Experts Comment on Oil Price Impact on Logistics
Jeff Berman, Logistics Management -- Supply Chain Management Review, 8/22/2008
Even though oil and gas prices have subsided somewhat in recent weeks, current price levels are impacting the playing field for shippers and carriers in ways which may have a lasting affect, according to two prominent transportation and economic experts. Jeff Rubin, chief economist of CIBC World Markets, and Bob Costello, chief economist and vice president of the American Trucking Associations, shared their views on how fuel prices are impacting world trade and domestic freight conditions in a conference call hosted by the National Association for Business Economics (NABE) yesterday, entitled “Oil Prices and the Cost of Logistics.”
Leading off the call, CIBC’s Rubin focused on how energy prices have impacted transportation costs and the broader ramifications of those increases are on transportation costs, in terms of global trade and global supply and what the inflationary ramifications may be if shippers move to more localized, regional trading, which is said is “where triple digit oil prices will likely lead us.”
In looking at the relationship between oil costs and transportation costs, Rubin explained that CIBC has found that fuel costs have become a growing percentage of overall trans-oceanic shipping costs that are reflecting the steady rise in fuel prices since the beginning of the decade—when they represented 20 percent of total transportation costs and have since gone up to roughly 50 percent of total trans-oceanic shipping costs. What’s more, if things continue at the current rate, Rubin said that figure is likely to bump up to 80 percent as fuel prices ultimately climb to $200 a barrel.
“For this reason, transportation costs track very closely to fuel prices,” said Rubin.
And the implications of this projection for shipping a standard 40-foot container from Shanghai to the US east coast have resulted in significant price hikes for shippers, he said, as one might expect from the profile on oil prices for this type of movement going from $2,000 to about $8,000 and possibly double again in the next four-to-five years.
“The implications of this—in many cases—are that we may be reversing the wage arbitrage that has pretty well-defined globalization and world trade patterns over the last ten-to-15 years,” said Rubin.
CIBC World Markets looked at the steel industry as an example to see what has happened as a result of what Rubin described as the “virtual tripling” in the costs of shipping a 40-foot container carrying steel. For steel production, he said the wage arbitrage is strongly in China or east Asia’s favor when comparing all-land domestic labor costs in the neighborhood of $35-to-$40 per hour with the same costs at roughly $5 per hour in China. But he said what people often lose sight of is that continual technological change has reduced the labor input into steel production, because we are now at a point where there is about 1.5 hours of labor time involved in the production of one ton of steel.
Buying steel from China today with today’s transport costs means that shippers are being “penny-wise and pound-foolish” noted Rubin. Penny-wise he said in the form of saving roughly $30 an hour on labor time, and pound foolish in the sense that savings on labor wage rates are “absolutely overwhelmed” by increasing transportation costs. The reason for this, explained Rubin, is that China has to ship iron ore from Brazil across the Pacific Ocean in ships that are burning $90-$100 bunker fuel to China and then have to convert the iron ore into steel and ship the finished product back to the US east coast, adding about $90 a ton to the cost of hot rolled steel.
“All of a sudden Chinese steel is becoming uncompetitive in the US marketplace, which is something that has not happened in the last couple of decades,” said Rubin. “It is showing up with China steel exports to the US down about 20 percent year over year. One might think that is the result of the depressed US economy, but you would be hard-pressed to explain at the same time why US steel production is up ten percent over a year ago while China’s steel exports are falling....This demonstrates some sort of reverse [globalization] impact. Who would have thought that triple-digit oil prices would breathe new life into America’s Rust Belt?”
The domestic impact: The ATA’s Costello began his presentation by explaining that 69 percent of US tonnage moves by truck, according to the ATA’s “US Freight Transportation Forecast to…2018,” which was released in January 2007.
“Over the years, we have benefited from logistics as a total percentage of the US GDP coming down,” said Costello. “But we recently have seen it start to go up for a few different reasons.”
One reason it has gone up he explained is congestion, which has gotten worse. This has in turn forced companies to hold more inventory, and highway transportation expenses are also adding to overall costs, too, which are also being passed along to consumers and shippers. This percentage also continues to go up in tune with oil prices, according to Costello, due to the fact that oil accounts for a large chunk of shipper and carrier freight transportation budgets.
Case in point, Costello noted that as recently as 2006 fuel was a little more than 20 percent of a traditional truckload carrier’s operating expenses, with wages and benefits accounting for one-third of these operating expenses. But in 2008, it appears—based on anecdotal evidence—Costello said it appears that fuel has surpassed labor as the number one expense for carriers.
“This is very new for this industry,” said Costello. “This means that the costs of domestic transportation are going to go up as oil prices continue to go up.”
And most of the large tractor-trailer combinations on the road today are actually less fuel efficient than they were a few years ago, due to various environmental improvements that have been made to trucks, said Costello. This is coupled with diesel fuel prices surging since earlier this year, on-highway diesel fuel prices peaked at $4.76 in April of this year. What really hurt motor carriers—and all forms of freight transportation, though—is how quickly it went up, because the marketplace could not adjust. And this resulted in a high number of marketplace failures, said Costello.
In terms of failure, Costello said it is not only the weak economy that has caused so many carriers to go out of business over the first half of 2008, but more importantly it has more to do with how quickly fuel prices went up.
“There was a group of carriers that just could not work with their customers to get some relief in that area, and as a result we saw nearly 2,000 carriers go out of business in the first half of 2008—the highest rates we have seen since the last recession,” said Costello. These numbers only include fleets with at least five trucks, although that vast majority of carriers have less than five trucks, which leads Costello to believe that the actual trucking failure numbers are even higher.
Going forward, it is unlikely fuel prices will subside significantly based on projections from the Energy Information Association. And if there is not much in the way of relief—and fall freight (peak) season looming—coupled with homes in the northeast using home heating oil, there may be a spike in diesel fuel prices, said Costello. He said that this is likely to have ramification in terms of freight rates going up.
Taking this another step, Costello said that ATA data indicates that the trucking industry is expected to spend $163.4 billion in diesel fuel in 2008.
“If you take the revenues of all other modes of freight transportation and add them up, it does not come to $163 billion,” said Costello. “This is a big issue. I don’t think that we have seen the full ramifications of higher fuel prices, even if we continue to see some relief.”
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