Producer Prices Rising
NY Times
Published: June 8, 2008

Surging oil prices are beginning to cut into the profits of a wide range of American businesses, pushing many to raise prices and maneuver aggressively to offset the rising cost of merchandise made from petroleum.

Airlines, package shippers and car owners are no longer the only ones being squeezed by the ever-mounting price of oil, which shot up almost $11 a barrel on Friday alone, to $138.54, a record.

Companies that make hard goods using raw materials derived from oil, like tires, toiletries, plastic packaging and computer screens, are watching their costs skyrocket, and they find themselves forced into unpleasant choices: Should they raise prices, shift to less costly procedures, cut workers, or all three?

The Goodyear Tire and Rubber Company is trying to adapt. Its raw material of choice now is natural rubber rather than synthetic rubber, made from oil. To sustain profits, it is making more high-end tires for consumers willing to pay upwards of $100 to replace each tire on their cars.

These steps have not been enough, however, particularly now that the cost of natural rubber is also rising sharply, along with that of many other commodities. So Goodyear has raised the prices of its tires by 15 percent in just four months.

"Our strategy is to raise prices and improve the mix to offset the cost of raw materials," said Keith Price, a Goodyear spokesman. "No one has predicted how long we can continue to do that."

The sense that many companies may be hitting a wall is palpable. Corporate profits peaked last spring and have shrunk since then, Moody's reports, drawing on Commerce Department data.

The housing crisis and the weakening economy are big reasons, but oil prices are adding greatly to the pressure on profits as retailers fail to pass along higher prices to consumers. That helps to explain why expensive oil has not yet pushed up the inflation rate.

So far this year, the nation's employers have been cutting jobs at an accelerating pace, particularly last month, when the unemployment rate jumped to 5.5 percent from 5 percent. But with the vise on corporate profits tightening and the price of oil continuing to climb, more dire action, including job cuts and higher prices, may be in store, economists say, although there is still room to avoid such steps.

"Companies came into this period with extraordinarily high profit margins," said Edward McKelvey, chief domestic economist at Goldman Sachs, "and some of the surge in raw material costs will be absorbed by lowering those profits."

Still, the prevailing attitude that the economy could just keep absorbing higher oil prices is being tested — for the first time in nearly 30 years. Adjusted for inflation, a barrel of crude is now more expensive than it was in 1980, the previous peak.

"The conventional wisdom a couple of years ago was that oil did not have that much leverage over the economy," said Daniel Yergin, chairman of Cambridge Energy Research Associates. "But now it plainly does. People are suddenly paying much more attention to their energy costs and trying to figure out how to manage them."

Goodyear has kept its head above water in part by passing along some of the higher prices to dealers. The dealers, however, have not been able to pass along all of those increases to consumers and are absorbing the difference in lower profits.

Since last spring, the average profits of the nation's corporations — from behemoths like Goodyear to small neighborhood retailers — have declined at an annual rate of nearly 6 percent, government data show.

Even companies that have been performing well in the economic downturn are sounding notes of caution. Take Costco, the discount retail chain, which offers a wide array of consumer goods, food, wine, furniture, appliances, beauty aids and much more.

Costco's profit was up in the first quarter, but James D. Sinegal, the chief executive, says he is "starting to be confronted with unprecedented price increases" for the merchandise that Costco buys to stock its stores. His first response has been to buy in extra large quantities so that he has stock on hand to carry him through subsequent price increases.

"We just made a big purchase of Tumi luggage," Mr. Sinegal said.

Procter & Gamble finds itself in a similar predicament. For its fiscal year beginning next month, it expects to spend an additional $2 billion on oil-based raw materials and commodities. That is double last year's increase, and it is carved from total revenue of just under $80 billion.

Price increases have helped to offset this cost. They have averaged nearly 5 percent for paper towels, bath tissues and diapers, all made with chemicals derived from oil, said Paul Fox, a company spokesman.

Natural oils have been substituted for ingredients made from petroleum; for example, palm oil now goes into a variety of laundry soaps. But like rubber, the cost of palm oil and other natural commodities is rising.

Trying to hold down raw material costs, Procter & Gamble has resorted to "compacting" a few laundry products, Mr. Fox said, so that the same amount of detergent fits into smaller and less costly containers made of plastic, which is derived from oil.

Still, the company's operating profit edged down to 20.1 percent of revenue in the first quarter, from 21.9 percent in each of the two previous quarters. "That 20.1 percent was down, but it was an improvement on the advance guidance we had given for that quarter," Mr. Fox said.

No business in America produces more of the oil-based ingredients that go into the nation's products than the Dow Chemical Company, based in Midland, Mich. From Dow's petrochemical operations come the basic ingredients of a wide variety of plastic bottles and packaging, including numerous containers once made of glass or tin.

Indeed, paint, computer and television screens, mobile phones, light bulbs, cushions, paper, mattresses, car seats, carpets, steering wheels and polyesters are all made with ingredients that Dow and other chemical companies refine from oil and natural gas.

Dow normally raises prices piecemeal. Last month, though, the surge in the cost of oil and natural gas, the company's principal raw materials, produced a rare across-the-board price increase of as much as 20 percent.

"We have taken out head count, automated, been very diligent on cost control," said Andrew Liveris, Dow's chairman and chief executive, "but these surges in energy prices are just one surge too many."

Dow's sweeping price increases will probably have a domino effect, resulting in higher prices or, more likely, shrinking profits, analysts say. Constrained by the weak economy and fewer wage earners among their customers, the nation's retailers have so far not been able to pass on to consumers much of the rising cost of products that depend on oil. The Consumer Price Index, minus food and energy, is barely rising.

"One of the surprises," said Patrick Jackman, a senior economist in the consumer price division of the Bureau of Labor Statistics, "is that the oil price surges of the 1970s passed through fairly quickly into consumer prices, and this time that is not happening."

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