Category Archives: Energy

Environmental Sustentation 20: Oil & Natural Gas

Oil and Natural Gas is an environmental damnation in more ways than one. It’s dirty fuel, that is regularly subject to price shocks, and it’s collection and transport often result in significant disasters to the environment, your bank account, and your reputation.

And even though you should move to greener power, in some cases you can’t. Biofuel is not always a viable alternative for transportation, especially for ocean freight (where it takes a lot of combustion to move those mega-carriers) or air travel. And you still need to power your current energy production systems until the new ones come online. So you are stuck with using oil & natural gas for at least some of your energy needs for the time being. (But hopefully with a plan to use less and less over time.)

And, as a result, have to live with the risks of shortages, price spikes, disasters, and the resulting financial and reputational damage that will result. So how do you survive?

Accurately predict future needs.

If your demand is going to spike because of expected sales spikes, or projected energy shortages in other areas, that is something you want to know in advance so you can be sure to contract for sufficient supply. Similarly, if demand is dropping, that is also good to know as maybe you can cut shorter contracts and buy more on the spot market without serious repercussions.

Acquire expert supply and price projections — from various sources.

Don’t just monitor supply and prices, try to understand where it is going so you can source, or re-source, at the best times. While an unexpected disaster, political decision, or pumping slowdown can change everything, the more informed you are, the better off you’ll be.

Have disaster recovery plans in place.

If there is a shortage due to a disaster, you want an alternate source. Don’t sole source if you can avoid it, and make sure you include a provision with the provider who gets the smaller award to increase business over time and that they can support a spike if you need it. If there is a transportation disaster, hopefully you don’t take possession or responsibility until it’s in your storage tank, but either way, you better have a plan to get another shipment sent through an alternate carrier, possibly from your other supplier, ASAP.

Start sourcing clean power and building your own power plants.

Most places in the world can produce a lot of power from wind, solar, or hydro-power, and not only should you be looking to buy from energy companies that produce this power, which can power your equipment, buildings, and even short-haul transportation (that run on battery packs), but if you are a large factor or office building that uses the equivalent of a small power plant of energy, you should be building your own, and only taking off the grid when you need supplemental. With so many regular failures in overtaxed and antiquated power grids, this is just good planning.

While we can’t rid our dependence on oil and natural gas just yet, we can certainly reduce our need for it and this type of planning will not only make it more affordable (if demand lessens), but also make energy consumption and transportation safer and more reliable.

Economic Sustentation 09: Oil & Gas Price Shocks

For the last twenty (20) years or so the West Texas Intermediate Crude Oil Price chart has been bouncing up and down like a yo-yo in the hands of a novice who doesn’t know how to work it, but doesn’t stop trying. And any other chart you pull up for international oil and natural gas prices is going to look similar. In other words, as we stated in our damnation post, within a one-year period, prices can double or be cut in half with little or no warning. And either situation will run havoc with your supply chain.

If prices double seemingly overnight, your costs are going up — way up. If you have a contract, you might be able to insist that your supplier absorb the increase since they were, at signing, charging you higher than market cost since they were taking a risk over a predefined period. But, at some point, their margins go to zero, and soon after that, the supplier is not going to put up with it anymore, especially if they are struggling financially. Then the shipments stop.

But it’s not much better when prices drop. While the first to cry foul when prices rise, suppliers are the last to play fair when the prices drop. Arguments that the deal was so good they were losing money on delivery, arguments of higher overhead costs, and arguments of temporary blips are brought to the table whenever you ask for a price concession, even if the contract guarantees you one.

So what can you do?

1. Tie Prices to an Index – Updated Daily, Averaged Weekly or Monthly

Base the contract on index prices, averaged weekly or monthly, and tie the price to that cost on the purchase order date. You’ll pay more if prices rise quickly, but you’ll also pay less when prices fall faster than expected. Then, you can simply acquire good prediction algorithms that have performed well over the long term, and plan for the shocks and not waste time arguing when they happen, leading to much more cordial relationships that can be focussed on service and customer service.

2. Master Predictive Analytics

Don’t just acquire an algorithm, understand it, and run models with slight market changes to see how oil prices shift when other correlated indicators shift. Get better than the competition and over the course of years, you will always, always, always come out ahead.

