Saturday, June 14, 2008

Impact of Oil on World Trade

It has been a crazy week for me -- pulling my hairs -- trying to figure out how to increase price. Life was pretty business as usual when crude oil stays around $ 100 -- not many people come back for price adjustment. As soon as crude oil hit $ 140, things had really changed. We need to cope with 26% higher electricity charges next month. Freight costs and plastic packaging costs are going up. Raw materials related to metals and plastics have been staying very high. We have been doing some productivity improvement to offset costs increase but there is no way you can cut costs in big quantum anymore. Any company with more than 20-30% cost cutting opportunity has been way too fat in the past and deserves to belly up.

With drastic costs increase, we have only two choices -- continue to let the business run below cost of capital or pass on the cost increase. Yup bite the bullet, pass on the costs is the only rational choice. But then we will have two risks (i) competitors hold on to same price to gain market share or (ii) customer reduce demand. It is very common for Asian businessman to hold on to their price by justifying harmony business relationship and have a long term view. It is going to be worse if you are competing with Japanese competitors. I think it is not necessary to get into the lecture of competitive advantage, branding, position, product innovation and etc. While it is fun for me to criticize financial results of public listed companies, I know how difficult it is to sustain high profitable growth and at the same time focus on return on investment by managing account receivable, account payable, month-on-hand, capital expenditure and etc.

Our team is also working on a few scenarios what will be our company strategy if crude oil price hit $ 150 or even $ 200 or $ 250 per barrel. It is a very bad news for Asia, "the factory" for the world. Why? High transportation cost will shift world trade pattern -- discouraging world trade. Production will migrate closer to the point of use.

Look at the period of 70s -- we had negative growth!

I have a customer was shocked and mad to find out the freight costs were more expensive than the products we sold them, they insisted we refund them money. Guess what, they start to look to buy from companies in Latin America. What happened to us was not a joke, look at this chart, freight cost from Asia is almost 3 to 4 times more expensive compare to shipping from Mexico.

China's freight intensive business has been declining since the oil price soared.

It is true that it will take time for many of industries to move from "here" to "there" because of infrastructure and supporting industries but this is a beginning of a reversal -- Asian will no longer can depend on export to spur growth. We will have to either move up the value chain, increase consumption or increase intra-Asia trade. Personally I need to get my resume ready(switch job to a different industry).

Are we over-reacting to possibility of high crude oil price? Well, I've been asking myself for months now, hoping it will top out but what if it don't? Like it or not, to manage business or investment, we got to be prepared at least mentally to cope with it professionally and personally.

Free-Trade Era May Be Nearing End Amid Food, Growth Concerns?
June 13 (Bloomberg) -- After six decades of ever-expanding international commerce, the high tide of free trade is ebbing.

As tens of thousands of South Koreans protest U.S. beef imports, rising commodity prices push nations to keep more food for domestic consumption and the U.S. chooses a new president who might be less supportive of free trade than his immediate predecessors, the world may be facing the end of a cycle that began in the immediate aftermath of World War II.

The liberalization of global trade has come ``to a screeching halt,'' said Fred Bergsten, director of the Peterson Institute for International Economics in Washington. ``It'll take years to rebuild the foundations of free-trade policy.''

Back to investment, based on what I'm experiencing now in the real world of manufacturing, I will avoid industrial sector and observe how they perform for a while. Consumer companies like Dutch Lady, F & N, Nestle and etc have great branding power but can it translate into bottom line preservation?


lsb said...

Both World Wars were fought to obtain market access.

Raymond said...

High oil prices will puch back the advance of global trade. Instead of globalisation, it makes more sense now to advocate regionalisation. Not surprising that US will look more to Latin America for their imports and Europe to Eastern Europe.

In a situation of high commodities prices, it is best to avoid industries that use raw materials as direct input, such as airlines, shipping and manufacturing. If you like transportation, better to invest in airports and port operators rather than airlines and shipping companies.

It's better to focus on raw materials producers like mining and plantations, and service sectors such as banking and telecommunication, which do not use any raw materials. Consumer products with strong brand names such as Nestle and dutch lady will fare much better in terms of pricing power compared to no-name producers.

lsb said...

Looking at history the standard of living improves all the time from the beginning, irrespective of wars or recessions (interrupted the uptrend for some years).

High oil price is a normal hitch in human’s progress and oil price is not the doom and the beginning of the decay of planet yet

Caution is the mode for this high price commodities time and opportunities can be abound.

lsb said...

USA will also no longer be the largest market. The freight charge will be costly both ways, so freeing up a lot of market nearer home too.

Trade will be as usual from Columbus till now and into the future.