Counting the Cost of Crude

Crude oil prices are already at record highs and are expected to hit $200 a barrel by early 2009—if not before. Analysts also suggest that oil prices are unlikely to fall below $100 for the foreseeable future. How will such increases transform supply chain strategies?

Oil is precious: at $130 or so a barrel and on a rising trend, it is an extremely valuable commodity; it is also running out.

Despite speculation over the size and accessibility of Arctic oil fields, OPEC estimates that known oil stocks will last for around 80 years while those in the “Peak Oil” lobby, such as Kjell Aleklett, president of the Association for the Study of Peak Oil & Gas, suggest that oil production may already have peaked and is likely to decline from 2012 onward. Extracting oil from many of these reserves is increasingly expensive while war and political issues are also limiting supplies.

While many disagree with the worse-case scenarios, most analysts now accept that crude oil pries will hit $200 a barrel within the year with the price likely to fluctuate between $100 and $200 in future. Such prices are simply a reflection of classic supply and demand economics. Growing prosperity in China, India—where Tata’s Nano car is now selling at around £1,200—and other developing economies means that many more people globally aspire to the lifestyles of the “affluent West”. Worldwide, there are some 750 million cars on our roads: this figure is expected to double by 2030. By 2050 the world’s population, currently some 6.5 billion, is expected to hit 9.5 billion. More people, more cars—and more demand for diminishing reserves of a precious commodity.

For the past 20 years oil prices have been artificially low and consumer attitudes to motoring, CPG supply chains, and industrial trading models have developed accordingly. In the early 1970s shops were largely in town centres and the majority of customers bought only what they could carry home on the bus. Since then retail parks and superstores at the edge of town have become the norm, with shoppers dependent on the car to take them and their trolley loads of shopping home. Major retailers similarly reduced their numbers of regional distribution centres to a minimum to streamline stock movements and benefit from high volumes, while many pan-European businesses used just one or two warehouses—often close to major inbound ports, such as Rotterdam—to supply the entire continent.

Fast forward to a world of permanently high oil prices and we are already seeing consumers reducing car usage, with older age groups especially preferring to “top up” at local shops rather than drive to remote store sites more often than is absolutely necessary.

Supply chain analysts, too, are developing models which optimise European distribution networks with multiple warehouse locations. Significantly many of these locations are in Central and Eastern Europe, with places like Constanta on the Black Sea seen as a more cost-effective option for Far Eastern shipments destined for these growing markets.

For businesses looking to the longer term, optimising supply chains with carefully sited multi-modal distribution centres is just the start. As the world’s economic centre—the new omphalos—moves eastward; and as the numbers of more affluent middle class consumers in developing markets expand, where do you look for growth? Where do you concentrate on developing joint ventures or expansion programmes? As importantly, from which markets do you consider tactical withdrawal?

The global goal posts have shifted and for many, Russia and Eastern Europe or the developing economies of Asia—with their higher birthrates and younger, aspirational, consumers—can represent a more lucrative long-term focus that traditional Western economies.

Keeping track of both total supply costs and regional sales growth patterns is crucial to maximising performance. Retail analysts often talk of the “total cost to serve”: in the recent past deflationary pricing in many sectors along with cheap oil have helped keep that cost down. In the new world economy that is no longer the case and both consumers and businesses have a painful period of adjustment ahead.