Oil and the changing nature of supply chains

Over the past few weeks, I've been trying to learn something about the economics of oil. If armies move on their stomachs, as the old soldier's expression has it, then supply chains move on petroleum. The global flow of goods depends on a reliable flow of affordable fuel.

This magazine has carried some excellent articles on the long-term prospects for oil and what they mean for managing supply chains. But even with the certainty that we've reached "the end of cheap oil," one would think that in the short term, normal rules of supply and demand would take hold. That was not the case in late 2011 and early 2012, when prices remained high even as demand fell and inventories grew.

The factors driving oil economics are dizzyingly complex. It's that complexity that leads to some counterintuitive realities, such as the disconnect between supply, demand, and price. Or this one: while the United States seeks ways to wean itself from imported oil, it is exporting petroleum products at the same time. Or this: a proposed regulation that's meant to limit speculation and price volatility in U.S. oil trading might do just the opposite.

I am drawing heavily on a presentation that Hussein Allidina, a senior petroleum researcher for the investment firm Morgan Stanley, made to the annual Nasstrac conference at the end of April, and on information derived from the International Energy Agency's monthly Oil Market Report. (Any faulty analysis here is all mine, however.)

Demand across the 34 industrial nations that make up the Organization for Economic Co-operation and Development (OECD) was relatively weak over the winter, according to Allidina, but prices stayed high in part because of lingering fears about the potential for an Israeli attack on Iran and because of some temporary supply disruptions. As bad as it seemed in the United States, it was worse in Europe and India, where prices were close to their 2008 peaks. OPEC—the Organization of the Petroleum Exporting Countries—continued to build inventories, not in spite of lower demand but because prices remained high.

But longer-term, demand is almost certain to grow faster than supplies. The world consumes some 90 million barrels a day, but Allidina projects that by 2016 total supply will grow by only about 6.6 million barrels a day. Keep in mind that while the United States and Europe are growing slowly, the economies of India, China, and other developing nations continue to grow rapidly. Price and supply volatility seem almost a given for years to come.

For a long time now, we've talked about the globalization of supply chains, and globalization is a real phenomenon. But I suspect we had better keep a close eye on the development of regional supply chains as businesses look for closer physical alignment among sourcing, production, and distribution as a means of protecting themselves at least a bit from the economics of oil.