Wednesday, May 14, 2008

Risk Impacts Of The Earthquake In Sichuan Province, China – Part 2

This updates my previous analysis on the prices of commodities as noted in Beijing Summer Olympics' Impact On Commodities Prices.

Expect to see a spike up in the prices of oil, natural gas, coal, coke, steel, copper and other base metals, cement, building materials, petroleum derived industrial chemicals, fertilizers, and rice.

Sichuan is a major supplier of products in China:
Factors For The Prices Spike

  • So far, an estimated 15,000 people have died with millions currently displaced from their homes. Given the chaotic condition, it is difficult to ascertain how quickly the region’s manufacturing, mining, farming, and fabrication works will be back up and running. Right now, everyone’s concern is survival, food and water, and shelter. Basic services as electricity, sanitation, and portable water are still out and will be for some time.

    It will take months before the area recovers sufficiently to begin producing in any meaningful quantity due to:
    • missing, dead, or injured skilled workers will need to be replaced
    • basic services need to be back online, including semi-permanent shelters, electricity, sanitation, and portable water
    • factories and mines need to be thoroughly inspected for safety prior to resumption of activity
    • areas close to damaged dams may be off-limits until the damages have been properly repaired

  • Travel into Sichuan province is extremely difficult due to its geography (click here for a map of Sichuan). Historically, there are only three access points into and out of Sichuan province, according to Xinhau News Service: the dangerous Yangtze Gorges in the east, the treacherous Changtao road across the mountains in the north, and the deep canyons and swift currents of the Dadu River and Jinsha River in the west.

    Given the extensive damages to the rail, bridges, and roadways, access into Sichuan province is even more difficult. This will make the influx of search and rescue operations, relief supply, and commodities a very slow process, resulting in substantial reduction in exports of products out of the region and necessary raw materials into the region.

  • Sichuan region is currently in its rainy season. According to Xinhau News Service, the rainy season begin in April and peaks in July and August. Given this, the rescue and cleanup process will take longer and will require more rescue and cleanup personnel.
Items That Will See A Temporary Price Spike
  • Agricultural products, especially rice - “Sichuan is also one of the major agricultural production bases in China, its output of rice, wheat, rapeseed, citrus fruit, peach, sugar cane, sweet potato and Chinese herbs all account for a significant share of China’s total.” “In 2006, its added value in the primary industry ranked 4th among all provinces.” - Hong Kong Trade Development Council. Due to the earthquake, agriculture production in Sichuan province will fall far short of its normal output, putting additional strain on staple supplies and prices. Since rice is a staple grain of China, there will be a need to import rice. This will further drive up the price of rice.

  • Oil, Natural gas, Coke, and Coal - Earthquake forced closure of natural gas, coke, and coal production. The reduction of coal and natural gas from the Sichuan area will lead to China importing more oil, natural gas, coke, and coal to make up for the shortfall and panic buying and hoarding that will occur.

    Additionally, the earthquake has damaged power generation capacity in Sichuan, which accounts for approximately 8% of all power production in China. Down power lines, damaged the dams, and damaged electric relay stations means that China will have to divert power from other regions to the Sichuan province until the province power generation structure can come back online. This will mean other regions of China may face temporary energy shortage and even brownouts, causing companies to hoard diesel, coal, and natural gas to ensure that they have adequate supply for their back up generators. The combination of these factors will drive the prices of oil, natural gas, coke, and coal higher.

  • Copper - Southern Sichuan region is a part of the major copper deposit in China, according to the China data center. The earthquake will have a material effect on the copper mine production as the mines will be shut down for sometime. Even when the mines come back on line, it will take time to get back to full production due to shortage of fuel, skilled workers, and other vital intermediate items.

  • Steel - Sichuan provides approximately 10% of China’s steel. With iron and coal mines closed, iron and coke will be in short supply, which will negatively affect steel production. Also, current production would most likely be placed on hold due to logistic issues such as how to transport the material in and out of the region and sufficient skilled workers at each production stage. Finally, the rebuilding of damaged areas of Sichuan province will require vast amounts of steel, so the price of steel will not go down. Rather, expect to see major price increases.

  • Chemical Products - Sichuan area supplies nearly 8% of China’s chemical products and raw chemical materials. With the damage to two chemical plants in Shifang, up to 100 plant workers have been buried under debris. Additionally, the spill of liquid ammonia requires extensive cleanup prior to the chemical plants restarting. Some of the chemical plants in Shifang include Hongda Chemicals (dye, pigments, food additive, rubber & plastics, drug intermediates), Shuangsheng Chemicals (phosphate, a key ingredient in fertilizers), Yongchang Chemicals (pigment) and Yunxi Chemicals.

    Given this, intermediate chemicals for producing fertilizers, food additives, pigments, and pharmaceuticals will have to be imported to make up the shortfall from the Sichuan region. This will drive up the price of these intermediate items as well as the finished products that rely on them.

  • Cement and Building Materials - After the cleanup, there is the rebuilding stage. With the rebuilding, there will be a strong emphasis on following proper construction codes and use of proper strength materials. This is the backlash from the use of inferior building materials in existing buildings and poor construction oversight. As the city rebuilds, it will use a large quantity of steel, cement, concrete, and other building materials

    Ed Kim
    Practical Risk Manager

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