Why Companies Are Leaving China

Last Updated May 26, 2011 7:39 AM EDT

Manufacturing will never disappear from China. Still, a growing number of companies are either scaling down their factory operations or moving them out of China altogether. Rising wages and price inflation have been the primary scapegoats. But there's another more deeply engrained problem facing businesses in China: Energy.

Problem 1: Supply and price fixing
China's energy appetite is squeezing its electricity supply, which comes mainly from coal and hydropower. Many Chinese provinces are already rationing power, in part because the worst drought to hit central China in 50 years has impacted the hydropower plant at the Three Gorges Dam. And this summer it's going to get worse.

State Grid Corp., the country's top power-transmission company, announced it would be forced to cut electricity supplies to industrial users this summer even further than expected because of capacity shortages, coal supply problems and a decline in hydropower output, Reuters reported. National power shortages are expected to be even worse than the summer of 2004, when China experienced frequent blackouts and thousands of companies had to shut down.

When supply is tighter than demand, market forces drive up the cost and folks either cut back or pay more. China's fixed power pricing system doesn't allow costs to be passed along to consumers. That leaves the government with the task of pumping the energy brakes through power rationing and issuing tariffs to major industries that exceed consumption limits.

Problem 2: Fuel costs
Even if the factory in China is able to keep the lights on long enough to crank out those widgets, it still has to get them to customers. That means putting them in shipping containers headed for North America and Europe. Thanks to rising fuel prices, that trek is getting more expensive.

AP Moller-Maersk -- which owns Maersk Line, the world's largest container shipper -- told CNBC earlier this month that high crude prices have forced the company to cut fuel consumption and pass costs onto its customers.
When fuel prices go up, we adjust our prices up; and when fuel prices go down, we reduce our prices. We are passing on about 80 percent of the cost to customers, which is very positive. So we are not that affected.
Maersk Line may be doing fine, but the factories in China making products for Walmart (WMT) and Target (TGT) are not. North American and European companies that set up manufacturing plants in China to keep costs low are likely already crunching the numbers. It's a low-wages-versus-energy-costs debate. If China's electricity problems persist and fuel costs maintain their lofty heights, expect energy to trump cheap labor.

Photo from Flickr user peruisay, CC 2.0
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