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March 13, 2008 - Supply Chain Digest Newsletter
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First Thoughts by Dan Gilmore, Editor

Supply Chain and $200 Oil

It hardly seems that long ago, but in 2005 I wrote a column called “Supply Chain and $100 Oil.” At the time, I believe oil prices had increased to more than $60 per barrel, Goldman Sachs analysts had just predicted we might see $100 per barrel oil soon.

Gilmore Says:

"Think about that for a second. It’s possible we could get a doubling from today’s level of staggeringly high fuel costs. The impact to supply chain strategy would be substantial."

What do you say?

Send us your comments here

That prediction turned out to be somewhat premature, but here we are. Those views were certainly more accurate than the predictions of many others who said in 2005 that oil would drop back to the $45 per barrel range. As oil went to $70 and then $80 per barrel in 2006 and 2007, many more said that wouldn’t last.

This week, of course, the price is $107 per barrel or so. That’s up something like 65% from the start of 2007. It’s already causing havoc in our supply chains. Transportation costs are rising despite significant overcapacity in most truckload and less than truckload markets, as we’re stung by the fuel surcharges that have enabled the carriers to push all of the fuel risk on to shippers.

How long will it last, and where is it headed from here? If I knew that for sure, I’d be trading oil futures on a beach somewhere, but all of us in the supply chain need to start thinking through what the impact will be on our costs and operations if we go further north from here.

Legendary investor and oil tycoon T. Boone Pickens, who has made billions understanding the energy markets, said a couple of weeks ago he thought oil prices would drop back to $85 or so for awhile, due to economic slowdown, but had a real chance of getting to $150 per barrel by the end of the year.

Last week, the same Goldman Sachs analyst team now says prices could be headed as high as $200 if the world economy gets revved up again and/or any monkey wrench is thrown into the world oil supply.

Think about that for a second. It’s possible we could get a doubling from today’s level of staggeringly high fuel costs. The impact to supply chain strategy would be substantial.

I think it’s good to understand how we got here.

  • World oil production is basically flat, at something like 86 million barrels per day for a few years now. This is consistent with the “Peak Oil” theorists, who believe that oil production globally has or will soon hit a maximum and then begin to decline. Though there are some fringe elements sometimes involved in Peak Oil topics, there are also many knowledgeable people who agree, and we’re seeing whole industry conferences on the topic.
  • We are adding very little in the way of new oil reserves world wide.
  • The buffer between capacity and demand that used to exist is gone – just a million barrels per day slack or something, as India, China and other developing countries consume more and more oil and reserves and production don’t budge.
  • The reduction of this capacity slack naturally leads to general upward price pressures, and means the slightest supply disruption (let alone a major) sends prices soaring.
  • The price of oil is fundamentally unhinged now from core supply and demand, and is controlled basically by what are called futures traders. One expert recently said there was a $10-15 premium in oil prices from the futures trading versus core supply and demand factors.

So, let’s look at a number of factors. I am going to use $200 per barrel as a potential point, in part because as mentioned, that has now become the new upper target, and because it makes for some easy math in terms of doubling from the $100 level of late. I am also not considering the impact on the economy, which could/would be substantial.

Obviously, the first and probably largest impact is on transportation costs. In order, rising fuel costs impact air carriers the hardest, followed by trucking and then rail. I am not quite sure, but would think ocean would be similar to rail.

Transportation analysts at Bear Stearns believe rising trucking fuel surcharges are the key factor in the increased recent diversion they are seeing of trucking freight going to rail despite the favorable environment overall for companies in the TL market (See Quarterly Bear Stearns Shippers Survey Suggests Trucking Capacity Glut may be Reaching Bottom.)

I have recently spoken with both a high tech company and a consumer soft goods company that both moved most product by air, but which are looking at how they can make ocean shipping work in the face of rapidly rising air cargo costs.

On the trucking side, Tiffany Wlazlowski, press secretary for The American Trucking Associations, told me this week “that for the first time, carriers in some cases are telling us that fuel costs are exceeding labor [driver] costs.” She says that for truckload carriers, fuel costs can now be 25% or more of total operating costs.

