Free Trade Anchored By Surging Oil Prices…

by BWK ~ July 1, 2008

“Free Trade?”

Not any more. Not at $145 per barrel of oil, and counting. Globalization was the key strategic change in the direction of world development in the 1990s. Fast-rising, and permanently-expensive energy prices are the key strategic change in the world of the first decade of the 2000s.

According to an article in the LA Times, it takes about 7,000 tons of bunker-fuel to fill the tanks of a 5,000-container cargo ship for a trip from Shanghai to Los Angeles.

Since 2005, the cost of that fuel has jumped 87% to $552 a ton, according to the World Shipping Council. This boosts the cost of filling the fuel tanks of a standard-sized cargo ship to not quite $4 million.

So is the price of fuel altering patterns of world trade? Of course it is. Another way of putting it is that rising fuel costs are acting like a “sea anchor” on globalization and world commerce.

Overall, the rising shipping costs from East Asia, due to higher fuel prices, are currently the equivalent of imposing a 9% tariff on East Asian goods entering North America, over the past two years.

If the trends keep on going, then at $200 per barrel the tariff equivalent rate will rise to 15%. So much for “free trade” and “most favored nation” status.

Really, even in a world of rising energy costs, the marketplace still works. Maybe it works with a vengeance. Or at least, the marketplace tells you what OUGHT to work. Public policy can always intervene to screw it up.

In the future, the “most favored” locale will be the one that can produce goods and get them to market at the lowest cost.

According to an official at the Port of Los Angeles headquarters, West Coast ports should gain business in an environment of rising fuel costs. This is because the West Coast ports are 10 to 12 days’ sailing time from Asia, versus the 18-to-20-dayroute from Asia to the East Coast through the Panama Canal. So far so good.

But then again, sea-shipping is still the cheapest way of moving heavy loads, based on cost per ton-mile. Barges are next-cheapest, followed by trains. Trucks are the least efficient part of the movement value chain.

And the discussion of using ports to move goods across the world ohly holds water (so to speak) as long as the Asian goods hold a fundamental production cost advantage.

But West Coast ports could also lose business under some scenarios, for some types of goods. If shipping costs get so out of hand that companies begin shifting production back to North America from Asia, then the ports will certainly lose that volume.

This reverse-migration of production is already happening. In the steel industry, for example, basic production of steel slabs (and also the higher-end value-added steel-making processes like hot-coiled strip), are moving back to North America. This phenomenon has contributed greatly to the rising asset values of U.S. steel-making plants and equipment. Why else would companies like Arcelor-Mittal, or Severstal be paying premium rices for U.S.-located steel facilities that just a few years ago were wards of the bankruptcy courts?

And higher fuel prices are causing firms to re-think whether they should have large, centralized plants. The question is, should a firm build smaller plants in different areas of the country? The deterioiration of the nation’s highway system, as well as clogged railways, makes trans-continental shipping more and more problematic. Hershey Candy may live to rue the day it decided to close up much of its shop in Pennsylvania and move major operations to Mexico.

Rising fuel costs are also altering local distribution patterns. High fuel prices are forcing restaurants, supermarkets, wholesalers, and upstream food manufacturers to look for suppliers closer to their operations.

Local food-sourcing is sparking a boom in some areas for arable farmland, to include dairy operations, orchards, vegetable-growing operations and smaller-scale feedlots. The benefit for vendors, and ultimately for consumers, is that they will not pay as much for freight. And the food might even taste better. Hey, “real food?” What a marketing concept.

Until we meet again,

Byron King

Note: Byron King is a frequent contributor to the free e-letter Whiskey & Gunpowder. To receive daily insights into energy, oil, commodities and other natural resources sign up here!

Additional Resources:
Oil Defies a Correction…
The Airline Waiting Game…
Energy Q&A Part II: Investing in Oil Refiners and Oil Service Companies
Energy Q&A Part I: Peak Oil and Oil
The Oil “Melt-Up” and Why the U.S. Economy Won’t Run On Windmills Alone…
US Agriculture Supply and the Coming Election
U.S. Factories: Where Did They Go?
The 2nd Fed… Carbon Permits