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Sharpening LTL Management: What to do about peak oil

As the economy recovers, shippers should expect fuel prices and LTL rates to rise due to global oil market supply constriction. Two experts take a closer look at where oil exports stand and how shippers need to prepare for pricing instability.

June 22, 2010

By Derik Andreoli

By this time, most logistics and supply chain professionals have heard about “peak oil” and have been warned that oil production will certainly peak in the future. Typically, oil supply is evaluated using production data, but production data alone paint only a partial picture of the supply constraints that contributed to the oil price spike in the summer of 2008.

While production certainly matters, only a portion of the oil that is produced worldwide is sold on the global market. Hence, net oil exports—the total amount of oil exported from surplus producer countries—offer a far more important measure of supply than production data alone.

The problem, however, is that global oil exports peaked in 2006; and despite a tripling in the price of oil, global exports were in fact lower in 2008 than they were in 2004. But why did exports peak while production continued to grow?

Over the last four decades the structure of the oil industry changed dramatically. In 1970, investor-owned oil companies (IOCs) like British Petroleum and Exxon Mobil controlled 85 percent of global oil reserves, and national oil companies (NOCs) controlled only one percent.

Today the tables have turned. IOCs control only six percent of the world’s proven reserves, and NOCs, like production giants Saudi Arabian Oil Company and National Iranian Oil Company, control 88 percent.

As the price of oil rises, net oil exporters experience a significant boost to export incomes. NOCs generate petrodollars that support a variety of domestic investments that create jobs and increase domestic demand for energy and fuel. But here’s the rub: Most net exporting nations subsidize their domestic consumption.

This market imperfection means that the real price of fuel in many of the exporting countries declines as the world price of oil rises. In 2005, the spot price for a barrel of oil was roughly $50. By 2008, the price had doubled to $100 per barrel. This doubling in price increased Saudi Arabia’s export earnings by nearly $400 million per day, and domestic oil consumption grew by 27 percent.

Oil exports peak when the rate of growth of domestic consumption begins to outpace the growth of production. As a consequence of rising incomes and growing populations, domestic oil consumption is rising rapidly in many net oil-exporting nations. Indonesia provides a good example of the peak oil export phenomenon.

Indonesia reached an oil production plateau in 1977 at just over 1.5 million barrels per day (mbpd). By 2000, production had declined slightly, but domestic consumption climbed steadily. Despite the elongated production plateau, oil exports clearly peaked in 1977, and in 2004 Indonesia transitioned from being a net oil exporter to a net importer despite the fact that the country was still producing at nearly 70 percent of peak volume.

A similar process is playing out in Mexico today. In 2004, Mexico was the number two supplier to the U.S. Between 2007 and 2008, net exports fell by 22 percent; and at the current rate of decline, Mexico will transition from being a U.S. supplier to a competitor by 2014.

A similar process has played out in China—the most important non-oil trading partner the U.S. has. In 1993, China was a net oil exporter; but by 2008, China was importing more than 4.2 million barrels per day (mbpd).

An even more unsettling trend emerges from an evaluation of exports by nation. While the total number of net exporting nations has remained relatively stable since 1996, the number of net oil exporters that have not yet reached peak exports declined from 39 to 12. Important producers like Saudi Arabia, Mexico, Nigeria, Norway, and the U.K. are not on this list, but the Democratic Republic of the Congo, Iraq, Sudan, and Angola are. These are the nations on which the U.S. will become increasingly more dependent—a fact that does not impart warm and fuzzy feelings.

So what does this mean for shippers and carriers? Transportation practitioners should expect fuel prices to rise and become even more unstable. Smart practitioners should already be working on ways to reduce their consumption. This means focusing on optimizing transportation planning and utilization—not just trying to figure out ways to get better rates from carriers.

Addressing the pending fuel shortage: Optimize, don’t just negotiate

By Hank Mullen

When it comes to building better LTL/shipper relationships these days, the old method of “I win you lose” just won’t cut it when you take the looming oil crisis into consideration.

Americans should remember that when in crisis mode we have adopted the famous “Join, or Die” mantra that Ben Franklin used to unite the country before the Revolutionary War. I say why not unite the nation’s carriers and shippers when it comes to fuel? I’ve been reading about “greening” for a few years now and I think the time has come to use our best and brightest to solve this pending crisis.

It’s actually nice to see the government’s enthusiasm to get involved. One approach that has been offered by the Department of Transportation is their recently developed plan called “Transportation for a New Generation” that’s aimed at developing solutions for “livability.”

And while my gut reaction would be to tell the government that it should let shippers and the greater transportation industry figure out how to get greener, it’s just not that simple.

