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Oil procurement case study and global market overview

Jul 22, 2011

There is one area of procurement spend that many schools are extremely wary of – oil.  It’s hardly surprising bearing in  mind the complex and volatile nature of pricing.  Supplier pricing models include Platts daily lagged, Platts weekly lagged, spot, open book and so it goes on.  As a result ensuring you are comparing “like for like” is a challenge in itself and one which many Bursars and Estate Managers simply don’t have the time to do.  In addition security of supply is of paramount importance to schools and, in respect of oil purchases, it seems the phrase “better the devil you know” is adopted by most.  As a result an area which is often a significant spend (sometimes second only to wages) tends to get overlooked.

Minerva has recently completed a project for a consortium of schools which has resulted in reasonable savings (between 3% – 14%) for some, but not all, of them.  The main reason savings were not more significant is down to the fact that the bulk of the price is not determined by the wholesaler or the distributor but by the oil producers.  As a result the only part of the price which can be ‘negotiated’ is the profit margin and load premia.  As wholesalers/distributors work on a high volume/low margin business model there really isn’t that much left for discussion!  That said, several schools made £000′s in savings as a result of the project and it’s still an area which should be actively reviewed especially where it’s a significant annual spend.

In addition to the savings identified in immediate pricing it’s also worth mentioning that contracts have been negotiated for ‘fixed forward’ pricing too.  There is a continuing upward trajectory on pricing and so a strategic decision to fix could well be a good one.  It’s important to choose when you do that though – you’ll note from the graph, which covers only a 12 month period, that small upward spikes or decreases in prices are apparent and could make a significant difference to the fixed price you negotiate.

Platts-Historic-Oil-Prices-May-2010-to-June-2011.png

So, if the bulk of the price is determined by the oil producers what influences their pricing?  I recently had the opportunity to participate in a Webinar run by Platts* which gave an excellent overview of the Global Oil Market.

 

Oil is obviously being consumed worldwide.  As an idea of consumption the USA (being the largest) uses 18,868m barrels per day, China 8,625m (and rising rapidly) with the UK using 1,611m barrels per day.

 

Expert opinion is agreed that the peak price of $140 a barrel (July 2008) is very possible again in the foreseeable future.

 

Annualised world growth is stabilising at 1m barrels a day but OPEC (the oil producing countries cartel) have not increased production which explains the continual rise in prices.

 

China really is the engine room of economic growth and, therefore, oil demand.  Chinese oil demand is estimated at 10m barrels a day but their own production can only offer 4m barrels a day and is flatlining.  As such for every additional barrel required this is a an additional barrel for the world oil market to cover.  In terms of the ‘winners’ supplying China these include Angola, Oman, Iraq, Kuwait, Kazakhstan and Brazil.

 

One of the biggest impacts on price volatility comes from uncertainty in the market from world events.  Most recently examples of this would include:

 

  • violence in North Africa
  • unrest in the Middle East
  • the earthquake in Japan
  • OPEC disunity

 

The situation in Libya is a prime example.  Production there, since the start of civil unrest, has fallen from 1.4m barrels a day to 200k or less.  They are a major supply of quality oil to Europe (Germany and Italy particularly) and much of the fighting has been in or around the production facilities.  Libya were supplying 2% of the total world oil.  Experts say it will take Libya many, many years to recover.

 

In fact Saudi Arabia has committed to the replacement of this volume and quality of oil and is filling up storage facilities to prevent such an impact in the future.  However, we’re only at the start of this process.

 

Overall, the oil market is still in distress and if you look at Saudi they have a “ring of fire” of countries in difficulty all around their borders; Egypt, Oman, Sudan and so on.  Violence in any of those countries could result in disruption in the export channels.

 

Overall the Libya/Saudi position is keeping the market on edge due to:

 

  • wariness of the Saudi’s being able to meet the shortfall left by the reduction in Libyan production
  • the removal of high quality crude oil and the concern about the quality of the replacement
  • conflicts in these areas look like they are set to last
  • there are regular attacks and damage to oil production infrastructure
  • some end-users are questioning the long term reliability of supply

 

Another psychological impact on the oil market was the earthquake, in March 2011, in Japan.  The ‘quake resulted in 1.4m barrels per day of oil refining closed down – this equates to 31% of the national capacity.  The world oil market has a strange relationship with Japan as they’re not sure what the relationship is in terms of supply.  After spiking in the immediate aftermath of the earthquake prices have started to come down due to the Japanese quick recovery.  Longer term, radiation exposure concerns means construction companies are reluctant to send staff and resources there and this could slow down the reconstruction.

 

If all of this weren’t enough you then have OPEC disunity to content with.  The meeting on June 8th this year was described by the Saudi Oil Minister as “…one of the worst meetings we have ever had”.  The current target and actual production will remain at 28.8m barrels a day and this is likely to remain unchanged in the short-term.  In fact the world oil market needs more than this but OPEC attempts to de-politicise the cartel and make it more about the economics has left the cartel divided.  Countries voting to increase oil production i.e. Saudi, UAE, Kuwait all have additional capacity.  Those voting against increasing production are, unsurprisingly, at full capacity.  As a result there’s a stalemate in the group and so, for the moment, this has resulted in no change in production, demand outstripping supply and an increase, therefore, in price.

 

Experts predict we are in for a bumpy winter with OPEC estimates that world oil markets will require 30.9m barrels per day in Q3 2011 and 30.5m barrels per day in Q4 2011.  With supply being limited to 28.8m barrels per day this means a 1.6-1.7m barrels per day shortfall.

 

It would therefore seem sensible to predict that the upward trending red line with continue to do so.  Time to get some fixed pricing in place……?

 

*Platts is a provider of energy and metals information and a source of benchmark price assessments in the physical energy markets. Platts was founded in Cleveland, Ohio in 1909 by Warren C. Platt (1883-1963) to provide “reliable market-based price information” on the oil industry.  It is widely used today as the baseline for industry pricing.

 




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