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Rising interest rates probably won''t kill the commodities bull market
By Timothy Aeppel
The Wall Street Journal
Wednesday, March 23, 2005
The recent rise in oil prices is reverberating far beyond the world's
energy-intensive industries, spurring cost increases for everything
from military tents in Iraq and weed killer in Iowa to shoes and
Barbie dolls in China.
The continuing surge is causing companies which a year ago saw higher
oil prices as a passing phenomenon to rethink their strategies. Many
are moving more aggressively to cut costs and raise prices to offset
raw material and energy costs that now appear likely to stay high for
the foreseeable future.
While rising oil prices are contributing to slower growth and higher
inflation, they haven't yet threatened to derail the global economy,
which remains robust and able to absorb the jolt, economists say.
Some companies are absorbing higher fuel costs themselves, while
others are passing on only a portion of the cost to customers.
Still, Germany, Italy, and Japan, all of which had slower growth than
the U.S. before oil prices started rising in late 2003, have seen
their economies contract partly because of higher oil costs. Many
developing countries also are struggling with higher oil bills.
In the U.S., the Federal Reserve yesterday said the rise in energy
prices "has not notably fed through to core consumer prices" as it
raised the federal funds rate a quarter point to 2.75 percent for the
seventh time since June. The rate is charged on overnight loans
between banks. But the Fed did warn of growing pressures on
inflation. And the Labor Department said higher energy and food
prices fueled a 0.4 percent jump in producer prices last month.
The price of oil futures, meanwhile, closed down $1.43, or 2.5
percent, at $56.03 a barrel on the New York Mercantile Exchange, off
the all-time peak of $57.60 hit last Thursday. In inflation-adjusted
terms, oil prices remain well below where they were in the 1970s and
1980s.
Around the globe, rising oil prices are percolating in myriad ways.
Airlines are suffering, for instance, but the direct impact on cargo
carriers is more severe, because they often fly bigger, four-engine
planes, travel longer routes, and stay in the air more hours. Still,
intense competition among passenger carriers has forced airlines to
absorb more of the cost of increased fuel, while carriers have passed
costs on to customers.
Meanwhile, the prices of materials derived from oil, including
plastic and synthetic rubber, also are going up, affecting computers,
packaging and car tires. Even military tents have been hit. Seaman
Corp., which buys petroleum-based coatings for industrial fabrics
used among other things for tents the U.S. military sends to Iraq,
saw a double-digit price jump in oil-derived raw materials just
before Christmas. It recently was told to expect another wave of
increases within 90 days. The closely held Wooster, Ohio, company has
passed part of the increase on to its customers, but also has seen
its profit margins squeezed.
In the U.S. farm sector, some economists expect profit to drop about
20 percent this year from last year's record high of $74 billion, in
part because soaring energy costs are raising prices on everything
from fuel and fertilizer to weed killer.
In Iowa, corn farmers are paying 20 percent more to fertilize their
fields this spring with anhydrous ammonia, a nitrogen-rich chemical
made from natural gas. Prices for natural gas, used broadly in
manufacturing, chemicals and power generation, have tracked oil's
rise and are near their historic highs. Meanwhile, makers of many
pesticides, which use petroleum-derived compounds, are trying to pass
along higher costs with retail price boosts this spring of 3 percent
to 5 percent.
The long-term effect of such changes is unclear. Ken Rogoff, a
Harvard University economics professor and former chief economist for
the International Monetary Fund, says a key difference between today
and the oil crisis of the 1970s is the transformation of "inflation
expectations." Three decades ago, higher oil prices quickly spiraled
into wage and price inflation. Since then, central banks around the
world have proven able to move quickly to stem inflationary pressures
by tightening monetary policy.
"As long as everyone believes the world central banks will raise
rates fast enough to anchor inflation expectations, oil won't
matter," says Mr. Rogoff.
Still, some economists warn that if oil rises to a higher level and
stays there, as some analysts predict, consumers could stop spending,
curtailing economic growth. The scenario is that spending cuts would
eat into employment, further damping consumer sentiment.