Unfortunately, shippers and carriers are focusing too much time negotiating fuel surcharges and not enough time addressing the real problem—how to optimize overall transportation and reduce fuel consumption. I propose that shippers and carriers stop the bickering and join forces to work collaboratively.

Fuel surcharges first became a hot topic in the transportation industry in the mid-1970s, when the U.S. Department of Energy (DOE) created the National Retail Average to compensate carriers for the volatile fuel prices of the OPEC oil crisis era. It operates the same way today as it did back then: Each Monday, a representative group of approximately 350 retail diesel outlets, including truck stops and service stations, report their retail diesel prices. The DOE then uses that data to issue the national average diesel price for that week.

This process became, by default, the baseline for the weekly fuel surcharge rates billed by the carrier. Today, fuel charges change on a weekly basis with most LTL carriers, and can vary as much as 25 percent from carrier to carrier. Under this scenario, if fuel prices increase during the week, the shipper wins and the carrier loses. If fuel prices fall during the week, the carrier wins and the shipper is the loser.

Fuel surcharges are calculated as a percentage of the shipment charges expressed as a percentage of the total shipment cost. As I write this article it just so happens to be in the 22 percent range. The less your shipment charge, the less the fuel cost portion. The higher your freight class, the higher the cost per shipment and the more you pay for fuel as determined as a percentage of the shipment cost.

Couple this with using conventional rate classification approaches and pricing freight gets even more polluted. Today there are 18 rate classifications ranging from a low of class 50 with a cost per hundred pounds of $63.71 to a high of class 500 with a cost per hundred pounds of $525.66 with no discounts. Your class of freight and your freight all kinds (FAK) range can reduce you total spend.

Let’s look at an example of how this works. If you have multiple freights classes, say class 50, 70, and Class 100, some carriers will give you a FAK Class 50. If you have a Class 100 shipment the cost would be $239.88 with a fuel cost of $52.77 for a total of $292.65.

Using the same carrier with a FAK 50, the shipment would cost $138.57 with a fuel cost of $30.49 and a total cost $169.06. You could also see a 25 percent reduction of the fuel that some carriers offer. To make matter worse, carriers toss in discounts of up to 90 percent.

This is a great example that shows that conventional approaches to pricing freight is analogous to a playing a shell game; sometimes things appear and sometimes they don’t. Depending on how shippers and carriers play the game, there is a winner and a loser. This approach is myopic and inefficient and encourages discontent, finger pointing, and distrust between shippers and carriers.

Optimize transportation, reduce fuel

The transportation community should instead work together to figure out how to optimize transportation and reduce the amount of fuel used. Perhaps it’s time that all organizations involved in the LTL mix explored a better way of working together and tied it to a national goal to reduce fuel consumption.

I love the concept of “vested outsourcing” that Kate Vitasek and her colleagues at the University of Tennessee are teaching. Using vested principles, shippers and carriers work together to find better ways to decrease fuel consumption.

The concept espouses transparency and fairness, and the transportation community should rise to the occasion to work together to optimize transportation and quit playing a shell game and bickering over fuel service charges and rate discounts where the company with the most muscle or political clout wins.

For example, Wal-Mart and UPS have started programs to reduce carbon footprints. These programs track the credits you can use and help provide visibility that should help reduce carbon and use less fuel. I particularly like the lead that Wal-Mart has taken in this area to focus on packaging.

Wal-Mart wants its 60,000 suppliers to cut the amount of product packaging they use throughout the supply chain by 5 percent starting in 2008, saving the world’s largest retailer $3.4 billion in the process. Wal-Mart’s five-year plan will monitor suppliers and recognize those who use less packaging, better materials and more efficient sourcing for the packaging they use. The company estimates its move will cut nearly $11 billion in supply chain costs and prevent more than 660,000 tons of carbon dioxide being released into the atmosphere.

The example above tells how reducing packaging 5 percent saved the money due to better load averages and more freight per trailer, allowing the carrier to use the equipment more efficiently.

If shippers realize that LTL pricing is based on density and value, then each pound per cubic foot reduction saved will allow for better carrier pricing and greater load factor—and they can use this better efficiency to help obtain better rates.

It all adds up: Same trailer, more shipments per trailer, better fuel cost per SKU. Now, what if Wal-Mart would take some of those savings and share it back with the suppliers and carriers who helped them optimize their transportation?

—Derik Andreoli, Ph.C., is co-founder of the energy think tank Energy Transitions Northwest and faculty affiliate of the Harvard Business School Microeconomics of Competitiveness Program. He can be reached at .(JavaScript must be enabled to view this email address)

—Hank Mullen is President of The Visibility Group and Freight Pricing Experts, a specialized consulting firm that seeks to use space occupied pricing to drive transparency and visibility to help companies optimize their transportation efforts. He can be contacted at .(JavaScript must be enabled to view this email address).

 

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