Crude oil is a cyclical business and once again it is going through a down-cycle. Current consensus estimates suggest that crude oil price is expected to stay well below USD 70/bbl this year, which is about 40-50% below its June 2014 levels. This sustained down-cycle is expected to have a considerable impact on other commodity prices, including direct (oil-based) and indirect. The existing contracts need to be reviewed both in light of the altered supply-demand situation for most categories, as well as due to the extreme cost pressures being faced by the oil and gas industry. This requires procurement teams to rework their sourcing strategies to cope with the swing in market conditions and contribute to make a positive impact on the bottom line.
Crude Oil Outlook
Crude oil prices are driven largely by macroeconomic supply-demand situation.
The demand can be primarily correlated to global economic outlook, while the supply to several factors, including what has currently become important - the strategy of major oil producers. Year 2014 witnessed supply-demand imbalance due to lower than expected world economic growth, and Saudi's refusal to reduce production in the wake of increased production by US shale oil producers.
In 2015, the oversupply is expected to continue in light of OPEC's continued refusal to be the swing producer. The expected annual global economic growth of 3.5% (Source: IMF) will not be enough to offset surplus oil supply. Hence, existing gap in supply demand of crude oil is unlikely to be bridged in 2015.
Further, this plunge in oil price has led to decrease in prices of other oil-based commodities as producers are required to pass the benefits to end consumers. Crude oil price decline and it impacts on commodity prices would force review of procurement strategies globally.
Procurement Intelligence and Analytics
During current times of volatile market conditions, procurement is under pressure to mitigate risks and achieve enhanced cost savings. Procurement intelligence and analytics can provide the insights needed re-strategize procurement function and the convincing arguments needed to support renegotiation.
In light of the rapidly changing environment and the requirement to review strategies globally, procurement intelligence and analytics is all the more important for the following reasons:
1) Oil producers - need for quick optimization to proactively help reduce cost
2) Oil-based product consumers - Need to confirm if the benefits accrued by suppliers are being passed on in their category prices.
1) Re-strategizing through Market Intelligence
Reassessment of the supply market can help timely adoption of the right sourcing strategy to achieve sustainable cost savings and supply security. Category buyers, when armed with timely information on market assessment & its drivers, trends and new developments, can strategically plan and nimbly respond to realize cost-saving opportunities.
2) Supply Risk Management
Changes in the current market scenario bring supply disruptions and cost management risks. With low oil prices, suppliers might lose on-going and up- coming projects leading to drop in their financial muscle power. It therefore becomes prudent to conduct thorough supply risk assessment and mitigation. This includes identifying weak links, tracking critical suppliers, conducting financial health checks, revisiting contracts, renegotiating deals, diversifying supply base, and working with suppliers to devise means of risk mitigation. Additionally, the price volatility should help review the cost hedging strategies of category managers.
The drastic change in supply chain prices demands category managers to revisit the contracts and sharpen their negotiation arguments. Market Intelligence can recommend the right mitigation measures to be adopted and their criticality - these could include inclusion of price flexibility or hedging clauses. Timely procurement intelligence can equip procurement professionals to conduct fact- based negotiations helping generate more value fast with lesser spend. Tools such as negotiation packs, price benchmarking, and cost inflation models can be effectively used for buttressing negotiation arguments.
4) Supplier Consolidation
Procurement professionals across organizations get new targets for budget optimization in current times of oil price disruption. Maintaining a large supplier base attracts huge cost, hence the need for consolidation becomes even more critical during such times. However, category managers need to carefully balance the requirements of consolidation with the requirements of ensuring supply flexibility to avoid undue disruptions. Insights into internal spend-analytics along with market and supplier intelligence can help formulate optimal supplier consolidation strategies.
1) Should Cost Modeling
Change in oil prices invariably impacts economics of a majority of the categories. It is important for category managers to understand cost structures in detail including cost drivers of raw materials, labor, transportation, overheads, margins, taxes, among others, to help quantify the impact of changing oil prices.
Cost models supplied by procurement intelligence are therefore useful not just to understand the cost drivers, but are used for negotiations, benchmarking, budgeting, and developing robust sourcing strategies.
2) Optimizing Spend through Better Visibility
Use of spend analytics and marrying it with market intelligence is an important measure being adopted by procurement function of larger organizations for spend optimization.
With evolution and deployment of sophisticated tools and techniques, it has become convenient for procurement professionals to convert raw data from invoices, PO's and contracts into actionable insights. Spend intelligence applied during low-oil price scenarios can provide significant insights into means of achieving substantial cost savings and cost avoidance.
Crude oil prices will continue to be low throughout 2015 and exert downward pricing pressure on several related commodities. This unexpected shift in the market can be envisioned as an ideal platform by procurement function to make significant positive impact by mitigating probable supply risks and maximizing cost savings.
Procurement professionals can achieve this mission by increasing their focus on procurement intelligence and analytics, which has proven to be instrumental in providing incisive supply market knowledge, objective arguments to support negotiations and highlighting risks and risk mitigation measures.
Ruppy Singh is Market Intelligence Manager within the Indirect Procurement function of BP. He is responsible for devising and managing procurement intelligence and analytics solutions. He holds an MBA in supply chain from Michigan State University.
Sandeep Syal is Senior Practice Expert with Evalueserve supporting procurement intelligence and analytics initiatives of indirect procurement function of BP. He holds post graduate diploma in business administration (Operations) and Bachelors in Chemical engineering.