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CIBC World Markets InC. StrategEcon - May 27, 200

Soaring transport costs suggest trade should bebothdampened and diverted asmarkets seek shorter, andhence,lesscostlysupplylines.AndthatspreciselywhatwehavewitnessedinresponsetopastOPECoilshocks.

Between1960and1973,exportsasashareoworldGDProsebyover50%,aunctionobothallingtradebarriersandcheaptransportcostswhenoilpricesaveragedlessthan$16perbarrel(intodaysprices).Similarly1987-2002sawanotherquantumleapinworldtrade,spurrednotonlybya30%dropintarisbutbystillrelativelycheap

transportcostsgroundedbyanaverage$27(constantdollars)perbarreloil.Insharpcontrast,exportsasashareoworldGDPwentabsolutelynowherebetweenthefrstOPECshockandtheatermathothesecond,despitea25%reductioninglobaltaris(Chart3).

Nodoubtthe1974and1981/82recessionsdampenedtrade,buttradeshouldhavereboundedstronglyonthebackohealthyrecoveriesromthoserecessions.Annualworld GDP growthaveraged3.5%, roughly the samerateasrom1987-2002whichsawworldtradegrowbyleapsandbounds.Tradeailedtorespondtoapick-up

inglobalgrowthbecausetransportcostswereexplodingduetosoaringoilprices.

TradenotonlyailedtogrowasashareoglobalGDPbutitalsodivertedalongincreasinglyregionallines.Withthecosto trans-oceanicreight surgingollowing the1973OPECshockandintotheearly1980s,theshareonon-petroleumUSimportsromEuropeandAsiaellbyastunning6percentagepointsinlittleoverahaldecade,

whiletheshareoimportsromtheCaribbeanandLatinAmericarosebyacomparableamount(Chart4).

ItsrelativelyeasytoseewhyAmericanimportersshitedtoregionaltrading.Trans-oceanictransportcostsliterallyexplodedduringthetwoOPECoilpriceshocks.Thecostoshippingastandardcargoloadoverseasalmosttripledjustasitdidoverthepastewyears.Ultimatelysoaringtransportcostswerebornebyconsumers,andmarketsrespondedaccordingly,substitutinggoodsthatcouldbesourcedromcloserlocationsthanhal-wayaroundthe

worldcarryinghugelyinatedreightcosts.

AdvantageUS

Towhat extentwill astronomical increases intransportcosts alter the huge (but shrinking) wage dierentia

Chart 2

TotalCostofTransportinga40'ContainerFromShanghaitoUSEastCoast

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

00 05 Current WTI

@$150

WTI

@$200

Inland Transport

Shipping

$

Chart

WorldExportsasaShareofGlobalGDP:HighlySensitivetoOilPrices

Chart

TradeDiversionDuringtheOPECOilShocks

0.25

0.30

0.35

0.40

0.45

66 68 70 72 74 76 78 80 82 84 86 88

0.05

0.10

0.15

0.20

From Europe and Asia (L)

From Latin America & Caribbean (R)

Share of non-energyUS imports

Share ofUS imports

Rate of Change

-20 0 20 40 60 80

1960-73

1974-86

1987-02%

=$15.6

=$50.9

=$27.5

* today's prices

Avg WTI*

8/14/2019 Will high energy prices reverse globalization

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CIBC World Markets InC. StrategEcon - May 27, 2008

Chart

China'sSteelExportstoUSFallWhileUSSteelProductionRises

Source: US Census Bureau, CIBCWM

Chart

USSteelProducersNowHaveaCostAdvantageOverChina

Source: IRST, AISI, JP Morgan, CIBCWM

between Chinese labor and North American laborremainstobeseen.Butwearealreadystartingtoseesomechange in capital-intensivemanuacturingwhoseproductscarryahighratiooreightcoststofnalsellingprices.

Takethesteelsectororexample.Withlittleoveranhour

andahalolabortimeembodiedintheproductionoatonosteel,andrelativelyhighreightcosts,theglobalcostcurveothesteelsectorischangingrapidly.GiventhatmostpartsoChina(andAsiaingeneral)areshortironore,gettingtherawmaterialstothesteelmill(mainlyromAustraliaandBrazil)addsanadditionalandgrowingcostnottypicallyincurredbyUSsteelproducers.Addtoitthe$90reightcostoshippingatonohot-rolledsteelsheetromChinatotheUS,andthetransportcomponentis largeenough to turntheglobal steelcostcurveonitshead.Evenattodaysoilprices,risingtransportcostshavealreadymorethanosetChinasotherwiseslimcost

advantage,givingUSsteelacompetitiveadvantageinitsownmarketorthefrsttimeinoveradecade(Chart5).

The rapidly changing economics o steel is alreadyreected inthetradestatistics.ChinassteelexportstotheUSarenowallingbymorethan20%onayear-over-yearbasistheworstperormanceinalmostadecade.WhilemanymightattributethisdeclinetotheslowdownintheUSeconomy,itisnoteworthythatUSdomesticsteel production has risenby almost 10% during thesameperiod(Chart6).

MexicoAnotherChanceatBat?

Exactlyhowmuchtrade,soaringtransportcostsdiverromChina(ororthatmatteranywhereelse)dependsultimately on how important those costs are in totacosts.Goodsthathaveahighvaluetoreightratiocarryimplicitly small transport costs, while goods with low

valuetoreightratiostypicallycarrysignifcantmovingcosts.