Also consider that by my estimate, based on available data, oil costs represent about two-thirds of the price of a gallon of diesel fuel.

So, this means that if oil goes to $150 (a 50% increase), truckload shipping costs, however they get there (base rates or fuel surcharges), would rise about 8.5%. If it goes all the way to $100 (a 100% increase), TL costs would rise about 17% - an incredible number. Think of the impact on the bottom line of most shippers. For those interested, here’s how I got there for scenario 1: .25 (fuel as percent of TL carrier cost) x 50 (percent increase if oil goes to $150) x .67 (percent of oil in current diesel cost).

I am almost out of space, so we can’t take a much deeper dive than this here. But we will soon – Dr. David Simchi-Levi of MIT and software company ILOG, one of the most respected supply chain industry thought leaders, is working on some analytics models for SCDigest readers on what this might mean for supply chain network design and trade-offs among transportation, inventory and distribution costs.

I haven’t seen it yet, but he told me just today some of the results are not what you might expect. I’m looking forward to it, and hope you are too.

What do you see happening if fuel costs rise by another 50% or more? Do you think this is likely?  What should transportation and supply chain managers be doing to prepare for this possibility?  Let us know your thoughts at the Feedback button below.

Let us know your thoughts.

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Dan Gilmore


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This Week’s Supply Chain News Bites – Only from SCDigest

March 13, 2008
Supply Chain Graphic of the Week - New Supply Chain Skill Requirements

March 13, 2008
Supply Chain by the Numbers: March13, 2008


The fear of the unknown tightened its grip on Wall Street last week.  However, overall, our Supply Chain and Logistics stock index withstood the biggest portion of the pressure.

The exception was within the software group as Logility fell 44.6% from last week’s closing price.  In the hardware group, both Intermec and Zebra saw little movement (up 1.7% and down 2%, respectively).  In the transportation and logistics group, Union Pacific was down 4.1%, followed by Ryder (down 3.6%).    

See stock report.


Each Week:

-Global Supply Chain
-Distribution/Material Handling
-Trends and Issues

Weekly On-Target Newsletter
March 11, 2008

Sorting it Out

by: Cliff

Top Management Involvement is Essential in Fostering and Sponsoring Distribution Automation Improvement Projects

Does your
environment foster Ideas that drive continuous improvement – or are creative proposals immediately shot down? Some companies are committed to material handling excellence.


Q. Who was M. King Hubbert and how is he related to supply chain management?

A. Click to find the answer below


Reader Question: Can Bucket Brigades Work with Mechanized Order Picking?

Reader Question: Is there a True Global RFID Standard?

See our expert answers at the links above. Share your knowledge or perspective.

Or, ask your question


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We're really behind again - bear with us. But keep the letters coming! In the next few weeks, we'll start adding feedback right on specific story pages, so you can see what others are saying.

The Feedback continues to come in at high levels.

This week, we're publishing more responses regarding our piece on 2008 Supply Chain Predictions, which brought togeter the views of a number of supply chain experts. Our Feedback of the Week is from Kate Vitasek of Supply Chain Visions commenting on this topic. We have several more letters on this, plus one more commenting on a similar set of predictions from AMR Research that we also published.

Give us your thoughts on this week's Supply Chain topics. As always, we’ll keep your name anonymous if required.

Feedbacks of the Week - On 2008 Supply Chain Predictions:

I like your article on trends. I am actually working with the University of Tennessee on their “mega trends” report this year.

I thought you might like my “analysis” of your article.I thought it would be interesting to count the number of times a few commonly discussed terms were used by the “experts.” See below.

Most used were “Cost” as in cost reduction and “Global” as in global supply chain/globalization.

The term “Network” came up 5 times related to improving network design.

Another interesting point is that the term “Out-source” primarily referred to firms re-examining their decisions.

Interestingly though, “Lean” was not mentioned at all, nor was “Optimize” or “Waste” in a Lean sense. I thought this is funny because Karl Manrodt and I are doing an update of the Lean study for APICS right now and the adoption rate of companies implementing lean philosophies in the supply chain areas is greatly improved over the last three years….indicating a significant number of companies are actually implementing lean concepts in the supply chain and not just manufacturing.

