Cheap energy is the new cheap labour

The price of oil keeps on falling; the shale gas boom has reduced the price of natural gas in the US to a third of that in France; Germany has appealed to Sweden for its support in expanding two coal mines; and the EU’s effort to switch to clean energy is troubled. For companies wondering where to locate, the world has turned upside down.

Cheap energy is the new cheap labour. For two decades, the biggest driving force in industrial globalisation was the gap in the price of labour between the developed world and China. That induced many industries – textiles, electronics and others – to shift production from high-cost factories in the US and Europe to places where people would work for a fraction of the cost.


Now, as the wage arbitrage between the north and south narrows, the energy gap is widening. Wage rates adjusted for productivity in China have risen to more than half the level in the US, according to Boston Consulting Group. Meanwhile, energy prices have been falling and the Opec oil-producing countries have failed to halt the decline. Some fortunate countries, especially the US, are gaining from both of these trends at once.

Although cheap fuel theoretically helps every energy-dependent country, the gains are distributed unevenly. The big beneficiary, thanks to shale natural gas, is the US. Not only is it helped by companies bringing manufacturing home but it is also an oasis of cheap gas. That is luring energy-intensive industries such as chemicals, petrochemicals, aluminium and steel.

Europe made the wrong bet. In the long run, making fossil fuels more expensive by subsidising renewables and charging for carbon emissions could bring the EU a steady supply of clean, cheap energy. At the moment, it is nullifying the benefits of lower energy prices and giving European companies an incentive to relocate.

“There are no energy-intensive investments taking place in Europe now,” says Dieter Helm, professor of energy policy at the University of Oxford. “Why would you locate a new investment in a place with both high labour costs and high energy costs, many of which are self-inflicted?”

Plainly, it is a lot more expensive and harder to build a new aluminium-producing plant or chemical works in another country than to outsource textile or electronics manufacturing to an existing plant in China. These are long-cycle, capital-intensive industries that cannot move on a whim.

Energy also takes a lower share of production costs in most industries than wages or raw materials. The EEF, the UK manufacturing body, says that energy comprises 5 per cent or less of costs for 70 per cent of its members. Aluminium-smelting is the biggest fuel-guzzler, at 30 per cent of costs.

European countries have tried to shield energy-intensive industries from the costs of switching to renewables. Germany, whose Energiewende policy of obtaining 80 per cent of electricity from clean sources by 2050 is causing intense stresses, has capped renewables charges to heavy industry, despite EU pressure to limit subsidies.

But the pressures are intense and are unlikely to recede. Even if European countries change tack, no large economy can match the US in shale gas. Even when the US starts to export liquefied natural gas to Europe, it will retain a significant cost advantage.

The comparative significance of energy grows as that of wages lessens. The “onshoring” of US manufacturing is assisted by rising wages elsewhere – between 2006 and 2011, Asian wages rose by 5.7 per cent per year, compared with 0.4 per cent in developed economies. Productivity has also risen: an advanced manufacturing plant often employs fewer than 200 people.

So companies are moving, often by picking the US when they make new investment decisions. BASF, the German chemicals company, is one example: it is allocating a quarter of its €20bn investment budget over five years to the US, and plans to build a $1.4bn propylene site on the Gulf Coast. Natural gas will provide not only the energy but also the chemical raw materials.

Even if a European company keeps a plant open, it can divert some of the production to the US. Voestalpine, the Austrian steel company, is building a €500m facility in Texas, at which it will make iron for two Austrian steel plants. It will use natural gas to power the blast furnaces in Texas rather than the coking coal it uses in Europe.

The temptation for Europe, caught in the middle of transition by unexpectedly low energy prices, is to dismiss such moves as marginal. Only aluminium smelters rely crucially on cheap energy; no company can close a Rhine steel plant for short-term gain; chemicals is a special case, and so forth.

This would be a mistake. In the long run, there are real risks for countries that impose high costs on themselves while their competitors enjoy low ones. If everyone from the US to China adopted the approach together, it would not matter. But in a world of cheap gas and coal, it does.

It is a hard challenge – the US is lucky to have large, accessible shale gas reserves. But Europe must start by realising that the comparative advantage of cheap labour is giving way to that of cheap energy. Turning a blind eye to that fact will not work.




John Gapper




Fonte: FT