Quotes of the Day

The factory floor at Asia Tile, in Surabaya, Indonesia, about 650km from Jakarta, is not a very happy or productive place these days. Earlier this summer, the company sent a quarter of its 2,700 employees packing, and employees fear another round of layoffs may be imminent. The reason, says Bambang Wicayo, the company's technical manager, is no mystery: skyrocketing oil prices have increased the cost of bringing in raw materials and delivering goods, while higher natural gas prices make it more expensive to fire the kilns that produce tiles. "If the price of gas continues to go up, we will not be able to compete," says Wicayo. "Things are only going to get worse."

Welcome to Oil Shock 2005. The spot price of brent crude hit $68 last Thursday—up 44% in the past 12 months—before easing slightly the following day. With the price of oil on the rise, its effects in Asia, on producers and consumers alike, are everywhere to be seen. Last week Beijing continued its frantic push to secure foreign energy reserves when China National Petroleum, a state-owned oil company, trumped an Indian government-controlled firm with a winning $4.2 billion bid for PetroKazakhstan, a Canadian-owned firm with vast oil and gas reserves in the former Soviet republic. China certainly needs the go juice. Motorists lined up for hours at filling stations in the country's southern province of Guangdong two weeks ago, waiting to fill tanks with petrol that was suddenly in short supply. The scenes of idle gas pumps and irate drivers, which evoked memories of oil shocks of the 1970s, were the result of weather-related supply disruptions, according to the government. The fuel flow was quickly restored, but no one is willing to predict the gas lines won't recur.

The impact of the 21st century's first oil alarm was equally apparent in other developing Asian countries. In Indonesia—a proud member of the OPEC cartel, never mind the fact that it's now a net importer of crude oil—the currency is in free fall and the government is burning through its foreign exchange reserves, thanks to a longstanding and increasingly ruinous policy of providing subsidized fuel to consumers. Gasoline in Jakarta costs a mere 27¢ per liter; some economists worry that if the government continues to spend an estimated $1 billion a month on fuel subsidies, as it's currently doing, a rerun of the 1998 financial crisis isn't entirely out of the question. In the Philippines, the fallout from higher oil prices only deepens the troubles of embattled President Gloria Macapagal Arroyo. A four-day work week and gas rationing are among the economically dubious coping strategies that Manila is now mulling. Arroyo, who has stopped flying and reduced the number of SUVs in her presidential entourage as a symbolic step, pleaded with her nation last week to conserve energy. "We must act now before it's too late," she said, "before the ruin sets in because of callousness and complacency."

Even developed, energy-efficient economies like Japan and South Korea are feeling oil's bite. Growth in Korea is likely to be at least 20% below what the Ministry of Finance and Economy was targeting at the beginning of the year, economists estimate. In Japan, $60 oil for 12 months could shave half a percent off GDP growth in an economy that had recently begun to perk up, according to Reiji Takeishi, a senior fellow at the Fujitsu Research Institute in Tokyo. The oil-price hikes so far, estimates Morgan Stanley economist Andy Xie, mean the Asia-Pacific region is spending 1.2% more of its total GDP on oil imports than it did last year. "There's no question that oil is the strongest headwind for growth now," says Xie. And if crude prices stay at current levels or go higher, the pain will only intensify. "This is a very delicate moment, no doubt about it."

Just how delicate? That depends on where the price of oil goes from here. The oil industry is already producing flat-out, and demand is still increasing—albeit not as quickly as last year—driven by increasing consumption in China, India and the U.S. Unless that demand cools, the fear is that prices will inevitably continue to surge. Analysts who expected global economic growth to slow—thus curbing some demand for crude—as oil passed $40 and then $50 per barrel have been proved wrong. "Warnings that [$50-a-barrel oil] would threaten a global downturn turned out to be too pessimistic," says Richard Berner, an economist at Morgan Stanley in New York. With prices threatening to bust through $70, though, the chances of an energy-related economic slump are growing by the week.

For many, that slump is already here. Jung Jun Ki, 65, owns a factory south of Seoul that makes plastic containers such as lunch boxes and trash cans, which are produced using oil-derived polypropylene. Jung, whose factory employs about 50 people, says as many as 40% of Korea's small and mid-sized plastics manufacturers have gone out of business in the past 18 months because, in a highly competitive industry, they've been unable to raise prices to compensate for higher production costs—the price of polypropylene has soared from $800 per ton last year to $1,200 per ton today. "Consumers expect plastics to be cheap," says Jung, whose own raw-material costs have increased by 50% in the past year without him increasing prices. "Now I lose money on every plastic container I make. Maybe it's about time I retire."

