Range-bound oil

18 months ago we hosted a live webinar in which Ric Deverell from Credit Suisse predicted that oil would be “range-bound” into the foreseeable future. This forecast caught my eye because of the overwhelming bias among supply chain prognosticators that the future was all about volatility. How counterintuitive to say that oil, historically a source of price spikes worthy of mention on morning talk shows, would henceforth be a pillar of stability?

Deverell was right, and with the world on edge over Syria, Israel and the Ukraine, it seems this relative calm is going to be hard to derail.

The cost of uncertainty

When modelling investments in supply chain assets including plants and distribution centres, network designers must build scenarios way out into the future. Since the working life of such assets is often 20 years, their economics need to work through all sorts of changing cost structures, including, notoriously, transportation costs. Planners who ran such models between 2005 and 2010 would have quite reasonably included oil prices ranging as widely as $40-150 per barrel. Not wanting to get caught out with uncompetitive supply chain costs in times of high oil prices would naturally lead many to choose smaller assets closer to customer demand.

Since 2011, however, the story has changed. At this very moment, war is building in the two regions traditionally most vital to world energy supplies – the Middle East and Russia – and yet oil prices barely budge. Compare this to the relative volatility riot created by the first Gulf War back in 1990 when oil jumped or fell by more than 10% in five of 12 months. Since July 2013, by contrast, no monthly jump has exceeded 10% and the average absolute monthly price change has been only 3.5% against 12.7% in 1990. Volatility may be in the air, but it’s not in oil prices.

Month-to-month percentage price changes, Cushing, OK WTI spot price FOB

This is not likely to change. With huge new reserves of both gas and oil now accessible through “non-traditional” technologies like horizontal drilling and hydro-fracturing and a clear rise in the viability of solar power and even wind as alternative energy sources, perhaps oil’s reign of fear is finally coming to an end. No doubt there is still plenty of movement to make the traders rich, but for supply chain strategists, the cost of uncertainty in transportation rates may have come down for good.

Network design for the next decade

If extreme oil price volatility is out of the equation going forward, then supply network design gains a few degrees of freedom which could mean more concentrated investments in property, plants and equipment. Plant investment decisions, for instance, can be at least marginally more capital intensive since longer transport lines are less risky. This should encourage the ongoing trend toward more automation and robotics in manufacturing.

Even more important, distribution centre designers will increasingly be able to justify more intensive capital equipment spending if big, centralised DCs win out over small, localised DCs. We’ve been tracking this question for several years now and the bias remains decisively in favour of building fewer, bigger centres (315 respondents opted for this choice in our recently closed CSCO survey) rather than smaller local ones (200 chose this option).

The big implication is that value-added services, including everything from custom packaging to software burn, will increasingly distinguish leading distribution networks from laggards. Looking ahead, many supply chain strategists will find that mega-DC’s handling massive item variety, light manufacturing and a wide range of shipping options make sense as a way to manage complexity in consumer demand. A few extra miles in transit could be a small price to pay for the market agility such an approach offers.

Volatility reality

This story is really only about oil. The World Bank’s Commodity Price Index data for the last 100 months shows plenty of movement in metals and agricultural prices. Who knows where these prices will go next? Oil, however, seems to have found its sweet spot. It may not be cheap but it should be reliable.

New app available for SCM World members! Read this column and any other SCM World news on your mobile device or tablet. Click here to find out how.