Feeling The Heat

NEW YORK—As crude oil continues to trade near all-time highs, one question on the collective mind of the toy industry is: what impact will rising oil prices have at retail? After all, factories need fuel to run machinery to make product, many compounds used for making toys are derived from oil and, of course, the product has to be shipped to market.

But production and shipping aside—what about the consumers themselves? Will they come out and “shop”—not to mention, spend—during the critical fourth quarter selling season?

The simple fact is that it costs more to manufacture and distribute toys today, and those added costs will be passed down to the consumer.

In fact, rising oil prices reach even deeper into consumer pockets. People have to heat their homes and fill their vehicles with gas to get to work. Those factors can drastically curtail the amount of disposable income available for non-essential products.

Pawtucket, R.I.-based Hasbro president and CEO Alfred J. Verrecchia, while reporting the company's third-quarter earnings last month, noted numerous factors that might impact the upcoming holiday selling season.

“As we look ahead with the higher costs of gasoline and expected increase in home heating costs, it remains to be seen how much of an impact this will have on consumer spending during the holiday season,” says Verrecchia.

The price of oil year-to-date has risen 48 percent (as of Oct. 18, about $63), according to research released by full-service brokerage firm A.G. Edwards, St. Louis. In a report, analyst Tim Conder writes, “Even more importantly to the toy makers is the price increase in plastics materials and resins used in manufacturing many products and clear packaging.” He says that oil-based resins account for about 7 to 10 percent of the cost of goods sold.

“[Consumer spending] is the question everyone is trying to figure out,” Conder tells Playthings. “We think not so much that the price of gasoline will affect consumer spending, but how cold the winter will be—literally. Plus, what demographic you are talking about. Obviously, [the price of heating a home] will affect some demographics much more than others.”

So, it seems, retailers located in more affluent areas may have less to fear in a consumer spending drop off than those located in middle- or lower-middle income neighborhoods, whose residents may struggle to keep up with the bills.

Conder adds that toy manufacturers have been able to cover this cost by selectively raising prices. In turn, there should just be a bump up in retail prices. But how big is that bump?

“[The effect on retail] pricing is and will be minimal,” New York-based Harris Nesbitt analyst Sean McGowan tells Playthings. “Most retailers raised prices from last year. If it cost $9 last year, now it's $10. I expect no surprises.”

Bloomberg.com recently reported that “U.S. consumers, and the businesses that depend on them, are bracing for what global investment bank Lehman Brothers called a “cold, dark and expensive winter.” This falls in line with the consensus of analysts who are pulling back consumer spending estimates.

The United States Federal Reserve Chairman, Alan Greenspan, states in various published reports that the sharp spike in energy prices that occurred after the Gulf Coast hurricanes will act as a drag on the U.S. economy, but the impact on growth and inflation will not be as severe as the oil shocks of the 1970s.

Greenspan is quoted in a speech to Japanese business executives in Tokyo in mid-October as saying that with world oil markets already exceptionally tight due to rising global demand, that the likelihood of a sizable spike in prices in the face of the loss of Gulf Coast production was “an accident waiting to happen.”

“Although the global economic expansion appears to have been on a reasonably firm path through the summer months, the recent surge in energy prices will undoubtedly be a drag from now on,” says Greenspan.

Everyday consumers aren't the only ones feeling the petroleum pinch. Bunker fuel, the stuff that's used to drive ships, has risen dramatically, raising shipping costs.

“Bunker prices, like most of the heavier products that come out of a barrel of crude, had lagged the major benchmarks of crude before 2005,” says John Kingston, director, global oil, for Platts, New York, an energy reporting and tracking firm. “But propelled by very strong demand, bunker prices have actually gained more this year than the benchmark crude grade, West Texas Intermediate. As the crude pumped on to the market by OPEC members had been heavy, it has tended to be rich in the heavier cuts, such as bunkers.”

Kingston says that bunker fuel prices continue to rise. “But a few things have happened: demand has been strong due to strong shipping markets; refiners have done everything they can to maximize lighter ends, such as gasoline, which has squeezed bunker supplies a bit—bunker fuel has risen almost 80 percent by mid- October from the beginning of the year. New York bunker prices have risen almost 92 percent.”

Jim Dow, editor of Intermodal Insights, the newsletter of the Intermodal Association of North America, tells Playthings that the retailers that will be most affected by the increased surcharges will be the little guys.

“They have added fuel surcharges, but there is a different rate for everything,” says Dow. “Low-value commodities and high-value commodities rate differently as far as charges go.”

Basically, says Dow, a Wal-Mart shipping hundreds of containers is not going to get the surcharge that a small retailer shipping a few might get.

“At the end of the day, it appears that prices will be affected by the surge in fuel costs, but it won't be alarming. A bump up in prices has and will continue to occur, but it will not be one of devastation.”

And on a bright shipping note, A.G. Edwards' Conder says that there is a boom in containership building right now. In a couple of years, there very well may be a glut of shipping space, which will slash shipping fees.