We dusted off the “playbook” from 2008, a time when West Texas Intermediate hit $147 a barrel to see what happened in the transportation sector and how companies reacted. Brent North Sea Crude was selling at a significant deficit to WTI, and only got to a high of about $122 a barrel. There has also been a lot written about oil prices of late – for the transportation industry in which it often is the second largest cost expenditure across all of the modes (second to labor only), it is a big deal.
In a private call with a large carrier in the trucking industry, it was learned that customers (shippers) are beginning to talk a lot about the rising oil price risk in the industry and the types of contingency planning / supply chain changes that they are getting into place to prevent a significant downturn due to rising oil prices.
As one would do in a strategic planning effort, here are a few situational analysis items to consider:
- Brent North Sea Crude has hit $123 a barrel before settling down off those levels temporarily. West Texas Intermediate has moved over $106 a barrel in recent trading. The volatility of the oil sector will make this information a constantly moving target. The important factor to keep in mind is that Brent is at all-time historical highs – and Brent is the primary driver of price for multi-national corporations, consumers in foreign countries buying US products, and even east coast US refiners import Brent as their core crude oil input. So, the US is exposed to Brent which is moving at an all-time high, and we can say that the impact of current oil prices on the US are likely worse than they were in 2008 (the US consumer is weaker than it was in the pre-2008 period after weathering the Global Recession).
- Geopolitical tensions have added supply fears that did not exist in the 2008 price spike. The 2008 spike was largely in reaction to growing demand in the emerging markets of China and India primarily. Speculation on the growth in demand helped to push oil prices higher. Today, we have significant supply concerns and that is a bit of an unknown as to how deep these concerns could push the premium on crude.
What can we expect from a spike in crude oil prices – what are likely areas to watch as we move forward – to understand the impact of crude oil? First, let’s review the likely scenario affecting oil prices moving forward.
1. With varying motivations, some analysts are fairly unified in their view that gasoline prices will hit $5 a gallon or higher this summer. That will push diesel to a premium of about $.20 to $.30 higher than gasoline during that period.
2. Wild cards in the mix revolve around geopolitical events. Some of the key areas to watch include:
a. Iran and the prospect of a conflict with the country. Russia has now vowed to support Iran in a conflict – and today Russia is the largest supplier of energy resources to Europe.
b. Nigeria tensions continue and risk spilling over into the oil producing regions of the country. Nigeria is a major supplier of oil (2.1 million barrels a day) and the fifth largest source of oil for the United States.
c. Mexico production of oil is still not hitting thresholds that analysts had predicted.
d. US infrastructure is getting delayed – infrastructure that is critical in getting crude oil supplies distributed throughout the country to regions and refiners that need it. Infrastructure spending probably will not be adequate to help alleviate the next spike crisis.
The following are some of the items to watch with regard to the impact on the transportation sector from this rising gas and oil pressure.
- One of the largest maritime companies announced that it had lost a significant amount of money – especially in the latter part of 2011. Assuming that this company is among the strongest in the world in its sector, we have a lot of concern for the weaker participants in the maritime sector as Brent North Sea Crude spikes. Slow steaming strategies, dropping prices to attract shipments to cover the fuel required for repositioning assets, and other cost-saving efforts will not come quick enough for some providers. The Baltic Dry Index is still showing the overarching problem with overcapacity in the maritime sector.
- Trucking lost about 4,000 firms in 2008 that averaged between 5 and 25 trucks per company. These companies, based on their size, have difficulty in hedging fuel costs and recovering the full impact of rising fuel prices through surcharges. Independent truckers also ended up parking their trucks in many cases and literally didn’t take loads that were available at the time.
- Air cargo will be hit and miss in many cases. Because companies continue to keep inventory levels low (see the chart at right showing the latest Business Inventory to Sales Ratio from the St. Louis Fed), some will still opt to utilize air cargo as a way of keeping shipment sizes low. We assume that the spike in inventory that we see in the chart at the end of 2008 is part of the fear that companies have. Cash tied up in inventory is cash that can’t help with liquidity. Therefore, there are risks to moving to larger loads to try and offset rising fuel costs.
- Supply chain managers in general may take a second spike in just three years as a sign that they have to make permanent contingency and risk mitigation moves to help insulate them from this spike. Near sourcing and using Toyota’s strategy of producing goods near their point of consumption could be a trend that we see a lot more of. That in itself will add more changes to the various modes in the US.
- Lastly, rail providers will see a windfall of activity. We know from working with companies in the sector that there is a point of diminishing returns at which rising fuel prices ultimately hurt the economy enough (reduce consumer spending, etc.) that it is a negative for rail. But, until the market hits that threshold, rail will benefit as a significant source of hedging against fuel spikes. In other words, rail companies should see an increase in market share as a result of rising fuel prices and supply chain managers will try to build-in slower transit times to be able to move more to intermodal types of moves.