Intro/Outro (00:01):
Welcome to dial P for procurement, a show focused on today’s biggest spin supplier and contract management related business opportunities. Dial P investigates, the nuanced and constantly evolving boundary of the procurement supply chain divide with a broadcast of engaged executives, providers, and thought leaders give us an hour and we’ll provide you with a new perspective on supply chain value. And now it’s time to dial P for procurement.
Kelly Barner (00:31):
There are two things that nearly all companies point to when they explain their rising prices. One is labor costs and the other is the cost of fuel. Now this isn’t just a business problem. Consumers are feeling it as well, depending on the taxes in your state and city gas prices were in the five to $6 range. Just a few weeks ago, diesel fuel is averaging $5 and 50 cents a gallon nationally up 68% from last year. Now, for context, a gallon of regular gasoline is up, but only by 41%. And it doesn’t really matter how big you are. There doesn’t seem to be an amount of leverage that can address this problem. In April, Amazon implemented a 5% fuel and inflation surcharge on third party sellers using its fulfillment services more recently on July 1st, Walmart informed suppliers that it would be adding pickup and fuel fees calculated as a percentage of the cost of goods bought from that supplier ups and FedEx have more than doubled their fuel surcharges on ground deliveries year over year, according to calculations by Cohen research and AFS logistics.
Kelly Barner (01:50):
And it goes beyond vehicles as well here in the Northeast and in parts of the world with similar climates home heating oil concerns for the coming winter are very real many delivery companies are promoting advanced purchase programs to help their customers, especially those on a fixed budget, prepare and put aside money so that they don’t have to suffer through what would otherwise prove to be a very cold or expensive winter. And again, it goes to farmers they’re paying $2 per gallon more year over year, which because of the size of their equipment tanks means between 500 and $850 more per tank making matters. Worse farmers can’t raise their prices or issue surcharges like Amazon and Walmart ups and FedEx. Their prices are set by the market and they’re trying different farming techniques to reduce their fuel consumption. But that’s only going to go so far.
Kelly Barner (02:56):
There was even an article in the Boston globe recently that pointed to ice cream trucks having to raise their prices by 20 to 30% to cover their fuel costs. According to the north American ice cream association, executive director, Steve Christensen, ice cream trucks are quote, unfortunately becoming a thing of the past to which I ask is nothing sacred in this week’s episode of dial P for procurement, we’re going to travel through the fuel supply chain from crude extraction to refining to the pump. We’re gonna better understand these tiers and look at the different profit margins where they’re the highest and where they’re the lowest we’ll consider, which types of organizations are taking on the most risk and which stages in the process require the biggest capital investments. Finally, we’ll take a quick look into how us sanctions against countries like Iran and Russia are playing into costs.
Kelly Barner (04:01):
But before I go further, let me introduce myself. I’m Kelly Barner. I’m the owner of buyer’s meeting point. I’m a partner at art of procurement, and I’m your host for dial P here on supply chain. Now I am constantly scanning the news for complex articles that I think are worth discussing. These are things that are obviously interesting, but could easily escape. People’s notice. My goal is never to lead you to a simple answer, but instead to provide the background and context, you need to form your own opinion. Dial P releases, a new podcast episode or an interview every Thursday. So be on the lookout for future episodes. And don’t forget to check out our past episodes as well. Before we get back to today’s topic, few quick favors, we’re building out dial P’s independent following. So if you enjoy what you hear today, give us a quick review on iTunes, offer up some stars in your preferred podcast platform.
Kelly Barner (05:07):
Even give us a share or a like on LinkedIn or Twitter, it’s really about expanding our audience so that we can broaden the conversation as always, I’m grateful for your interest and attention. So thank you for spending the next few minutes with me, all right, back to fuel. Why is fuel so expensive for the answer we need to dig into the oil supply chain? There are three segments in the supply chain. There’s upstream, midstream and downstream upstream includes exploration and production. These are the companies that drill oil and gas, Wells, and extract the oil midstream where we’re not actually gonna spend much time. Today is predominantly focused on transportation to refineries using pipelines, trains, and tanker operators. And then finally downstream. Now these are the organizations that most of us generally associate with the oil supply chain. It includes both refineries and gas stations, but we’re going to begin at the beginning upstream with crude oil production about 100 countries produce crude oil, but as of 2021, just five countries account for 51% of all production worldwide in 2018, the United States became the world’s top producer with 14.5% followed by Russia at 13.1% Saudi Arabia at 12.1% Canada at 5.8 and Iraq at 5.3.