OR, if this is too mathematically advanced for you, and you are willing to accept sub-optimal outcomes (which will still be better than what you get now)

A. Always Lock Prices in for the Long Term.

So the cost stays the same unless a ceiling or floor, defined as a price percentage, is met. If the average price over a month goes up or down more than, say, 10%, then the price shifts by a fixed percentages, such as half of that. In addition, negotiate for clauses that allow the organization to auto-renew automatically at the current price at an time in the last six months, for the same time-frame.

B. Make sure the ceiling and floor shifts with every price change.

While the cost shift will be absolute, the price should only change every time the price changes by more than a fixed percentage from the price being paid, not the locked-in price.

C. Reduce Oil and Natural Gas Dependence.

Invest in renewable power sources such as solar, hydro, and geothermal so that, over time, you become less dependent on oil and natural gas and the price uncertainty they bring.

Economic Damnation 9: Oil & Gas Price Shocks

Take a look at the West Texas Intermediate Crude Oil Price chart for the last twenty (20) years over on Macrotrends.net. It’s bouncing up and down like a yo-yo. And any chart you pull up for international oil and natural gas prices is going to look similar. In the chart, we see oil goes from a high of about $38 in 1997 to a low of about $16 in 1998 to a high of about $47 in 2000 to a low of about $26 in 2002 and then a series of gradually increasing perturbations until it reached a high of about $145 in 2008 before it crashed down to about $43 in the same year. And so on.

In other words, within a one year period, prices can double or be cut in half without almost any warning. And either situation can run havoc with your supply chain. Let’s tackle the obvious situation first. Prices double seemingly overnight. Your costs are going up – if not right away, very very soon. If you have a contract, you might be able to insist that your supplier absorb the increase since they were, at signing, charging you higher than market cost since they were taking a risk over a predefined period. But, at some point, their margins go to zero, and soon after that, they are not going to put up with it anymore, especially if they are struggling financially. They are going to insist upon fuel surcharges, or simply stop honouring your contract and fail to pickup. Now, of course, you can try taking them to court, but in the interim, no shipments, no sales, and screaming customers which cost your organization much more than it could recover in a legal battle years down the road. If you don’t, you are buying on the spot market, paying 10%, 20%, 30% or more than expected for transport, eroding your margins, and possibly even losing on every delivery to your customers if you are working on thin margins to a competitive marketplace. You can either try to pass the costs on, and risk angry customers, or try to ride it out.

The non-obvious situation is when prices drop. Suppliers are the first to cry foul when prices increase rapidly but the last to insist on being fair when the drop. When was the last time they voluntarily dropped a fuel surcharge after fuel prices dropped back to the levels they were when they cut the contract to begin with? Never! You will have to spend a lot of time and effort to negotiate prices down to reasonable levels, and even more time tracking prices to benchmarks to know when you need to start those negotiations — this takes resources, and that costs money. This is a situation where you’re damned if prices rise and you’re damned if prices fall. It’s damnation all around.

And that’s just the short term damnation. If prices drop too much, the first thing the producers are going to do is pump less oil, reduce production, and wait until demand nears (and maybe even exceeds) supply, so that prices will start to rise again. In other words, as soon as you manage to successfully negotiate the price reduction, you’re only a few months away from the supplier coming back with a new surcharge request. The pendulum always swings and knocks you in the head upon every return.

One Hundred and Forty Five Years Ago Today

One of the earliest US monopolies, as ruled by the US Supreme Court in 1911 under the Sherman Antitrust Act of 1890, was formed.

Until its dissolution into 33 smaller companies, Standard Oil, formed by John D. Rockefeller, was the largest oil refineries in the world. By 1890, it controlled 88% of the refined oil flows in the U.S. The company, which almost single-handedly innovated the business trust, mastered horizontal and vertical integration, streamlined production and logistics, lowered costs, and consistently undercut competitors. This alone is not a bad thing, as all supply chains should strive for this, but, as noted by the US Department of Justice, Standard Oil offered

Rebates, preferences, and other discriminatory practices in favor of the combination by railroad companies; restraint and monopolization by control of pipe lines, and unfair practices against competing pipe lines; contracts with competitors in restraint of trade; unfair methods of competition, such as local price cutting at the points where necessary to suppress competition; [and] espionage of the business of competitors, the operation of bogus independent companies, and payment of rebates on oil, with the like intent.”

and did what they could to force the competition out of business. This is monopolistic, illegal under the Sherman Anti-trust act, and, to be blunt, unfair. If your processes are efficient enough, your products good enough, and your costs low enough, the public will choose you on their own — there is no need for discriminatory practices or a refusal to work with suppliers that will also work with your competition. Plus, as some of us know all too well, some customers aren’t profitable and monopolies get stuck with those problem customers, but lean, mean, supply-chain machines don’t.