For Asia—indeed for the world—retirement is not an option. The critical question now is what impact the current surge in oil prices will have on the global economy's two great growth engines, China and the U.S. To a remarkable extent, the two economies have so far seemed bulletproof, absorbing the price hikes and steaming ahead. China grew at a shade under 9% last year and its oil consumption rose more than 15%. But due in part to its outmoded factories and lack of insulation in most buildings, China is a highly inefficient user of energy: to produce a dollar of GDP it burns two and a half times the energy that the U.S. uses, and nine times what Japan consumes. Analysts now worry that the economy is finally beginning to show the strain. "We're particularly concerned that rising energy costs will amplify the existing squeeze on corporate profit margins in China," says Ben Simpfendorfer, an economist at JPMorgan Chase in Hong Kong. Indeed, Shanghai Petrochemical, a unit of the state-owned oil company Sinopec, warned last week that profits in the second half of this year will decline significantly. If other companies feel a similar pinch, as Simpfendorfer fears, that could crimp one of the main drivers of China's current economic boom—spending by companies to build and equip new factories and other businesses. While the economy is still growing at an impressive clip, says Morgan Stanley's Xie, the trend toward deceleration "is pretty clear."

And as China goes, so goes much of Asia, because the mainland's booming demand is critical for regional industries as diverse as Malaysian palm oil, Korean steel and Japanese high-definition TVs. Optimists point out that the impact of the oil-price spike may be softened by the fact that coal, not oil, generates most of China's electricity, somewhat shielding its factories from the effect of rising oil prices. The government also limits the impact of rising fuel costs by dictating the price of gasoline and diesel at the wholesale level each month. Wholesale gas prices in China are currently about 80% of what the market price is in, say, Singapore. But fixing prices at an artificially low level also has the less-desirable effect of cutting profits at China's major refiners—all of which are state-owned. Energy analysts suspect this was one reason for the recent gasoline shortages in southern China, with some companies perhaps holding back oil from the domestic market rather than selling it at a steep discount. Still, the overall economic impact of higher fuel costs may not be calamitous, even if Beijing allows wholesale prices to creep up closer to market levels. For one thing, only seven out of 1,000 Chinese own cars, compared with 222 out of every 1,000 people in a country like South Korea.

More pressing for China and the region: the impact of oil on the world's most powerful economy, the U.S. Like China, America has absorbed the rising price of crude with surprising ease so far. But $70, if that's where prices stick, is a different story. It's already clear, at least anecdotally, that the oil virus is finally beginning to have an impact on spending by U.S. consumers, who drive much of the world's demand. Wal-Mart, for example, has warned that its profits are already getting hit by high gasoline prices. And the retail giant may not be alone. According to the University of Michigan's monthly survey, released last Friday, consumer confidence in the U.S. dropped sharply in August, due mainly to oil. "If growth in the U.S. slows significantly, all of Asia's exporters will feel it," says Xie. The good news is that oil demand falls when the economy flags, which in turn sends the price back down—sometimes sharply. But economic recession is a painful way to get cheaper gasoline.

In the meantime, governments in the region are scrambling to cope with the oil shock—risking popular ire in the process. Malaysia, a net exporter of oil, cut its subsidies on gasoline and diesel fuel by 7% and 23% respectively last week. Indonesia did the same in March, increasing the price of gasoline by 29%. In Thailand, Prime Minister Thaksin Shinawatra, who last year resisted pressure to eliminate fuel subsidies during an election year, reversed course this year as the oil bills mounted. On July 12 he announced the end of subsidies, which he hopes will curb demand for oil imports that have wrecked Thailand's current account. Last year, Bangkok ran a $7.1 billion current-account surplus, versus a deficit of $6.2 billion in the first half of this year.

In Beijing, too, the soaring price of oil and sporadic gas and diesel shortages are drawing the attention of the government, which has drafted plans to levy steep taxes on gas-guzzling cars and SUVs. The new taxes could add as much as 27% to sticker prices. As one of the world's growing gas hogs, China's conservation efforts matter enormously. But it will take time for such measures to have much impact—and until they do, China's neighbors may simply have to get used to oil at almost $70 a barrel. It's a painful prospect.

• Bill Powell Shanghai
• Queues at filling stations in China, gas rationing in the Philippines, job losses in Indonesia—the global oil-price crunch is starting to get real. Will Asian economies run out of gas?