, in spite of the US slowdown, fuelling fears that global inflation will continue to rise. The rise - an average 85 per cent - surpasses the record increase of 71.5 per cent agreed in 2005, when the commodities boom gathered pace.

- excerpt from the FT's "Chinese agree 96% jump in ore prices"

So why include the price of the North American Special Aluminum Alloy Contract with a story on Rio Tinto's massive price increase on steel?  Because they are all related.  Like the West Texas Intermediate's price is one of the benchmarks for oil (besides Brent), the London traded NASAAC tends to be the benchmark price for aluminum being used in Chinese-made products.  It all comes together.  But, for the sake of completion, allow me to produce one more metals chart from the good folks at the LME.  The LMEX is a combination of copper, aluminum, lead, zinc and tin.

lmex_chart
(LMEX Index chart courtesy of the London Metals Exchange, 2008)

How much to ship that?!?

Ah, now we get to the part many free traders like to avoid, the cost of shipping.  Now there are many ways to calculate shipping, but virtually everyone goes off a benchmark/index.  There are many shipping indices, but there is one that takes the three carrier sizes (Panamax, Capsize and Supermax) for raw goods ranging from crude oil to grain to zinc. Known by either the Baltic Dry Index or the Dry Goods Index.  The index is administered by the 264 year-old London-based Baltic Exchange.  Confused a bit?  The Baltic Exchange has nothing really to do with the Baltic Sea, its just the name of the group.  They keep in constant contact with all the shippers and ship brokers, getting the latest prices for moving goods by sea.  

This is an over looked index by many, and really should be paid more attention to.  Considering that most of our goods are made overseas, seeing if the price of shipping is going up or down would give you a heads up on inflation.  The Baltic Dry Index (BDI) has its swings like many other things, but besides the number of available ships, petroleum plays one of the largest factors in the price you see on the index.

bdi
(Baltic Dry Index chart courtesy of Investools.com, 2008)

Looking at the chart, the price (in blue) and the moving averages (green and red) have gone up. Now match that with the prices of the other charts and you will see a pattern.  This is especially true with oil (for some reason, the oil chart isn't uploading, sorry, but I'm sure Jerome has one).  The index is priced in dollars, though I'm not sure if it is per 150 tons or more.  Something interesting to note, according to the Baltic Exchange's site, three countries (Greece, Germany and Japan)are the top ship owning countries.  Given the drop in the US Dollar versus the Euro and the Yen, this could add to increase in the BDI.

This brings us full circle back to our original story.  As the video noted, the cost of shipping has become unafordable for many companies.  Though the BDI has seen a slight reprieve, should oil continue upwards (despite any curbiture in speculation), we could see the Dry Index break out of it's previous high of $11,400.  If $9k stopped that furniture company, can you imagine what say $10 or $14k will do with others?  

Writing this, I'm finding myself sort of glad oil is going up.  Now, please, don't get me wrong.  A lot of people are hurting, especially the working poor.  But, as we can see, there have been responses.  A couple of years back, when gas was cheap and SUVs filled the streets, did we really hear people come out and support a push for alternative fuels?  How about conservation?  Or even taking the bus?  Now we have plans to actually expand all of these things!  Mind you, we could move quicker, and the government could help the poor in some way with the price of petrol.  

It is this writer's hope that we start to see a move back to making things here.  Nothing against those who work in service jobs, but we really could use some good ol' fashioned union manufacturing jobs as well.  For decades, Just-In-Time has really meant a quicker way to lose this work to cheaper wages.  Its nice to know that these free trade bastards are getting some sort of economic karmic justice.  Seeing the situation, perhaps Barack Obama or (gulp) John Airbus McCain will help in implementing more incentive to bring the work here.  I don't know what exactly, maybe you good folks could come up with some ideas on the comments section.  One bad thing though, and I hate to leave on a negative note, with the increase in the Dry Index and materials I mentioned, we're gonna see inflation go up even further!

