At first glance, it seems like a contradiction.
Now that North American auto production is rising to record levels, raw materials such as steel, aluminum and copper ought to be more expensive, right?
Instead, they've gotten cheaper — a lot cheaper. Automakers and suppliers are spending about $1,325 per vehicle for their raw materials — $669 less than in August 2014, according to a study released earlier this month by AlixPartners.
Prices are soft because Chinese manufacturers have sharply scaled back their purchases, while econ-omies in Europe and Japan remain shaky, said Mark Wakefield, director of AlixPartners' automotive practice in the Americas.
But who gets to hang onto that windfall? Do automakers or their suppliers keep the extra cash?
"There is a lot of gamesmanship about who keeps what," Wakefield said. "Nobody expected this big a price drop."
AlixPartners calculated costs by tracking prices of 15 raw materials from August 2014 through October 2015. Every commodity had a big decline, from palladium, down 25 percent, to crude oil, which dropped 51 percent.
It's not just manufacturing costs that have declined; shipping costs are down sharply, too. Diesel fuel prices fell 25 percent to $2.90 per gallon in that same period. As a result, component shipping costs have fallen $147 per vehicle, AlixPartners estimates.
Over the years, automakers and suppliers have developed two major strategies to cushion the shock of price fluctuations.
The first approach is for automakers to buy commodities such as steel or aluminum in bulk, then resell to their suppliers. This allows automakers to get bigger discounts on volume purchases.
The second strategy is to index the price of certain raw materials so that a component's price can be adjusted every three to six months. This works for steel and aluminum — materials that can be bought or sold via public exchanges.
Indexing gained popularity when raw material costs were going up. Automakers and suppliers realized it was inefficient to renegotiate contracts every time raw material prices fluctuated. Indexing created an automatic mechanism to deal with that.
Problem solved, right? Well, not quite. AlixPartners estimates indexing covers just 70 percent of total commodity purchases, leaving the rest open to negotiation.
If it's a specialized material, for example, there may be no public benchmark price. So the onus is on the automaker to call in the supplier and try to claw back earlier expenditures. And that's what is happening in the current environment, says Wakefield.
Even if a material is indexed, the supplier benefits if the contract calls for price adjustments only every six months or so, rather than on a quarterly basis.
So, how long will the party last? Quite awhile, if crude oil prices are any indication.
Brent crude oil, the international benchmark for oil prices, will average $57 a barrel next year, according to a poll of 11 banks published last week by The Wall Street Journal. That's up from $44 a barrel last week but down $100 in the summer of 2014.
Likewise, steel prices seem certain to remain weak for a while. On Nov. 6, ArcelorMittal announced third-quarter losses of $700 million, and the world's largest steelmaker blamed it on cheap steel exports from China and weak customer orders.
"China is the biggest consumer, and they are ratcheting down," Wakefield said. "And among the raw material producers, nobody wants to be the guy that takes capacity out."
Moreover, the dollar is stronger than ever, so raw materials can be imported at bargain rates.
Nevertheless, Wakefield is advising clients to update their indexing formulas to take the guesswork out of raw material prices. "Customers don't necessarily have to lock in long-term contracts" for raw materials, Wakefield said. "But you do want to have a fair relationship with your suppliers."