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As crude-oil prices soared to record levels in July, South Korea's flagship airline, Korean Air, established a nine-member fuel-management team charged with a single purpose: contain escalating fuel costs by wringing every last bit of mileage out of their aircraft. One idea the team floated during early brainstorming sessions was to ask crew members to lose 4.5 kilograms each, thus lightening in-flight loads. Another was to install rest rooms next to airport gates, using the power of suggestion to encourage passengers to shed a few grams by relieving themselves prior to boarding. Someone even proposed limiting the number of toothpicks in the aircraft galley to one per passenger. These ideas were discarded, but more practical ones were quickly implemented. Korean Air removed two unused TV antennas previously mounted on the rear of all its planes. The reduction in drag saves almost 30 kilograms of jet fuel per hour. Pilots now shut off one engine while they taxi, saving yet more fuel. And luggage is now loaded farther aft, shifting each plane's center of gravity and helping to keep the nose lifted with less power while flying. "We've got to make these ideas work," says Lee Chul Hyung, head of the fuel-management team. "Fuel costs are gobbling our profits. What could be more serious than that?"
Because fuel now accounts for more than a quarter of operating costs, airlines are particularly vulnerable to rising oil prices. But with crude rising to more than $49 per barrel on Aug. 20—compared with an average of $20 per barrel over the past 15 years—few businesses in Asia are unaffected. Although there was a sigh of relief as the price fell back to about $43 last week, oil is still more expensive than it has been in the past 20 years—and the realization is sinking in that Asia may have to learn to live with higher energy costs indefinitely. With OPEC producers struggling to pump enough to meet booming global demand—and with supplies jeopardized on an almost daily basis by political events in Russia and Venezuela and by terrorist attacks in Iraq—energy experts predict that oil is unlikely to fall to less than $30 per barrel and will probably remain substantially higher. Prices "are going to start with a 3 or a 4 for some time," warns Spencer White, chief Asia strategist for Merrill Lynch.
So far, oil's effect on Asia's economic performance has been muted. The region as a whole is projected to grow at a brisk 7% pace in 2004, according to Merrill Lynch. But economists estimate that every $5 increase in oil prices shaves 0.2% from the GDP growth of the Asia-Pacific region, and the longer prices stay high, the stiffer the economic headwind. In the past few weeks, Asia's export-led economies have begun to show signs of stress. With higher oil prices putting a drag on consumer spending in America and raising costs throughout Asia's supply chains, "We are facing a lower growth path over the next 12 months," says White.
For inefficient manufacturers and companies that can't pass higher costs on to customers due to competitive or contractual constraints, a world of $40-per-barrel oil could prove distinctly inhospitable. The Chinese city of Yuyao, a sprawl of factories and warehouses about three hours from Shanghai, has been a center for the plastic trade and related light industry for more than three decades. Last year, the roughly 1,000 merchants in Yuyao's main commercial district did $1.7 billion in business, selling everything from granulated PVC to finished plastic products, such as grips for fishing rods and motorcycle windshields.
But petrochemicals are a major component of plastic, and Yuyao—often known as "Plastics City"—is under siege. According to local merchants, the price of a ton of ABS (acrylonitrile-butadiene-styrene), a common ingredient in hard-plastic products, has virtually doubled since March. "The prices for raw materials have gotten so high that no one is making a profit," says Mrs. Xu, who runs a small raw-materials factory with her husband. Xu, who declined to give her full name, says many of the factories she supplies have gone bankrupt this summer. Xu Songquan (no relation), who has been in the plastic-molding business since 1977, explains that factory owners who negotiated contracts with foreign companies earlier in the year when the price of oil was lower "settled on an export price, and now they can't make money so they're just going bust." Adds Zheng Shihua, who runs a trading house out of a storefront that doubles as his family home: "I never dreamed the prices would get so high. I'm scared to buy raw materials now, because I don't know when the price will fall. It's like playing the stock market."
The tumult in one Chinese industrial backwater may seem a minor concern, but it has ominous overtones for the rest of Asia. China's fast-growing economy and voracious appetite for raw materials (as well as for cars, cell phones and other middle-class baubles) has made it an increasingly key trading partner for its neighbors. Demand from China, for example, played a large role in hauling Japan's export-driven economy out of a prolonged slump. The mainland's neighbors have already been warily monitoring Beijing's efforts to cool overheated sectors such as real estate, fearful that clampdowns on credit and investment could crimp their China trade. Now there's a new worry: "China's dependence on oil is very high," says Shuji Shirota, chief economist at investment bank Dresdner Kleinwort Wasserstein in Tokyo. "If [oil] prices choked off growth in China, that would have a big effect on Japan."
Indeed, when it comes to oil, Asia faces a peculiar conundrum—a kind of macroeconomic China Syndrome. Vigorous mainland growth is great for regional trade, but China's outsized appetite has also driven up global commodity prices, including for crude. China, which is expected to consume 6.3 million barrels of oil per day in 2004, surpassed Japan last year to become the world's second-biggest oil guzzler (trailing only the U.S.). China "is emerging as one of the most decisive factors" in global energy markets, according to a June report published by Cambridge Energy Research Associates, a U.S.-based consultancy. This year, global consumption of oil has jumped by 2.5 million barrels per day, the sharpest rise in demand in 30 years. China's surging oil imports accounted for as much as 30% of the increase, according to Jeff Logan, senior energy analyst for the Paris-based International Energy Agency.
