In October 2006, the world's biggest container ship, the Emma Maersk, owned by A.P. Moeller Maersk of Denamrk, docked for the first time in the UK port of Felixtowe loaded with nearly 45,000 tons of Chinese-made goods including MP3 players, computers, Christmas trees and crackers. The Emma Maersk, which is 400 metres long (1,300 ft), 56 metres wide and 60 metres tall, and dubbed the SS Santa, unloaded more than 3,000 containers for supermarkets and stores before heading to mainland Europe.

The calculus of globalization has become more complicated as the high price of oil has dramatically increased the cost of moving goods around the globe, posing a major threat to price stability and overseas manufacturing, finds a new report from CIBC World Markets.  Shipping cost is on average the equivalent of a 9 percent tariff on trade. “The cost of moving goods, not the cost of tariffs, is the largest barrier to global trade today,” the report concluded, and as a result “has effectively offset all the trade liberalization efforts of the last three decades.”

The price of crude oil has fallen more than 20 per cent since it closed at a record high of $145.29  in New York on July 3rd last. However, the price is expected to remain high in the long-term because of supply constraints and rising demand in Asia. In December 1998, the West Texas Intermediate benchmark front-end crude price, fell to $10.72 on the New York Mercantile Exchange.

"Exploding transport costs may soon remove the single most important brake on inflation over the last decade - wage arbitrage with China," says Jeff Rubin, Chief Economist and Chief Strategist at Canadian brokerage CIBC World Markets. "Not that Chinese manufacturing wages won't still warrant arbitrage. But in today's world of triple-digit oil prices, distance costs money."

The report finds that the cost of shipping a standard 40-foot container from East Asia to the North American east coast has already tripled since 2000 and will double again if oil prices head towards US$200 per barrel. These soaring energy costs are threatening to offset decades of trade liberalization and force some overseas manufacturing to return closer to home.

"Unless that container is chock full of diamonds, its shipping costs have suddenly inflated the cost of whatever is inside," adds Rubin."And those inflated costs get passed onto the Consumer Price Index when you buy that good at your local retailer. As oil prices keep rising, pretty soon those transport costs start cancelling out the East Asian wage advantage."

Rubin says that these forces may reverse the impact of globalization.

"Higher energy prices are impacting transport costs at an unprecedented rate. So much so, that the cost of moving goods, not the cost of tariffs, is the largest barrier to global trade today."

The report, which was published in May, noted that it cost US$8,000 to ship a standard 40-foot container from Shanghai to the North American east coast, including in-land transportation. That's up from just US$3,000 in 2000 when oil was US$20 per barrel. At US$200 per barrel of oil, the cost to ship the same container is likely to reach US $15,000. Since May, the Baltic Dry Index - a measure of international shipping costs - has fallen 40% because of the slowing world economy, but international business has been given a preview of the impact of sustained high oil prices.

The impacts of these rising costs are already being seen in capital intensive manufacturing that carry a high ratio of freight costs to the final sale price, such as steel production. Soaring transport costs, first on importing coal and iron to China and then exporting finished steel overseas, have more than eroded the wage advantage and suddenly rendered Chinese-made steel uncompetitive in the US market.

Underscoring this is the fact that China's steel exports to the US are falling by more than 20 per cent year over year, while US domestic steel production has risen by almost 10 per cent.

"That's great news if you are the United Steelworkers of America,"says Rubin. "Long lost jobs will soon be coming home. And the more that oil and transport costs rise for Chinese steel exporters, the more that North American steel wage rates can grow. But if you're a steel buyer, your costs are going up regardless of whether you're sourcing from China or Pittsburgh."

Economists refer to the neighbourhood effect - putting factories closer to components suppliers and to consumers - to reduce transportation costs, which may grow in importance in response to sustained high oil prices. Long global supply chains where components and sub-assemblies that make up a product, are made on different continents, are likely to face scrutiny.  

In response to high transport costs, the Swedish furniture manufacturer, Ikea opened its first factory in the United States in May. Some electronics companies that left Mexico in recent years for the lower wages in China are now returning to Mexico, because they can lower costs by trucking their output overland to American consumers.

The New York Times says that plants in industries that require relatively less investment in infrastructure, like furniture, footwear and toys, are already showing signs of mobility as shipping costs rise.

Until recently, standard practice in the furniture industry was to ship American timber from ports like Norfolk, Baltimore and Charleston to China, where oak and cherry would be milled into sofas, beds, tables, cabinets and chairs, which were then shipped back to the United States.

But with transportation costs rising, more wood is now going to traditional domestic furniture-making centers in North Carolina and Virginia, where the industry had all but been wiped out. While the opening of the American Ikea plant, in Danville, Virginia., a traditional furniture-producing centre hit hard by the outsourcing of production to Asia, is perhaps most emblematic of such changes, other manufacturers are also shifting some production back to the United States.

Converting transport costs into tariff equivalents shows how disruptive soaring energy prices can be. Jeff Rubin of CIBC Markets notes that oil at US$150 per barrel equates to an 11 per cent tariff rate - a level last seen in the 1970s. At $200 per barrel of oil, "we are back at tariff rates even prior to the Kennedy Round GATT negotiations of the mid-1960s," he says."Even at US$100 per barrel of oil, transport costs outweigh the impact of tariffs for all of America's trading partners, including Canada and Mexico."

Rubin points to history to show how higher energy and transport costs serve to dampen trade and force markets to seek shorter, and cheaper supply lines. Global exports have soared in all periods over the last 50 years when trade barriers were reduced and oil prices were low, his analysis shows. But he says exports "went absolutely nowhere" during the oil and energy crises of the 1970s, and for several years after despite reductions in global tariffs and healthy recoveries from recessionary periods.

"It's relatively easy to see why North American importers shifted to regional trading during that time,"says Rubin."Trans-oceanic transport costs literally exploded during the two oil price shocks. The cost of shipping a standard cargo load overseas almost tripled, just as it (has) over the past few years. Ultimately, soaring transport costs were borne by consumers and markets responded accordingly, substituting goods that could be sourced from closer locations than half way around the world carrying hugely inflated freight costs."

Rubin says that goods with a low value-to-freight ratio will be the most sensitive to rising transport costs. A "surprisingly high percentage" of Chinese exports to North America fall in this category, and include furniture, apparel, footwear, metal manufacturing and industrial machinery, he notes.

"Freight-sensitive Chinese exports to the U.S. now account for 42 per cent of total exports - down from 52 per cent in 2004," says Rubin, adding he estimates "that if it were not for the dramatic increase in transport costs, growth in Chinese exports to the U.S. since 2004 would have been 35 per cent stronger than the actual tally."

Rubin says there is "certainly no reason why we should not expect to see at least comparable if not greater trade diversification" than was seen during the oil shocks of the 1970s. "Instead of finding cheap labour half way around the world, the key will be to find the cheapest labour force within reasonable shipping distance to your market."

In that type of world, Mexico's proximity to the rest of North America combined with its labour costs will give it a second chance to compete with Pacific Rim production, says Rubin who further predicts that when oil prices reach US$200 a barrel, it will cost three times as much to ship the same container from China than from Mexico.

"To put things in perspective, today's extra shipping cost from East Asia is the equivalent of imposing a nine per cent tariff on East Asian goods entering North America. And at oil prices at US$200 per barrel, the tariff equivalent rate will rise to 15 per cent."

"In a world of triple-digit oil prices, distance costs money. And while trade liberalization and technology may have flattened the world, rising transport prices will once again make it rounder," says Rubin.