NEW YORK, May 27 /PRNewswire-FirstCall/ - CIBC (CM: TSX; NYSE) - The soaring price of oil has dramatically increased the cost of moving goods around the globe, posing a major threat to price stability and overseas manufacturing, finds a new report from CIBC World Markets. "Exploding transport costs may soon remove the single most important brake on inflation over the last decade - wage arbitrage with China," says Jeff Rubin, Chief Economist and Chief Strategist at CIBC World Markets. "Not that Chinese manufacturing wages won't still warrant arbitrage. But in today's world of triple-digit oil prices, distance costs money." The report finds that the cost of shipping a standard 40-foot container from East Asia to the U.S. eastern seaboard has already tripled since 2000 and will double again as oil prices head towards US$200 per barrel. These soaring energy costs are threatening to offset decades of trade liberalization and force some overseas manufacturing to return closer to home. "Unless that container is chock full of diamonds, its shipping costs have suddenly inflated the cost of whatever is inside," adds Mr. Rubin. "And those inflated costs get passed onto the Consumer Price Index when you buy that good at your local retailer. As oil prices keep rising, pretty soon those transport costs start cancelling out the East Asian wage advantage." Mr. Rubin says that these forces may reverse the impact of globalization. "Higher energy prices are impacting transport costs at an unprecedented rate. So much so, that the cost of moving goods, not the cost of tariffs, is the largest barrier to global trade today." The report notes that it currently costs US$8,000 to ship a standard 40-foot container from Shanghai to the U.S. eastern seaboard, including in-land transportation. That's up from just US$3,000 in 2000 when oil was US$20 per barrel. At US$200 per barrel of oil, the cost to ship the same container is likely to reach US $15,000. The impacts of these rising costs are already being seen in capital intensive manufacturing that carry a high ratio of freight costs to the final sale price, such as steel production. Soaring transport costs, first on importing coal and iron to China and then exporting finished steel overseas, have more than eroded the wage advantage and suddenly rendered Chinese-made steel uncompetitive in the U.S. market. Underscoring this is the fact that China's steel exports to the U.S. are falling by more than 20 per cent year over year, while U.S. domestic steel production has risen by almost 10 per cent. "That's great news if you are the United Steelworkers of America," says Mr. Rubin. "Long lost jobs will soon be coming home. And the more that oil and transport costs rise for Chinese steel exporters, the more that North American steel wage rates can grow. But if you're a steel buyer, your costs are going up regardless of whether you're sourcing from China or Pittsburgh." Converting transport costs into tariff equivalents shows how disruptive soaring energy prices can be. Mr. Rubin notes that oil at US$150 per barrel equates to an 11 per cent tariff rate - a level last seen in the 1970s. At $200 per barrel of oil, "we are back at tariff rates even prior to the Kennedy Round GATT negotiations of the mid-1960s," he says. "Even at US$100 per barrel of oil, transport costs outweigh the impact of tariffs for all of America's trading partners, including Canada and Mexico." Mr. Rubin points to history to show how higher energy and transport costs serve to dampen trade and force markets to seek shorter, and cheaper supply lines. Global exports have soared in all periods over the last 50 years when trade barriers were reduced and oil prices were low, his analysis shows. But he says exports "went absolutely nowhere" during the oil and energy crises of the 1970s, and for several years after despite reductions in global tariffs and healthy recoveries from recessionary periods. "It's relatively easy to see why American importers shifted to regional trading" during that time, says Mr. Rubin. "Trans-oceanic transport costs literally exploded during the two oil price shocks. The cost of shipping a standard cargo load overseas almost tripled, just as it (has) over the past few years. Ultimately, soaring transport costs were borne by consumers and markets responded accordingly, substituting goods that could be sourced from closer locations than half way around the world carrying hugely inflated freight costs." Mr. Rubin says that goods with a low value-to-freight ratio will be the most sensitive to rising transport costs. A "surprisingly high percentage" of Chinese exports to the U.S. fall in this category, and include furniture, apparel, footwear, metal manufacturing and industrial machinery, he notes. "Freight-sensitive Chinese exports to the U.S. now account for 42 per cent of total exports - down from 52 per cent in 2004," says Mr. Rubin, adding he estimates "that if it were not for the dramatic increase in transport costs, growth in Chinese exports to the U.S. since 2004 would have been 35 per cent stronger than the actual tally." Mr. Rubin says there is "certainly no reason why we should not expect to see at least comparable if not greater trade diversification" than was seen during the oil shocks of the 1970s. "Instead of finding cheap labor half way around the world, the key will be to find the cheapest labor force within reasonable shipping distance to your market." In that type of world, Mexico's proximity to the rest of North America combined with its labor costs will give it a second chance to compete with Pacific Rim production, says Mr. Rubin who further predicts that when oil prices reach US$200 a barrel, it will cost three times as much to ship the same container from China than from Mexico. "To put things in perspective, today's extra shipping cost from East Asia is the equivalent of imposing a nine per cent tariff on East Asian goods entering the U.S. And at oil prices at US$200 per barrel, the tariff equivalent rate will rise to 15 per cent." "In a world of triple-digit oil prices, distance costs money. And while trade liberalization and technology may have flattened the world, rising transport prices will once again make it rounder," says Mr. Rubin. The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/smay08.pdf CIBC World Markets is the wholesale and corporate banking arm of CIBC, providing a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.
SOURCE CIBC World Markets