Direct Ripple Effects of the Oil Price Collapse

Spend Matters welcomes this guest post by Pranav Padgaonkar of GEP.

The oil price collapse over the last 6 months has received tremendous media coverage. Most of it has analyzed the effects on the energy market, financial markets, national economies and gas prices at the pump. It is unfortunate that the impact of the oil shock on financial markets exceeds that on products directly made from this oil! In fact, apart from gas, the media seems to have completely overlooked the drastic impact on other products derived from oil. But as procurement professionals, we need to know all the downstream connections to products and services we source so that we can plan our strategy accordingly.

Some examples of products affected include:

  • Plastics – The plastic resin price indices directly follow the oil index with a 3-4 month lag. So in 2015, the entire plastics industry – be it home appliances, furniture, storage or packaging will be under price pressure from customers – companies having index-linked contracts can see a cost benefit, but others will have to renegotiate with suppliers to derive the benefit.
  • Wax – Everything from food processing, frozen food packaging to candles comes under price pressure as customers demand that the cost reduction be passed on.
  • Pet Coke - It is a major raw material for a variety of carbon products and is also used as a fuel. The balance can shift from it to met coke.
  • Fertilizers, Lubricants, Sulfuric Acid, etc.

In addition, several services are also affected by the price shock:

  • Ocean Shipping – Most ocean contracts already have a fuel component tied to the Heavy Oil Index, but such a big shock might prompt renegotiations from either party
  • Road Transport – Index-tied contracts are not as common as in ocean – and hence customers will have to work very hard to get the cost benefits passed on
  • Road Construction – Asphalt and tar prices reaching rock-bottom can shift the balance back from concrete to asphalt roads as best value, creating significant retooling requirements
  • Air Travel – So far, airlines have managed to avoid passing on the cost benefit to consumers. However, on the cargo side, which is a B2B-scenario, we are seeing rates decline.

In general, if we look at a typical manufacturing business, here are the principal areas to target for re-examination of costs:

  • Logistics (Ocean, Road, Rail, 3PL/4PL, Air) both inbound and outbound
  • Energy (Electricity, Natural Gas, Renewable Energy)
  • Packaging – especially plastics packaging
  • Raw Materials – Any plastic components used in manufacturing
  • Financial Services (especially any oil-linked hedging)
  • Greenfield contacts, especially ones involving road construction
  • Travel – Employee air travel

Further, the medium term future price of oil is not predictable right now. As a result, even after we examine these categories, it is difficult to determine how long to lock prices down. The general consensus currently is that a 1-year fixed-price contract is relatively safe, as oil prices are likely to take that long to recover. These renegotiations will help us tide over the short term and show management the benefit they are asking for. But at the end of 2015, these contracts will have to be thoroughly reviewed, to ensure that we do not see an uncontrolled escalation when oil rebounds.

For more interesting thinking on procurement, visit the GEP Knowledge Portal.

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First Voice

  1. Andrew Cox:

    All very interesting, but I think you are missing the point about best practice in the oil & gas industry. Incremental and decremental pricing can and should be a central tent of all long-term relationships, but your focus on 1 year deals reinforces the current damaging short-term thinking endemic in the industry.

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