Here is the complete analysis.

Lean = 0
Improve = 1
Optimize = 0
Cost = 22
Value = 5
Network (supply chain) = 5
Outsource = 7 (emphasis is on re-examining “myoptic” decisios)
Off-shoring = 1
RFID = 1 (discussed “implosion” / refocus on practical usage)
Collaborate = 0
Metrics / performance = 1
Global / globalization = 21
Waste = 1 (focus on money spent on technology)
Green = 6
S&OP = 1
Strategy = 3

Kate Vitasek
Founder and Partner
Supply Chain Visions

More on Supply Chain Predictions for 2008:

On your 2008 Supply Chain impact commentators:

  1. The rush to source from China is going to change. Quality and liability fears, transportation costs, customs delays, exchange rates, consumer backlash, inconsistent timing and domestic demands within China are going to impact the decision to source or not source.
  2. Alternative countries are moving to the fore front. Vietnam, Laos, Thailand, India, all will see an increase as the logistical lines within those countries and through those ports improve. Watch what happens with Vietnam as the ports are improved and more steamships call on the ports. Trade with those countries will explode once the first steamship line decides to add direct Europe of direct trans-Pacific service to those ports.
  3. Week and “follower” organizations will jump into bidding contests for services, with a singular focus on low rates (because that is what the investors are demanding). When it is all done end up with below market rates for below market performance, and will have to resort to elevated “broker” rates, wondering why the carriers they awarded the business to is not accepting the tenders. Smart logistics and transportation players will build relationships with carriers and service providers to protect costs. The smart players will pull to quality, recognizing that the slightly higher rates buys better performance, and they smart shippers will see lower total cost from not having to work with the brokers.
  4. Brokers are going to make a lot of money this year. They are going to sell as much empty capacity as they can, and enjoy high margins as all of the “bidders” go searching for the capacity that they did not secure with the low bid awards.
  5. Capital spending on systems will be tight, but subscription based providers will have a good year. Watch at least one major “traditional” license WMS vendor decide to roll some sort of on-demand WMS offering. It will be a stripped down system that will not be very attractive, but it will be something that all of those less than $300MM operations are going to need. Maybe we see SmartTurn really take off this year.
  6. 3PL warehousing and logistics services will not be mega deals, but lots of small operations for lots of small players.
  7. Finding really good talent is going to be hard. There will be lots of mediocre talent with experience and a lot of older experienced talent that just does not want to make a move. The really good people are going to be much harder to find as more and more demand picks up from the medium sized and growing companies.
  8. Oil will be very tough to figure out. Expect energy costs to stick a fork in the roast several times this year.

David K Schneider
David K Schneider & Company, LLC

Interesting that there is nothing on the AMR list about the need to address environmental issues as part of SCM. We are seeing ever more interest in the green agenda from our clients (private sector and public sector. My view is that there will be a growing focus on transport efficiency in 2008 - whilst using fewer vehicles traveling along more efficient routes is part and parcel of good supply chain practice it is also good for the environment.

The objective of a business is to grow shareholder value, so it would be a brave organization that decided to do everything it could to be green irrespective of costs. However, as fuel costs rise, economic and environmental concerns will converge even more. This is reflected in new IT technologies such as dynamic routing and scheduling and carbon footprint optimization tools - both missed by AMR!

Jeremy Hammant
LCP Consulting
Great Britain

Fun reading and I particularly identified with the sentiments offered by Dr’s Tompkins and Fisher regarding total vs. landed costs, and retailer store level operation’s execution importance, respectively.

Tom Miralia
Distribution Technology Inc


Q. Who was M. King Hubbert and how is he related to supply chain management?

A. M. King Hubbert was the Shell geologist who in the 1940's developed the "Hubbert's Peak" graphs that showed how the production from individual oil wells - and he argued, the entire supply of oil - follows a predictable curve that builds to maximum output followed by steady decline. The concept has been adopted by "Peak Oil" theorists, who believe the world is at, or very near the top, of the output curve right now.

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