Procurement Should Care That Oil Came Close to $140/Barrel on Friday

Earlier in the year, when oil hit $100 for the first time, the talk was how long it would stay there. Procurement organizations cared insomuch as higher prices meant rising transportation, plastics and related costs. But few thought it would stay there for a sustained period of time and only a handful of practitioners I spoke with viewed it as an emergency situation. Flash forward to June 8th. Oil reached nearly $140 on Friday. According to a New York Times coverage of the story, "Oil prices had their biggest gains ever on Friday, jumping nearly $11 to a new record above $138 a barrel, after a senior Israeli politician raised the specter of an attack on Iran and the dollar fell sharply against the euro ... The strong volatility in energy markets in recent weeks have continued to puzzle investors and traders. Prices keep rising despite a lack of shortages in the market, and strong evidence of lower consumption in industrialized countries. But investors seem to be caught in a bullish mood, focusing instead on perceived risks to future oil supplies and continued growth in oil demand from emerging economies that subsidize fuels."

Regardless of whether we can attribute the rise to speculation or not, it's about time procurement organizations put $140/barrel oil at the very front of their agenda. According to a recent CIBC World Markets report, when oil hit $120 a barrel, "Every 10% increase in trip distances translates to a 4.5% increase in transportation costs." Their study concludes that the cost to ship a container from Shanghai (including the inland Chinese transportation costs) to the Eastern US seaboard has risen over 250% since 2000 when oil was $20 per barrel. Even though the current numbers seem high to me -- $5000-$6000 feels more like it, even factoring in inland costs -- the CIBC report should make us all aware of the impact of oil prices on global sourcing. At $140 per barrel, the China equation is going to make sense for fewer and fewer categories of spend for companies.

In a post from early June, I wrote, "Already, I'm seeing evidence that companies are reevaluating whether or not it makes sense to ship containers halfway around the world to save a few margin points (or not as the case may be). In certain cases where production has moved to low cost regions on a permanent basis (e.g. textiles, PCBs, certain finished electronics products) it's unlikely the global sourcing boom will slow." But when it comes to heavy products -- as my wife likes to say, if you can't fit in a shoebox, it's probably no longer a good candidate for China sourcing -- I bet this will be a summer of reckoning for companies who are seriously invested in global sourcing efforts which involve moving cargo halfway around the world.

From an advice standpoint, I'd recommend three steps before determining a specific strategy to mitigate the price of oil on transportation. First, create a scenario modeling tool in Excel or another application that shows the impact of oil prices on your actual transportation costs at $130, $140, $150, $175 and $200 a barrel. Second, figure out how much you can pass along to customers in the form of price increases or surcharges (if that's even possible). Third, consider the cost of staying with your current bets by taking volatility out of the equation through financial hedging strategies. With this information in hand, it should be possible to make more informed strategic decisions around maintaining current global sourcing strategies versus opening up past decisions to new considerations.

- Jason Busch

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