|
As we all know, the price of oil has increased dramatically over the past 24 months. With oil prices rising above $60 per barrel in recent times, the obvious impact of this increase is felt each time we pull into a gas station. But higher gasoline prices are only the tip of the iceberg when it comes to understanding the impact of rising petroleum prices on the economy. In addition to the price for a gallon of gasoline, we have also witnessed rising prices for "distillates" such as heating fuel, diesel fuel and aviation jet fuel.
Beyond these somewhat obvious categories are a multitude of areas that are also impacted by rising petroleum costs. To get a handle on these costs, the next time you fill up, think about all the materials that get you to your corner gas station. The asphalt in the road that you drove on, the construction equipment used to manufacture that road, the tires on your car or truck, the resins and steel used to manufacture your vehicle, the synthetic materials in the clothes you are wearing and even the plastic in your wallet are all impacted to varying degrees by petroleum prices.
Raw material costs for many industrial manufacturers have risen sharply in recent months. Part of this can be attributed to major events such as Hurricane Katrina, which initially reduced oil supplies by an estimated 1.4 million barrels per day and natural gas supplies by an estimated 8.8 billion cubic feet per day (BCFD). But natural disasters aside, the current price is being driven largely by consumer demand. This is different from past oil price increases which have been chiefly attributed to supply (OPEC) shortages. Despite the increased cost of petroleum, consumers have yet to materially change their driving habits.
The result of higher petroleum prices on manufacturers has a compounding effect. Many manufacturers rely on consumer spending and retail sales, which can change rapidly during an economic slowdown. The fact that a manufacturer is facing higher raw material costs for petroleum-based products at the same time that consumers are paying higher prices for gasoline, natural gas and heating oil can have an exponential impact. Basic chemicals, such as petrochemicals and industrial gases, are made from crude oil, natural gas, etc. These chemical "feedstocks" are used to produce commodity chemicals such as polyethylene and phosphates. These commodity chemicals are eventually used to create a multitude of specialty chemicals used in resins, paints, coatings, adhesives, pharmaceuticals, soaps and more. Clearly, at this level, few if any industries can escape some impact of rising oil prices.
Besides chemicals, other industries that have been directly affected include textiles, transportation, agriculture, rubber, plastics, construction and aerospace. When a company is paying higher oil or natural gas prices to heat its building, using oil or gas fired equipment in its manufacturing process and paying higher raw material prices because of the petrochemical content in those materials, the impact can be substantial. In certain instances, companies have been able to pass some price increases through to its customers to offset these rising costs. However, for those companies that have no pricing power, profitability suffers directly from these increased costs.
For someone managing a portfolio or considering the underwriting of a credit, the key is to monitor the impact petroleum prices will have on the individual company. In the case of one textile manufacturer we recently visited, the combination of higher prices for synthetic fabric, coupled with the large quantities of natural gas used in production, was essentially eliminating its entire profit margin. In another situation, the operating costs, and ultimately profitability, of a glass manufacturer were significantly impacted by the sharp increases in natural gas prices.
With the increasing global demand for petroleum products, particularly given the increasing industrial development in countries such as China, few are predicting a return to oil prices of $30 per barrel. In fact, there have been some experts suggesting that oil prices could well exceed $100 per barrel as global demand continues to grow. While no one can predict the future, it would be prudent to understand what the impact would be on a portfolio company if in fact the price of oil continues to rise dramatically. That analysis should include not only the obvious, such as increased heating or transportation costs, but also the potential impact on raw material costs and production costs. That is why the price you pay at the pump is truly only the tip of the iceberg when it comes to the impact of higher petroleum prices. |