Standard Oil is a good business case to keep in the back of your mind. They did a lot right, and a lot wrong. Take the good, and leave the bad, and your business — and supply chain — might be better for it.

Procurement Trend #10. e-Procurement Integrates Sustainability

We’re down to seven anti-trends. And even though most of the “future” trends we are now discussing are recent enough that the older generation can actually remember their beginnings with clarity, we need to follow LOLCat’s lead and find a way to stop the beat of the futurists‘ drum because, even with these trends that started in some of our life-times, the drum has been beaten to death and I still fear, like LOLCat, that the futurists’ may soon return to the age old art of cat-skinning to make a new one!

So why do these hare-brained futurists (who obviously re-enacted one too many Looney Tunes skits during wabbit-season) keep pushing the integration of sustainability into e-Procurement as a future-trend? Is it because, after years of real forward thinkers trying to convince the Businessman that cost-savings and sustainability weren’t diametrically opposed ideas, the futurists finally clued in? Or is it because

  • energy prices are going through the proverbial roof

    and they are grasping at straws trying to find a solution (and lucked on the right one)

  • raw material supply is running out

    and they finally realize the importance of sustainability in supply management, but since that’s not catchy, they chose to integrate it with the first concept they pulled out of their hat (and got lucky again)

  • CSR is increasing in importance with consumer concern

    and since customers are telling them to buy responsibly, and buying is e-Procurement, this must be the way to go.

Well, they are right. But leading companies have recognized this since the 1990s and have been doing this for well over a decade. They recognized that while renewable energy had a high-up front cost because it required large investments in solar panels, windmills, and turbines and new plants to either store excess energy produced during peak times in natural pump storage or huge battery arrays, it’s cost over time approaches pennies per Megawatt hours as sun, wind, and water power, unlike coal and oil, is free. Once the plant construction costs are paid off, it is just maintenance costs. It doesn’t matter if the technology is only 80% efficient and the pump storage only captures 60% of excess energy. The energy is free! Plus, these forward thinkers, unlike our futurists, also recognized that fresh water would soon be in short supply and invested in plant redesign to minimize water requirements.

Energy Prices

You need to go renewable to the extent possible and put plans in place to get to 100% renewable energy for all fixed operations and short-haul transport as soon as is feasible. While electric and bio-diesel may not yet be a suitable option for long-haul 18 wheelers, trains, and air-planes, electric and bio-diesel has bee proven cost effective for local courier delivery and hybrid has been proven cost-effective (by Walmart) for long-haul 18-wheeler transport. And if you build your own power plant, the long-term return from solar, wind, and/or water power, depending on where your operations are located, will be enormous. So there’s no excuse to not be using renewable energy for the majority of your energy needs. Plus, the first company to get 100% renewable for its operations gets huge bragging rights and brand karma!

Raw Material Supply

As per our post on increased raw material scarcity, you have to facilitate alternate designs that reduce or eliminate rare earth minerals and other expensive metals in limited supply and design for recycle in the interim so that you can recover as much as possible of the rare-earth minerals as possible to keep future costs down. (Preferably without outsourcing to a third-world country that breaks down your products in improper environments without proper containment and safety gear for handling your products that contain hazardous chemicals. No one wants your e-waste, especially if its hard to handle. If even India enacted anti-dumping legislations for e-waste, that should tell you something.)

Corporate Social Responsibility

We are approaching the point where it is no CSR, no sale, with many consumers, and as far as the doctor is concerned, it cannot come soon enough. We won’t knowingly put up with sweatshops and unsafe working conditions at home, so we shouldn’t put up with it in our supply chain. To turn a blind eye is hypocritical and, to be blunt, just unacceptable. It is time to get sustainability initiatives in place, embed ethics in the supply chain, and embed responsibility in the organizational culture. Suppliers don’t have to go the extra mile, but they should provide their workers with safe working conditions, a fair wage based on the local market, and actively insure that child labour is not used in their supply chain.