The worry for Asia is that it's more exposed than other parts of the world to future oil shocks—whether caused by China's newfound love of automobiles or, say, by a pipeline explosion in Iraq. That's because the region is poor in oil resources. Only Indonesia and Malaysia are net exporters of oil; the rest of the region depends heavily on expensive imports of Middle Eastern supplies. Asia's oil imports as a percentage of GDP are three times higher than the U.S.'s and the European Union's, according to a recent report by Goldman Sachs. Industrialized Japan and South Korea are especially vulnerable as the world's second- and fourth-largest oil importers.
Little wonder that U.S. Federal Reserve Chairman Alan Greenspan warned last month that "the recent run-up in oil prices, if sustained, may exert a significant drag on Japanese economic activity." Although oil is not the only factor, Japan's robust spurt does seem to be flagging: GDP growth slowed to 1.7% in the second quarter from 6.6% in the first quarter, and recent data on inflation, joblessness and consumer spending were all weaker than economists expected.
Still, no one envisions energy prices knocking Japan back into recession. Since the 1970s oil shock, the country has diversified its energy sources—expanding nuclear power and natural-gas use, for example—and has learned to conserve. Japan consumed less oil in 2003 than it did in 1993. "High oil prices are a big issue, but they don't blow the economy off the map the way they used to," says Ken Courtis, vice chairman of Goldman Sachs Asia, in large part because "there has been a tremendous attempt in Japan to produce more with less." The specter of American consumers cutting back on spending because of steep increases at the gas pump may, in fact, pose a bigger danger to Japan than oil shortages. "As long as it's a short-term [price] rise, the economy can deal with it," said Heizo Takenaka, Japan's Financial Services Minister, at a recent press conference.
But South Korea hasn't sufficiently diversified its energy base, and the economic outlook there is murkier. Last year, the country spent $23.1 billion on imported oil. That amounted to 4.4% of GDP, making South Korea more exposed to oil shocks than almost any country in the region. (By comparison, energy spending came to only 2.9% of GDP in Taiwan). "In South Korea, no oil means no economic activity," says Ku Ju Kwon, director of overseas exploration at Korea National Oil Corp.
In the country's grimy industrial trenches, the crunch is on. Kim Jong Gwan, manager of a factory west of Seoul, says he paid 74¢ per kilogram at the start of the year for the raw materials he uses to make plastic pipes. Today the price is $1.04. To keep costs down, the factory started using more recycled polyethylene pellets, but competitors are doing the same and the cost of recycled material has jumped 20% and will be up 40% by the end of the year. Kim tried to raise prices, but customers threatened to switch suppliers. So he now finds himself checking the price of oil each morning and worrying helplessly about the possibility of further attacks on Iraq's oil pipelines. "I'd risk my life for this company," he says, "but all I can do is run around trying to scrounge raw materials. In the worst-case scenario, we'll have to close."
That's a familiar nightmare for other manufacturers across the region, from toymakers to electronics companies. Andy Xie, Morgan Stanley's chief economist for Asia, says the region's industrial stalwarts face such competitive markets that they often can't pass along price increases to customers. "They are at the bottom of the global trading system and are the most vulnerable to a price squeeze," he says. Although corporate profits this year have been relatively strong across Asia, Xie expects this to change in coming quarters, with corporate earnings likely to decline next year.
Adding to such concerns, consumer prices in South Korea surged to a three-year high in August, largely due to rising energy costs. Higher prices for heating oil, gasoline and consumer goods act as a brake on domestic consumer spending, which Korea badly needs to boost to revive its economic growth. Recent data suggests that South Korea may be entering a period of "stagflation," in which slowing economic output is accompanied by rising costs. The ruling Uri Party has proposed tax cuts to help spur domestic consumer and corporate spending. But export growth slowed to less than 30% year on year in August, making it less likely that the country can reach this year's target GDP growth of 5%. In this precarious situation, a spike in oil prices might well tip the country into recession. "Needless to say, if oil prices were to approach $50 per barrel and stay there, all bets would be off," wrote Goldman Sachs economist Sun Bae Kim in a recent report.
For now, economists in Asia are keeping one eye fixed on oil prices, the other on China. Second-quarter GDP numbers showed the economy is still growing at a blistering 9.6% per year. But Morgan Stanley's Xie warns that "China can't grow at this speed when oil prices are this high." China's annual oil bill is running at $89 billion, or 5.3% of GDP, twice as high as the global average, says Xie, who worries that if oil prices remain above $30 per barrel, growth rates will inevitably be hit. "They have to slow down," Xie says. "There is no alternative."
China is already suffering from widespread power blackouts because it can't produce enough electricity to meet booming demand. Faced with production-line shutdowns, many factories are generating their own power with diesel generators, further depleting China's overtaxed supply of petrochemicals. One foreign executive whose company has invested in a power plant in Guangdong province says oil prices are so steep that the venture is now barely turning a profit. It can't raise rates because tariffs are fixed by the government—and the government doesn't want to relax tariffs because that would contribute to inflation. "If prices go up a little higher and there's no subsidy in the works, then of course we're going to be shut down," says the executive.
With luck, relief might be on the way. White, the Asia strategist for Merrill Lynch, expects crude to fall to about $35 per barrel, easing the pressure on regional economies. He sees Asia's GDP growth contracting from about 7% this year to just under 6% in 2005—still an eminently respectable performance. But in a world kept constantly on edge by terrorism, the threat of a price shock triggered by a spectacular attack on energy infrastructure or by further instability in the Middle East can't be dismissed. Says the foreign executive at the Guangdong power plant: "Oil is our biggest expense—and our biggest uncertainty."
- Jim Erickson | Hong Kong
- Asian businesses reeling from record-high oil prices are realizing higher costs may be here to stay. How fast economies adapt will be the difference between growth and stagnation