AsurprisinglyhighpercentageoChineseexportstotheUSallinthelatercategory.Furnitureapparel,ootwear,metal manuacturing, and industrial machineryaltypical Chinese exports, incur relatively high transporcosts.

And there is alreadyevidence thatChineseexportsoreight-intensive goods are already beginning to slowunderthepressureorapidlyrisingtransportcosts.

While there has been a general slowdown in exporgrowthtotheUSoverthepastyear,itisnotablethattheslowdownisarmorepronouncedingoodsthatcarryrelativelyhighreightcostscomparedtothosethatdonot.Onayear-overyearbasis,thiscategoryisnowallingorthefrsttimeinmorethan10years(Chart7,let).Freight-sensitiveChineseexportstotheUSnowaccountor 42% o total exportsdown rom 52% in2004Inact,weestimatethatiitwerenotorthedramaticincreaseintransportcosts,growthinChineseexportsto

theUSsince2004wouldhavebeen30%strongerthantheactualtally(Chart7,right).

China's Steel Exports

to the US

-40

-30

-20

-10

0

10

2030

40

50

60

70

Jul-07

Sep-07

Nov-07

Jan-08

Mar-08

y/y % chg

US Steel Production

-6

-4

-2

0

2

4

6

8

10

Jul-07

Sep-07

Nov-07

Jan-08

Mar-08

y/y % chg

200

300

400

500

600

700

800

China US

Raw material, energy & labour Transport to US

Avg cost of producing and shipping

one tonne of hot-rolled steel sheet

$

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CIBC World Markets InC. StrategEcon - May 27, 200

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Chart 8

RelativeShippingCoststotheUSEastCoast:MexicoversusEastAsia

0

2,000

4,000

6,000

8,00010,000

12,000

14,000

16,000

00

05

Current

WTI@$150

WTI@$200

From China

From Mexico

Cost of shipping a

40' container to

US East Coast

($)

Savings by Switchingfrom China to Mexico

0

2,000

4,000

6,000

8,000

10,000

12,000

00

04

Current

WTI@$150

WTI@$200

0

2

4

6

8

1012

14

16

Per 40' Container (L)

Tariff equivalent (R)

%$

Chart 7

ElevatedFreightRatesAreAlreadyImpactingChina'sTradewithUS

Source: US Census Bureau, Golisticsmgnt, De 2007, CIBCWM

Freight-Intenstive

Exports to US

-5

0

5

10

15

20

2530

35

40

Oct-06

Dec-06

Feb-07

Apr-07

Jun-07

Aug-07

Oct-07

Dec-07

y/y % chg

Growth in Non-EnergyExports ($Bn)

2004-2007

219

169

Transport

costs fixed at

2004 level

Actual

Estimated exports"loss" due to

higher transportcosts

Chart 9

Mexico'sNon-EnergyExportstotheUS

60

80

100

120

140

160

180

00 01 02 03 04 05 06 07

Freight-intensive goods that compete directly

with ChinaOthers

Index 2000=100

Source: US Census Bureau, CIBCWM

HowmuchoChinesemanuacturingproductionwillbecominghomeremainstobeseen.Butthereiscertainlyno reason whywe should not expect to see at leastcomparableinotgreatertradediversionthanwesawduringtheOPECoilshocksothe1970s.

While there remains a strong imperative in the world

economy to arbitrage wage costs, the arbitrage willincreasinglytakeplacewithintheconstraintsimposedbysoaringtransport costs. Insteadofndingcheap laborhal-wayaroundtheworld,thekeywillbetofndthecheapestlabororcewithinreasonableshippingdistancetoyourmarket.

Inthattypeoworld,lookorMexicosmaquiladoraplantstogetanotherchanceatbatwhenitcomestosupplyingthe North Americanmarket. Inaworldwhere oil willsooncostover$200perbarrel,MexicosproximitytotherestoNorthAmericagivesitscostsahugeadvantage.

Compare,orexample,howrelativetransportcostshaverecentlychangedbetweenthePacifcRimandMexico.Iin2000Americanimporterspaid90%moretoshipgoodsromEastAsiatotheUSeastcoast,todaytheypay150%more,andwhenoilpricesreach$200perbarrel,theywillpaythreetimestheamountitcoststoshipthesamecontainerromMexico(Chart8).Toputthingsinperspective, todays extra shipping costrom EastAsiaistheequivalentoimposinga9%tarionEastAsiangoodsentering theUS.Andatoilpriceso$200,the

tari-equivalentratewillriseto15%.

ItseemsthatAmericanimportersarestartingtodothemathandalreadyshitingsomebusinessromChinatoMexico.WhilethepaceoshipmentsromChinatotheUSisslowingmainlyamongreight-intensivegoods,evennon-energyMexicanexportstotheUSarestillrisingatahealthyannualrateomorethan7%.Andinterestinglythegoodsthathaveseentheastestgrowtharetheonethat,onaverage,aremorereight-intensiveanddirectlycompetewithChina,suchasurniture,ironandsteel,rubberandpaperproducts(Chart9).

Inaworldotriple-digitoilprices,distancecostsmoneyAndwhiletradeliberalizationandtechnologymayhaveattenedtheworld,risingtransportpriceswillonceagainmakeitrounder.