Originally created 01/31/05

Energy costs trickle through global economy

There's nothing like a trip to the gas station to raise one's awareness of energy prices. Yet it doesn't require filling up the tank - or opening a utility bill, for that matter - to feel the bite of rising fuel costs.

Carpet, fertilizer, paint, polyester and plastic toys, all of which are petroleum-based, are more expensive to make, wrap and ship these days. As a result, companies around the globe are struggling and a growing number are charging more for well-known products, including Goodyear tires, Scotts fertilizer and Kenmore refrigerators.

So far the price increases have been modest, and economists say there is little threat of inflation or other serious damage to the economic recovery. But if energy costs stay high, consumers might have to dig even deeper for home furnishings, auto parts, agriculture products and more.

"As long as the economy stays strong and the basic commodities prices stay very high, products made from these commodities are probably going to increase in price," said Bill Jewell, vice president for energy at Houston-based Dow Chemical Co., the largest U.S. chemical manufacturer.

Energy markets got a minor break this weekend from OPEC, which did not cut production when it met in Vienna. That's what some OPEC members, fearful that a supply glut would develop, were advocating - at least until oil prices neared $50 a barrel last week.

Instead the cartel decided to keep its daily production ceiling at 27 million barrels, but said it might have a telephone consultation - based on market conditions - before its next meeting in March.

Crude futures are now about $47 a barrel, though many analysts believe prices could average more than $40 a barrel in 2005 due to strong demand from China and the United States, instability in Iraq and Nigeria and the cautious production strategies of OPEC members and publicly traded oil giants.

In the meantime, the evidence of high energy costs trickling through the economy only grew last week.

Dow Chemical said it raised prices 28 percent in the fourth quarter, helping it boost profits by 10 percent. One of its key products is polyethylene, a derivative of natural gas, that is used to make everything from shower curtains to plastic bottles. By contrast, appliance maker Maytag Corp. blamed higher costs for energy and raw materials as it swung to a bigger-than-expected fourth quarter loss.

"Even some of the goods coming from China are starting to increase in cost," said Don Duncan, president of the Washington-based Society of the Plastics Industry - an assertion backed by some Chinese manufacturers.

Yet despite the extra burden felt by manufacturers in the U.S. and abroad, many of whom say it isn't always possible to pass along higher costs, economists say there is little risk of severe or widespread financial pain.

Steven Wieting, a senior economist at Citigroup in New York, said a major reason why consumer prices haven't risen sharply in the United States is that as people spend more on energy-intensive products and services they naturally rein in spending in other areas.

"You'll find that the price of plenty of things will go up, but then the demand for other things will go down," he said.

Similarly, Federal Reserve Chairman Alan Greenspan has repeatedly nodded to higher energy prices as an area of concern for the economy, while maintaining that there is little risk of consumer prices spiraling out of control. That said, Fed policymakers may very well raise interest rates when they meet this week in Washington in order to keep inflation in check.

Because customers have shown they are capable of tapping the brakes on spending, many manufacturers say they have only passed along a portion of the higher costs. In some cases, stiff price competition forces businesses to absorb the higher costs in their entirety.

At the Beijing Paint Products Factory in China, the cost of petroleum-based raw materials have risen more than 50 percent in the past two years, squeezing profit margins at a time when the fuel needed to run machinery and transport goods is also more expensive.

"Prices for our end products have risen only 6 percent to 8 percent during that same time, so rising oil prices have hurt our profitability," said Zhang Jing, manager of production.

Shao Zhijin, chief engineer at the Beijing Xuelian Wool Spinning Garment Factory, shares those headaches, having seen costs for polyester and acrylic fabrics rise by more than 10 percent and 50 percent, respectively, in the past two years while retail prices have only risen marginally.

Brussels-based carpet manufacturer Berry Group raised its prices about a month ago, but is finding out there is a limit as to how far it can go.

"We're vertically integrated so we produce the yarns ourselves, so that's a big help," said market manager Philippe Harinck. "But the main problem is to get the price increases through to the customers."

Similarly, Germany's BASF AG has been charging more for its products. Rising demand for petrochemicals as the global economy recovers has helped BASF and U.S.-based competitors such as Dow Chemical achieve pricing power.

But BASF spokesman Michael Grabicki said the company could be forced to cut output if the economy weakened and customers no longer needed to swallow higher prices.

Linda Yueh, an economist at the London School of Economics, said high oil prices have had less of an inflationary effect in Europe because of the strength of the euro against the U.S. dollar. However, she expects producer prices to increase if energy costs remain high, causing the most pain in manufacturing centers such as Germany and France, both of which run a trade surplus. Service-oriented businesses will be less affected, she said.

"As to whether that leads to inflation," Yueh said, "if the oil prices are calculated and built into producer prices, it's possibly inflationary. But the effects are not as severe as if you had an unexpected rise in oil prices, like a shock of some sort."

The biggest shock by far caused by high oil prices has been to the U.S. airline industry, which has been unable to raise fares due to stiff competition and which lost nearly $9 billion in 2004.

The outlook is less dire for energy-intensive manufacturers.

The Scotts Co. absorbed higher costs for urea and other petrochemicals in 2004 and didn't raise prices for fertilizer, weed control and other agriculture products on the assumption that natural gas prices would come down. "Going into 2005, however, it became more clear to us that there wasn't going to be any relief," King said, explaining the company's recent decision to raise prices by 2 percent to 4 percent.

Other U.S. companies that have announced price increases due to higher costs for raw materials, energy and transportation include Goodyear Tire and Rubber Co., which uses synthetic rubber made from petrochemicals, and Whirlpool, which relies on petroleum-based plastics and resins for its wide assortment of white goods.

Still, economists said rising prices are not entirely inconsistent with a financial recovery and that, as long as interest rates remain relatively low, consumers have the ability to borrow money cheaply.

Another reason the U.S. economy has been able to grow amid soaring fuel prices is that America is far more energy efficient than it was 30 years ago, when the Arab oil embargo caused an oil price burden that sank the country into recession. Moreover, oil futures would need to reach $80 per barrel to surpass the all-time peak, in inflation-adjusted terms, set in February 1981.


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