Tags: Barack Obama, commodities, Economy, free trade, inflation, jobs, John McCain, shipping (all tags)

Comments

10 Comments

Re: Oil hurting the pillars of free trade

I can certainly see a shift back to more local or regional production of goods of all kinds.  That will help create jobs here at home, yes.

But it won't make it any cheaper to make stuff here than it was before.  Consumers are going to have to get used to higher prices.  The jobs are a nice silver lining, but this is still a raincloud.

by Reaper0Bot0 2008-06-27 08:11AM | 0 recs
Re: Oil hurting the pillars of free trade

Wage-related inflation is indeed a risk.  A component of labor costs is healthcare, which could be offset by universal health coverage.  Perhaps that could ease inflation levels a bit.  

by johnny venom 2008-06-27 08:26AM | 0 recs
Re: Oil hurting the pillars of free trade

Higher oil prices will favor local production, but it will not create more jobs...quite the contrary, actually !

by SevenStrings 2008-06-27 08:49AM | 0 recs
Re: Oil hurting the pillars of free trade

we bring jobs back but at what cost?  seriously, this is so ominous. While the prices of everything rise around us, wages are at a standstill. Companies try cutting cost by reducing hours and overtime, furthering the standstill in wages.

If you make minimum wage of 5.85- how will you even survive if the prices of gas and goods continue to increase?

by alyssa chaos 2008-06-27 08:33AM | 0 recs
Re: Oil hurting the pillars of free trade

You'll ride a bike or bus or walk to work.  You won't travel much.

People have to understand that this whole society is built on assumptions that were pretty stupid.

Life as we know it will simply become too expensive for most.  We'll start clustering (well, it's already starting, it'll just accelerate) into the cities and living far more locally.

by Reaper0Bot0 2008-06-27 08:39AM | 0 recs
Re: Oil hurting the pillars of free trade

im pretty sure alot people dont have the luxury of riding their bike, given they live in the suburbs and work in the city- but clustering in major cities come with a higher cost of living while you save money on transportation. I think it evens out pretty well.

i want to see what the new america looks like after oil really crushes us. we'll probably look more like European countries that are pedestrian friendly.

we need a huge investment in public transportation, nationwide, or we're dooommmeeed.

by alyssa chaos 2008-06-27 08:51AM | 0 recs
Re: Oil hurting the pillars of free trade

Let's work on building a time travel machine, and then send someone back to when development in cities first started really picking up. And then tell them to get their act together and make sure accessible public transport is included in their design plans.

I mean, that's the best plan I got, I'm open to better suggestions. But it'd still probably be cheaper than trying to build up the infrastructure from scratch now.

by Skorri 2008-06-27 10:03AM | 0 recs
Re: Oil hurting the pillars of free trade

haahaa. yeah. better suggestion: teleporter- seems better than a time machine.

by alyssa chaos 2008-06-27 10:27AM | 0 recs
Re: Oil hurting the pillars of free trade

Man, it's a good thing I didn't go ahead with my time machine plan before I consulted with you. You're absolutely right, a teleporter would probably be about a thousand times easier to engineer than a time machine, and it'd solve both the public transit problem AND the oil shortage. It's fail proof!

by Skorri 2008-06-27 10:41AM | 0 recs
Re: Oil hurting the pillars of free trade

Bear in mind that JIT inventorying has gotten into areas of the economy far beyond its original base in manufacturing.

When the Kobe earthquake hit in Japan in 1995, there were enormous secondary effects from JIT deliveries shutting down all over the country. Plenty of small urban retailers, for example, had learned to stock their shelves thinly and then rely on mid-day JIT delivery. When the trucks stopped coming, they were screwed.

It gets better. At your nearest hospital, medical devices and drugs are handled via JIT. If those supply chains break, medical care essentially stops in its tracks. An avian flu pandemic would do that quite nicely.

--

by marquer 2008-06-28 03:15PM | 0 recs

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