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The rising price of oil is making some Chinese imports uneconomical, driving U.S. manufacturers to look for suppliers closer to home.
By Mel Duvall
Also See:Oil's Rise Creating Havoc for Global Supply Chains
"Globalization is reversible." That is the remarkable statement that begins a report by CIBC World Markets on the dramatic impact the price of oil is having on corporate supply chains.
The report's authors, Jeff Rubin and Benjamin Tal, contend that with oil at $130 per barrel the cost advantages of shipping some products from far flung sources overseas, such as China and India, have been virtually eliminated. And with oil forecasted to rise even higher—Goldman Sachs recently predicted oil could reach $200 per barrel within two years—more products will fall below the waterline.
"Higher energy prices are impacting transportation costs at an unprecedented rate," they state in the report, published May 27. "So much so, that the cost of moving goods, not the cost of tariffs, is the largest barrier to global trade today."
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Soaring energy prices are, in turn, creating new pressures for CIOs and supply chain leaders, says Kevin O'Marah, chief strategy officer for Boston-based research firm AMR Research. It is up to those leaders to provide their businesses with software and business intelligence tools to make decisions on where best to source goods, and at what threshold it may make sense to switch to a closer supplier.
Software packages, such as transportation and logistics management offerings from vendors like i2 Technologies, Manhattan Associates, Oracle and SAP, allow companies to weigh a wide range of variables, such as the cost of the good at source, fuel and transportation rates, tariffs, and landing fees, to determine where best to source products. As the price of fuel rises, perhaps making one supplier uneconomical, companies also need to have flexible enterprise systems in place to automate changes in workflow, such as purchase orders and accounting.
Consider, for example, the costs involved in transporting a 40-foot container from Shanghai, China, to the U.S. eastern seaboard. In 2000, when oil was roughly $20 per barrel, it cost only $3,000 to ship a container. Today, with oil at around $130 per barrel, it costs $8,000. Should oil climb to $150, it will cost $10,000 and at $200 per barrel, it will be $15,000.
Rubin and Tall suggest that with such potentially dramatic transportation cost increases, the huge wage differential between the U.S. and Chinese labor is being offset to a degree that some products are now clearly cheaper to manufacturer domestically.
Take steel. One ton of rolled steel requires about 1.5 hours of labor, but at the same time its weight and volume incur high freight costs. China and most parts of Asia must also, for the most part, import iron ore for steel production, and when combined with the roughly $90 freight cost of shipping a ton of hot-rolled steel to the U.S., China loses its advantages. The impact is already being felt. Chinese steel exports to the U.S. are down 20% year over year, and domestic U.S. steel production has risen almost 10%.
Rubin and Tal don't attempt to suggest Chinese imports will suddenly come to a dramatic halt, but they do argue that importing certain products—like steel, furniture and paper products—will no longer make sense. Nor do they think production will necessarily shift back to the U.S. The rising price of oil may give closer supplier countries, like Mexico and Brazil, a chance to seize the opportunity.
With oil at $130 per barrel, the 40-foot container that costs $8,000 to ship from Shanghai, is only about $3,000 to transport from Mexico, and with oil at $200 per barrel, it would cost about $5,000 to ship the container from Mexico, compared to the $15,000 for Shanghai.
"While there remains a strong imperative in the world economy to arbitrage wage costs, the arbitrage will increasingly take place within the constraints imposed by soaring transport costs," they conclude. "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."
Choosing to drop a trusted supplier and bring on a new partner can be a difficult decision and cause repercussions down the supply chain. That's why companies will need to lean on their IT departments for tools to ensure they carefully vetted the business case.
"Companies need to be looking at their models, and asking questions like, 'What to we do if oil reaches $150, or if it reaches $200?'" says O'Marah. "You need to have access to the right information to make those decisions."
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