Kelly Barner (06:50):
This all really comes down to what the prevailing price per barrel of crude is in 2021, we started the year with the price per barrel, about $50. And we ended the year around 75. Now this was mostly driven by people returning to their pre pandemic living and working patterns. And what happened was demand started to get ahead of supply. So I mentioned that we were gonna talk about profit margins and risk and investment. So it’s fair to ask are crude oil producers getting rich? Well, not necessarily. It all depends on the price per barrel. According to the association of convenience and fuel retailing, a barrel has to sell for about $56 to make drilling new Wells profitable with the 2021 average of about $71. A barrel producers got $15 in profit or 21%, and that’s a good year, but that’s one year the 2020 average was about $42, not enough to make money or make drilling new Wells profitable.
Kelly Barner (08:05):
But as we all know, 2020 is a good year to use in benchmarking for absolutely nothing. So let’s go back a little further in 2019, the average was $64 a barrel so enough to make it profitable, to drill new Wells, but not with a lot of wiggle room. This is a highly volatile market, and it’s very hard to turn a profit when you can’t plan for what that price per barrel is going to be quarter over quarter or year over year. Now, before we head downstream, I thought this was interesting. Here’s how a barrel of crude breaks into the different types of fuel that we use. There are about 45 gallons of crude in each barrel. Nearly half 20 gallons becomes gasoline, 11 gallons become U L S D or the diesel fuel used by logistics providers. The remainder is divided out into small portions things like home heating oil and jet fuel, but you can be sure that that breakout means that the changing price per barrel of crude does affect different uses differently.
Kelly Barner (09:21):
As we move downstream, we start by looking at refineries. They’ve been in the news a lot lately, mostly being asked to account for their record high profitability. And it is true that their profit margins have been at record levels. Exxon Mobil, Chevron, and shell, the three largest oil companies reported a collective 46 billion in profit in the second quarter. Now, to be fair, this profit is from more than just refining crude oil, but refining is one of their most lucrative activities. Here’s an example of another company Valero brought in 4.7 billion in net income in Q2 and that’s 29 times what they brought in a year ago. And it was above what were already elevated expectations for their profitability. So why are refineries able to make so much money and truth? It comes down to classic supply and demand. Refinery capacity is a huge problem worldwide right now it’s on the way down for several reasons.
Kelly Barner (10:32):
One reason is the cost of retrofitting older plants to bring them up to more modern operating standards. Another reason is simply maintaining plants that are already operating well. And in fact, we know that according to the American petroleum Institute, there are 11 fewer refineries operating today than there were before the pandemic. Just two years ago, Politico reports that us fuel producing capacity has fallen by nearly 1 million barrels a day since early 2020. And as I’ve said, consumer demand is up. This mismatch between supply and demand is creating bottlenecks and breaking points and of course, prices to spike at the pop. But it also isn’t as simple as just saying the refineries are the bad guys in a recent wall street journal article Matthew Blair, an equity analyst at tutor Pickering, Hal and company pointed out that quote refineries are a high fixed cost business and small changes in margins can have a big impact on profitability.
Kelly Barner (11:42):
So let’s go back to Valero with their 29 times profitability Q2 year over year, they spent 20, 20 and 2021 with break even or negative net profit margins. And they average between two and 4% a year between 2012 and 2020. Now, given that information and the volatility of money in this industry, it’s understandable that any refinery’s carrying heavy debt may have closed down during the pandemic either because they could no longer afford to off operate profitably or because they could not afford higher sustainability driven insurance costs that they have to carry. In addition to that, they’re affected by higher labor costs and the increased cost of steel. So these record profit margins are likely not lasting and they’re certainly not reliable. So if these refineries are smart, while they’re making a ton of money today, they’re paying off debt from the past and they’re saving for the inevitable rainy day in the future.
Kelly Barner (12:51):
Let’s consider one last part of the downstream fuel supply chain gas stations. This is simple gas stations are not making any money on gas. 55% of convenience stores are one location operators or franchisees. And even when they display the brand of a major oil company like shell or mobile, they’re usually not owned by that company. So the markup on gas is about 30 cents a gallon, but with credit card fees and overhead gas stations make about 10 cents per gallon, regardless of how much you actually pay. And of course that changes a little bit per gallon, but they’re not seeing huge swings in profitability. Here’s an example, even with the elevated gas prices, let’s say you pay about $4 for a gallon. The gas station makes 2.5% on that put 15 gallons of gas in your SUV, and they have made a whopping dollar and 50 cents. So they’re definitely not getting rich.
Kelly Barner (14:01):
Now, the last thing I wanna address in this discussion of the oil supply chain is the role that sanctions against companies like Russia and Iran are playing in global supply. And therefore global prices sanctions against Russia in particular are causing widespread concern, mostly in Europe on the part of countries like Germany and France, because they have greater reliance in March of 2022. The Biden administration announced that the us would not import oil or gas from Russia. And our imports from them have been increasing. In recent years, we went from 520,000 barrels a day in 2019 to 540 in 2020 to a 20 year high of 672,000 barrels per day in 2021. Ironically, this increase in import of Russian oil was due to sanctions that the us had placed against Venezuela and attempting to replace that supply. So you can see why Biden had those recent talks with Saudi Arabia about increasing their production.
