Oil price drop will hurt your supply chains

Roger OakdenSupply Chains & Supply Networks

The good and bad of oil.

If you are a private motorists or your business is a passenger airline operator, the drop in oil prices brings a smile to your face.In the past five months, the international price of oil has fallen about 40 percent.

But if you are a logistician reviewing your future supply chains, your smile may not be as big! In December 2009, the January 2015 futures contract price for oil was U$95 per barrel, yet today’s price is U$64 per barrel. In 2009, it was forecast that the price of oil would continue to rise, yet analysts are predicting that in 2016, oil could be as low as U$29 per barrel! Already,freight rates on some routes have dropped 40 percent.

As a logistician, on what price range will you base your supply chain assumptions?

As we are aware, the price of traded commodities is a factor of demand and supply; demand for oil has reduced and supply increased (in America by 65 percent over the past five years), The International Energy Agency (IEA) has stated that output from major oil fields has already peaked and the rate of decline has accelerated; the global situation requires that multinational oil and gas companies review their investment plans.

The Norwegian consultancy Rystad Energy has stated that in 2015, oil and gas companies will make their final investment decision on about 800 projects valued at approximately U$500b and planned to deliver around 60 billion barrels of oil.

Project costs are increasing

While the oil price is decreasing, the cost of exploration and delivery is increasing – materials, new technologies and skilled labour.One third of the planned projects are ranked as ‘unconventional’, requiring horizontal drilling or ‘fracking’. For example, an unconventional project in the British North Sea with a projected output of 300m barrels and a cost of U$10b requires a price of more than U$100 per barrel to justify commencement.

Already, it appears that about 30 percent of the future investments will be delayed until the oil price at least exceeds U$100 per barrel! The result is expected to be a reduction in supply by 2020 and therefore rapidly escalating prices – enjoy the good times while they last!

In addition to the reduction in viable projects, about 80 percent of oil reserves are controlled by state supported companies which are under-investing in new oil fields due to governments maximising their income from royalties, increasing resource nationalism and corruption.

The medium to long term outlook is therefore the same as it has been for some time – a reduction in supply (even with reductions in demand) and higher prices. As a logistician reviewing your supply chains, the current movements in the price of oil are unlikely to change your view that supply chains will most likely become shorter over the long term (10+ years) and that increased effort and investment is required to reduce your organisation’s total energy consumption and reliance on external energy sources.

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About the Author

Roger Oakden

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With my background as a practitioner, consultant and educator, I am uniquely qualified to provide practical learning in supply chains and logistics. I have co-authored a book on these subjects, published by McGraw-Hill. As the program Manager at RMIT University in Melbourne, Australia, I developed and presented the largest supply chain post-graduate program in the Asia Pacific region, with centres in Melbourne, Singapore and Hong Kong. Read More...