Falling Oil Prices Reduce Oil Company Spending – and Procurement Costs

On Monday, crude oil prices hit a 5-year low, with the American oil benchmark trading around $63 per barrel. Oil prices had dropped 40 percent since the summer and hit a level not seen since July 2009. To compare, West Texas crude was at $107 a barrel in June.

While Tuesday eventually brought a slight boost, with sweet crude pushing $66.88 a barrel in New York, early morning trading saw a low of $65.29 a barrel – the lowest since Sept. 2009. Wednesday morning saw more volatility, with prices dropping another 4%.

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The impacts of these plummeting oil prices are being seen throughout the industry – from major oil companies slashing 2015 spending and production outlooks, to others cutting jobs and some considering whether or not to continue developing major projects. But there are also benefits for procurement organizations (outside of oil and gas firms).

Just How Bad is it for the Energy Industry?

"We're in a tailspin,'' Tom Kloza, global head of energy analysis at the Oil Price Information Service, told USA Today this week. "The world is facing a possible glut of oil in 2015. Consumers typically paid $470 billion-$480 billion for motor fuel between 2011 to 2013. We're on track for about $449 billion this year and likely to pay $75 billion to $100 billion less next year."

Oil and gas companies are taking action in response to lower profits and lower oil prices. ConocoPhillips said it would cut 2015 capital spending by 20% and lower its spending on development energy drilling by 23%. The world’s fifth-largest energy company will shed $1.5 billion from its development drilling budget next year. The amount it spends on major projects will decline by $1 billion to $4.8 billion.

“We are setting our 2015 capital budget at a level that we believe is prudent given the current environment,” said Ryan Lance, ConocoPhillips’s chairman and chief executive, according to The New York Times.

BP, too, announced it would be making cuts, this time in the form of staff reduction. The company will do away with some middle-management positions and other staff.

Royal Dutch Shell said it needs crude oil prices to rise to $70 a barrel in order to justify pursuing a new project, The Wall Street Journal reported. BP, however, considers $80 a barrel a safe price to be confident making new investments. Other companies like Chevron are being forced to reconsider production forecasts. A Chevron spokesperson said the company’s 2017 production forecast was made based on a Brent crude price of $110.

Oil Prices Likely to Remain Low

Oil prices are expected to stay low during the next year, analysts say. An increasing North American oil production and continued supply from other oil-rich regions may further contribute to future drops in prices. Tamar Essner, lead energy analyst for NASDAQ, told USA Today that crude oil futures could stay below $70 a barrel even until 2017.

What this means is oil and gas companies will have to rework production outlooks, business spending and other forecasts – that is, if they haven’t already. Moreover, they’ll need to play catch up in procurement to manage costs. Jean Baderschneider, former chief procurement officer for ExxonMobil, was regarded in the industry as one of the executives leading the charge for oil and gas companies to more effectively drive savings and reduce total costs and risks. Other O&G procurement teams have learned from ExxonMobil’s best practices (but much opportunity remains for further savings).

What it Means for Procurement

Outside of the oil and gas market, the drop in oil prices should (generally) be welcome news for procurement organizations, as the oil and energy prices decline results in lower manufacturing costs. Moreover, other commodities are likely to decline in “sympathy” as well, as some economists point out.

Writing in Surplus Record, my colleagues Jason Busch and Lisa Reisman recently suggested that:

“Lower oil prices (which recently hit levels not seen since 2010) also portend lower manufacturing and logistics costs heading into 2015 for companies that did not enter into long-term contracts earlier in 2014 … In short, reduced oil and energy prices are a very important industrial driver heading into 2015. If Brent crude continues to trade at less than $70 per barrel, it will be a strong indicator that manufacturing costs will continue to remain low relative to 1H2013 and earlier levels. And, low costs (provided consumer demand remains strong at the end of the supply chain) are generally a positive indicator of manufacturing trending in positive territory.”

But they also point out how it’s necessary to make sure to hold your suppliers accountable to price de-escalation clauses in longer-term agreements. Now might be a good time to consider hedging to lock in lower commodity prices as well.

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First Voice

  1. Omar Khan:

    The benchmark US oil price at under $61.00 a barrel, is at the lowest level since mid 2009. Many manufacturing companies farther removed from oil production are clearly going to benefit from falling oil prices. Procurement professionals in general and specifically at the manufacturing companies where oil is used as feed stock need to be on the lookout for OPEC announcements on the crude production and subsequent changes in oil prices. Industries such as chemicals, tires, tubes, synthetic rubber and related products stand to benefit tremendously on raw material prices as well as shipping & freight charges. This is a great opportunity to renegotiate raw material and freight contracts as well as for inserting future contract price adjustment clauses tied to benchmark US Oil prices.

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