Kelly Barner (15:12):
Unfortunately, the refinery capacity issues that we’re seeing in the United States seem to be systemwide. The Saudis are also at max production levels. The world has short capacity, but as big as those numbers sound, let’s put us consumption of Russian oil into context. According to the energy information administration quote in 2021, the United States consumed an average of about 19.7, 8 million barrels of petroleum per day, or a total of about 7.2 billion barrels of petroleum per year, Russian oil at 672,000 barrels per day, or 254 million barrels a year is 3.4% of our annual consumption. Remember two that our production is down by 1 million barrels according to Politico. So this is an issue to be sure, but it’s not enough of our total demand to drive the kind of price increases that we’re seeing. And on top of it, the sanctions are not really working. China is the single largest importing country of Russia’s crude oil and they account for almost a third of the country’s oil exports.
Kelly Barner (16:33):
So they’ve found another place to sell their wears the other problem that exists in the oil supply chain. And it’s one that plagues other supply chains as well is the issue of traceability. There are some bad actors out there obscuring the source of oil to avoid sanctions. Some Russian oil is being refined in India and Iranian oil is being smuggled out. This was actually an example of great timing. I love nothing more than when I’m researching an episode of dial P and relevant news breaks. So on July 31st, the wall street journal ran an exclusive story titled us eyes sanctions against global network. It believes is shipping Iranian oil. And what they reported in this story is that Iranian oil is being transferred, shipped to ship mid ocean, and then it is being blended with Iraqi oil so that all of the oil can be passed off as Iraqi avoiding global sanctions.
Kelly Barner (17:37):
The article reports that this may account for as much as 25% of Tehran’s oil exports. Now, fortunately there are no allegations currently being made that Western firms are intentionally violating these sanctions. Although ExxonMobil Coke and shell PLC are all named as being involved in some of these transactions. It’s a good reminder that as supply chain professionals, we can’t let a desire to control costs cause us to turn a blind eye or to pretend that traceability down to the source isn’t possible when in fact it should be. So that brings us to what do we do? Well, we know that fuel costs are volatile at every step of the supply chain and not everybody’s making a lot of money. Despite all of this risk, they have to be prepared to brace for it. Doesn’t just involve the costs of the raw materials. There’s a lot of capital intensity to this refinement process and today’s winners can easily become tomorrow’s losers in an instant.
Kelly Barner (18:45):
If that weren’t enough instability, fuel is subject to constantly changing regulation and geopolitical impacts. And because it affects the cost of nearly everything we buy either directly through the price of a gallon of gas or indirectly through what we buy at retail locations and the food that we buy at the supermarket, the cost of production in this industry affects every consumer and every business. So my advice for consumers is to be wise and manage your expenses. Watch those prices at the pump, do what you can to conserve fuel, but mostly be aware. And that is especially important. When we come back to that topic of home heating oil, do not think for any stretch that by November, December, this is automatically going to have worked itself all out. We don’t wanna hear terrible stories about people on fixed budgets, living in unbearably cold situations. This winter, from a B2B perspective, we have to be realistic if Amazon and Walmart can’t control their shipping costs without adding surcharges.
Kelly Barner (19:56):
Most of the rest of us probably can’t do it either. And the same goes directly for fuel prices. If ups and FedEx can’t negotiate better prices based on their volume. The rest of us have very little chance of being able to do so, but that doesn’t mean we can’t be strategic about managing the surcharges themselves. If you have to accept one, you accept it, but it then becomes your job to monitor the price per barrel prices at the pump so that you can be the first company to call up a logistics provider, to call up a supplier and say, I think it’s appropriate to roll this surcharge back. That is your job, especially if you happen to work in procurement. Now that’s my point of view, and this is a constantly changing complex industry, but given its impact on every single facet of the economy, we owe it to ourselves to understand it.
Kelly Barner (20:53):
I’ve shared my point of view, but as you know, I wanna hear from you as well. So now that you’ve listened to this episode of dial P for procurement, join the conversation and let me know what you think. Find a posting on LinkedIn about the episode and share your thoughts, add additional information, find it posted on Twitter and add in some comments. It doesn’t take much more than that for us to get a conversation started and arrive at a better solution. Of course, please share this episode with anyone in your network that you think would enjoy it and reach out to me directly on LinkedIn. If you have knowledge to share, let’s work together to increase our understanding and figure out the best solution until next time. I’m Kelly Barner on behalf of dial P and supply chain. Now have a great rest of your day.
Intro/Outro (21:45):
Thank you for joining us for this episode of dial P four procurement and for being an active part of the supply chain now community, please check out all of our shows and events@supplychainnow.com. Make sure you follow dial P four procurement on LinkedIn, Twitter, and Facebook to catch all the latest programming details. We’ll see you soon for the next episode of dial P for procurement.
