Oil Won't Stay Cheap
By Larry Lapide -- Supply Chain Management Review, 1/1/2009
As I write this column, starting my third year writing “Insights,” I feel compelled to provide an update to my first two columns that dealt with high oil prices and their implications for supply chain practices. Those were written at a time when oil had supposedly skyrocketed to $50 per barrel after a couple of decades of hovering in the $20 to $30 range, in real terms (see Exhibit 1). About this time I had also participated in a panel at the 2006 Council of Supply Chain Management Professionals (CSCMP) Annual Conference where we were cautioning attendees about the end of cheap oil.
Oil is trading today in the low $40 range after having really skyrocketed to $147 per barrel. Since those first two columns, few questioned the premise of the end of cheap oil, as they struggled with a sense of urgency to cope with the rapidly rising prices and their effect on supply chain costs. However, I'm already starting to see that these lower oil prices (albeit in the midst of one of the worst economic climates since the Great Depression), are changing the view of the end of cheap oil as U. S. consumersstart seeing gasoline prices back below $2.00 per gallon. In this regard, people are figuratively singing the song “Happy Days Are Here Again.” Ironically, according to Wikipedia, “The song is probably best remembered as the campaign song for Franklin Delano Roosevelt's successful 1932 Presidential campaign.”
Based on oil price fundamentals, I don't believe that the happy days of cheap oil are back or coming back; remember, $40 is almost twice what it was during the cheap oil era. However, on the plus side, lower oil prices should give supply chain managers more time to plan and implement practices that squeeze oil out of their supply chains. They need to do this in preparation for long-run prices that will likely get higher and be more volatile, based on my simplistic view of the long-term fundamentals. (A caveat: recall, I am in no way an oil expert or economist!)
Long-Term Price Fundamentals
The basic drivers of long-term oil prices are both demand and supply related. On the demand side, the run-up of prices since late 2004 was caused by increasing global demand, especially from growing Eastern economies such as in China and India. Empirical data supports a view that oil is the lubricant needed to enable economic growth. Countries consuming more and building up logistical infrastructure, plants, buildings, and homes need energy to do it—and oil is the energy alternative du jour for the next couple of decades.
One could argue that the current financial crisis that has negatively affected economies worldwide was the major determinant of oil prices falling from $147 to their current levels. Once economies get back on their growth tracks—they can't stay bad forever—there is only one way for oil prices to go, and that is up as global growth resumes.
On the supply side of the oil equation, there appears to be enough to last a few decades more. And we're hopeful that progress in developing alternative sources can extend that even further. That said, the world will need to start discovering and tapping into reserves (such as oil sands) that are more difficult and expensive to extract. In the future, there will be a lot less of just putting a hole in the ground and lo-and-behold the oil starts gushing out, just like it happens on TV and in the movies. So in the long run, it will be more expensive oil because discovery and extraction costs will rise. These cost increases coupled with rising global demand point in the direction of increasing oil prices over the long haul. Supply chain managers, who have not yet done so, need to get on the oil-efficiency bandwagon.
Time to Get More Oil-Efficient
There are a fair number of our supply chain brethren that heeded the caution in my first two columns. I showed an older version of Exhibit 1 in those columns and argued that two decades of low “real” oil prices allowed them to improve supply chain performance using practices that in reality were predicated on cheap oil. During those decades we also saw the emergence of supply chain management as an enabler of better business performance. Some managers were also prodded to do something quickly by oil prices that hit levels I thought were a long way off. So I suspect that while oil efficiency gains were made, they were short-term fixes.
So with these lower oil prices that I hope will last a while, supply chain managers should take the opportunity to revisit their practices with a focus on oil efficiency, assuming oil-based energy costs might triple and quadruple from today. Here are some of the suggestions from my first two columns:
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Partner with customers and re-evaluate their inventory-fixated JIT manufacturing and inventory replenishment programs that tend to be less oil-efficient. Most require smaller, more frequent shipments and result in more empty trucks on the road. Such programs also tend to rely on the use of less oil-efficient truck rather than rail, and air rather than ocean freight.
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As a customer of your suppliers, partner with them to revise your own programs. Remember the Golden Rule: “Do unto others as you would have them do unto you.”
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Re-evaluate outsourcing and off-shoring strategies, as many of these were driven by labor-cost arbitration during cheap oil. Shipping goods over long distances is not consistent with being oil efficient.
In summary, use this period of price relief to implement more lasting oil-efficient practices. A proactive approach will help your company be more competitive when the oil price shocks start anew—and your competitors that haven't planned for the long run are caught short.
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