Perhaps no other commodity trickles further down (pardon the pun) the supply chain than petroleum. As a result, identifying the impact of petro-economics on the supply chain extends from the as far upstream as direct materials to as far downstream as shipping costs. In order to identify the “who” in your firm’s petro-economic equation, it is necessary to determine the “what”.

Specifically, what products in your supply chain are either made from of transported using petroleum? Even a cursory analysis of purchased goods will quickly reveal that a plurality of your procurement, if not a majority, is touched by petro-economics.

The degree to which fossil fuels color the horizon of a firm’s spend can be eye-opening, however. It’s simple enough for a chemical toll blender to point to the effects of rising oil costs as a driver for COGS pricing. Additionally, the shift in Natural gas prices that results from comparative economics throws a blanket over direct material prices. Yet the impact of petroleum prices stretches as far as the packing peanuts in a box of laboratory glass, the stretch wrap around a pallet of copy paper, or the cost to deliver an overnight letter.

Consider that all the way downstream, at the foot of the supply chain delta, lies a box of office supplies. The delivered price of those items is likely affected by material costs driven by petroleum prices, packaging costs driven by petroleum prices, shipping costs driven by petroleum prices and the like. So, while the invoice may say Staples or Corporate Express, the check you cut is also paying ExxonMobil, BP and all the rest.

What’s meaningful to consider is not just that the Oil Barons are also your supplier for even the most tactical purchase, but how much those oil price movements can affect the cost of delivered goods. One needs only to do the simple math of the affect of a fuel surcharge on an overnight letter to understand just how much fuel cost can drive tactical purchases. Further still, the economic impact of globalization on integrated supply chains that once drove prices downward is now driving them upward. Oil that sold for $10 a barrel a decade ago, when integration was in its nascence, now sells for $115. To better understand the impact of oil costs on international shipping, a 40 foot container moving from Shanghai to the US cost about $3,000 in circa 2000, now costs around $8,000, a 167% increase (WSJ, Aug2008). As a result, cheap goods such as fasteners, textiles, and other foreign goods with favorable labor economics are suddenly losing their price advantage. Consider also that overseas freighters are also slowing top speeds by 20% to conserve fuel. Delivery times are stretching as a result.

Nonetheless, the degree to which a firm can exercise agility in its supply base is often tempered by the impact of consumer trends. The de- integration now necessary for low cost supply is not usually an option for the downstream customer. So what is a buyer to do?

In our next piece, we’ll discuss how to approach petroleum pricing both in negotiations with direct suppliers and by teaming with indirect suppliers.
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