The Rising Cost of Crude Oil Casts a Cloud over the Economic Recovery
At the depths of the Great Recession, a barrel of crude oil cost $40. Last Friday, the number closed at over $104 U.S., with no relief in site. Michael Irvine of the Kent Group, a petroleum consulting firm expressed the view that it's not only the situation in Libya that's causing the spike in crude. " It’s not as much related to the Middle East as many people would think, but more fundamentally on the basis of global crude oil demand having increased steadily for many months now. Demand for crude oil globally is at, or higher than the pre-recessionary levels."
There is a direct inverse correlation between increases in oil costs and economic activity. According to new report on CBC News, for every $10 increase in the cost per barrel of crude oil, GDP decreases by 0.5% over the next 2 years. Journal of Commerce Economist Mario Moreno estimates that U.S. consumer spending growth, excluding gasoline and other energy, is reduced $11 billion, or one-tenth of a percentage point, for each 17 cents that average gasoline prices for all grades rise above $2.90 a gallon. If average gasoline prices reach $4 a gallon in the U.S., he forecasts consumer spending on non-fuel purchases would fall $60 billion or 6.5 percent.
Higher energy prices also reduce consumer confidence, a key component of sustained economic growth. A 4 percent rise in gasoline prices from December to January contributed to a drop in the Reuters/Michigan consumer sentiment index of 72.7, down 1.8, in mid-January.
Of course energy prices are not the only costs on the rise. Prices for other commodities such as copper, steel and aluminum have also been receiving an updraft. Recently there have numerous reports of dramatic increases in food prices, notably wheat. Some experts have suggested that the inability of people to feed their families in Egypt was a large contributor to overthrow of the Hosni Mubarak and has been a key factor in the turmoil in other countries in the region. Other reports indicate that U.S. housing prices may have hit bottom. This suggests that continuing cost increases in food, energy and housing may curtail or even derail economic growth.
This places freight transportation companies and shippers in a tough spot. For many years carriers have adopted fuel surcharge formulas that bear some relation to fluctuations in the cost of crude oil to help offset the rise in fuel costs. While there are some industry standards (e.g. Freight Carriers Association of Canada), there is a significant variance between the individual surcharges levied by each carrier and the energy efficiency of different modes and carriers within modes.
On the other hand, shippers are not shy to negotiate these fuel surcharges. Under pressure, some carriers will roll their surcharges into their freight rates or waive them on occasion to secure particular pieces of business. The key issue for carriers is to maintain the momentum of the energy conservation initiatives (e.g. speed limiters, SMARTWAY, switch from national to regional truckload focus) that were put in place when a barrel of crude oil spiked to $147 in the mid 2000’s.
Shippers need to focus on the basics of freight management. This includes packaging optimization to reduce cubic space occupied, consolidating freight to take advantage of lower cost modes of transport, network design, local versus offshore sourcing and managing lead times/mode switching (e.g. truck to rail) when feasible. Shippers should also be doing their due diligence on their transportation providers, checking on their fuel efficiency (e.g. miles per gallon) and energy saving initiatives.
All eyes will be on the ISM Purchasing Managers Index that has shown positive growth for the past 21 months, to determine if the economic growth curve that we have been on can be sustained through this period of upward pressure on energy costs. The big question is how high will crude oil costs go in the coming weeks and months?