Getting Ready for Higher Commodity Prices

Despite the global downturn, many commodity prices have climbed significantly in recent weeks and months? But if demand is not pushing the market, what is? Certainly speculators to some degree. But also a general belief that demand will return, eventual scarcity, the Q4 and Q1 ramping down of raw material production in existing mines and facilities and decreased investment in new mining and mineral resources are all playing a role. So is the general belief that there's no way we'll be able to enjoy inexpensive energy prices (which even in the case of metals, play a major role in the cost of production).

Consider what Bob Ferrari recently had to say over on his blog, Supply Chain Matters, about rising oil and energy costs. Bob notes that prices for these commodities present a double whammy for cost containment not only because they're "not driven by normal demand and supply forces" but also because of general expected uptick in demand that will drive prices "to $110 a barrel by 2015" according to the U.S. Energy Information Administration. Which if you're doing the math, is a price that is significantly higher than typical inflation or the rate of return for typical market investments.

In short, Bob concludes -- and I would agree -- that the "world economy has been fortunate to have a hiatus in cheaper oil during this damaging recession". But I'd extend Bob's forecast out to other commodities as well. Procurement organizations that have been riding down commodity prices in recent quarters and calling these downward trends "cost savings" to management are likely to face a very rude awakening in the coming quarters and years. And this is why it's not only a good time to source or re-source direct materials in today's market -- it's essential from a commodity risk management standpoint to reduce prices on all non-raw material components of what suppliers are providing given that the rest of the equation is bound to move only in one direction over time.

Jason Busch

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