Moreover, companies face other sources of inflationary pressure
besides oil and natural gas. Commodities of all types, particularly
key metals such as copper, have soared recently, while a weaker U.S.
dollar has exposed the U.S., China, and other dollar-linked economies
to import-price inflation.
Though consumers so far are absorbing higher gasoline prices at the
pump, they are being hit in other ways. At a recent conference,
Mattel Inc. Chairman and Chief Executive Robert Eckert told analysts
and investors the toy maker was forced to take "a very modest price
increase" of 2 percent to 4 percent in January on its products,
including Barbie dolls, to partially offset what he sees as a long-
term higher cost level for key materials and services linked to oil.
Those include resin plastic, a petroleum-based product that is a
universal component of Barbie and other toys, as well as
transportation. Barbie dolls are made in China and Indonesia and
distributed worldwide.
Rising oil also is boosting the cost of raw materials for diapers,
panty liners, Swiffer dusters and other consumer products made with
petroleum-based fabrics. Polymer Group Inc., a producer of fabrics
made from petroleum-based products, said on Friday that rising costs
of polypropylene and other key petroleum-based raw materials have
forced it to raise prices globally, including on all products sold in
the U.S.
The North Charleston, S.C., company said the price of polypropylene
climbed more than 50 percent in 2004 and has risen an additional 10
percent to 15 percent since December. Polyester prices also have
risen 15 percent since January, the company said. Dennis Norman, a
Polymer Group spokesman, declined to specify how large price
increases will be and said they will vary by global region. The
company operates 21 manufacturing facilities in 10 countries.
Polymer Group says its largest customer is Procter & Gamble Co. P&G
declined to comment on whether the company would raise prices on its
products using PGI material.
Similar effects are being felt outside the U.S. Europe was somewhat
buffered from rising oil prices last year by the weakness of the
dollar against the euro. That made oil imports less costly than they
would have been otherwise. But a relatively stable exchange rate this
year has meant Europe has felt the renewed rise of oil prices fully.
High oil prices were one factor that recently led Germany's BMW AG to
warn its 2005 profit might not be quite as high as last year's record
mark. The Munich-based luxury-car maker says it expects its 2005
results to be "approximately" at last year's level, suggesting they
might be lower, even though the company foresees record sales volumes
this year.
In China, costlier oil has rippled through the fast-growing
manufacturing sector in the form of higher costs of plastic and other
petroleum-based materials that are used to make everything from toys
to pharmaceuticals to house paint. So far, manufacturers have managed
to absorb much of these costs without prompting higher prices for
consumers. Strong and rising demand around the globe for Chinese
products means many companies are enjoying growth in their overall
profits even as high oil prices diminish their profit margins.
But there are indications the situation could change if oil prices
stay high. Paul Goodman, chairman and CEO of DFP Shoe Co., a maker of
women's footwear in southern China, says that during much of last
year, fierce competition prevented him from raising his shoe prices
even as the cost of polyurethane and other inputs rose sharply with
the price of oil.
In recent months, he said, he and his competitors have increased the
amount they charge their buyers by about 5 percent. The increase is
still smaller than the rise in production costs. "You can't just
whack buyers over the head" with a big jump in price, he said. Still,
he said, he anticipates shoe prices will continue to creep up if oil
prices don't come down.
High oil prices are costing manufacturers in other ways. Chronic
electricity shortages throughout China have led many factories to
purchase generators that run on diesel fuel. China's electric grid
becomes especially strained in the summer, when air conditioners are
running across the country, and higher oil prices will mean higher
diesel costs as the weather heats up.
Companies worldwide also are stepping up efforts to curb energy use
in the face of higher prices. Kerry's Bromeliad Nursery Inc. in
Homestead, Fla., one of the U.S.'s largest commercial orchid growers,
has been hammered by the rising price of natural gas to heat its
greenhouses as well as surcharges on shipping plants to big box
retailers like Home Depot. The company recently put insulated shades
in its greenhouses that can be closed at night to cut the heat loss,
shaving more than 20 percent off its heating bills.
"When you're standing next to a 3-inch gas main hissing loudly," said
President Kerry Herndon, "you're listening to the sound of money
burning."
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