Supply Chain Management 2015 Energy Outlook

Derik Andreoli, Ph.D.c., senior analyst at Mercator International LLC, shares his observations on the energy sector in this exclusive interview with Supply Chain Management Review

Supply Chain Management Review: What were the most significant shifts in the energy sector last year?

Derik Andreoli: The biggest story in the energy sector has to be the 30% decline in oil prices since June to a level not seen since the global recession cut a whopping 6% from global consumption back in 2009. This price decline has come as a result of surging U.S. oil production, and global demand which has lagged on the back of a significant deceleration in the growth rate of Chinese demand.

Unfortunately for consumers of diesel fuel, the extreme softening of global oil prices has not translated to U.S. pump prices. The national average price for a gallon of diesel declined by only 5% in the Rocky Mountain region and just 7% on the West Coast. While prices have declined by a greater amount in the Northeast, the declines there were from highs associated with the “Polar Vortex” that rocked the region in the first quarter.

Speaking of the Polar Vortex, natural gas prices are up nearly 20% from last year levels, and this is largely the result of the nearly unprecedented surge in demand last winter which pulled natural gas inventories down to a cyclical low that was just half the prior 5-year low.

Derik Andreoli, Ph.D.c., senior analyst at Mercator International

“If this winter is particularly bad on the East Coast, we will see prices rise significantly, just as they did between January and March”Derik Andreoli, Ph.D.c., senior analyst at Mercator International

Inventories have grown faster than normal, but it at the end of the build season, volumes remain nearly 10% below the prior 5-year low. If this winter is particularly bad in the East Coast, we will see prices rise significantly, just as they did between January and March.

SCMR: Were you surprised by any of these trends?

Andreoli: I was, and remain, surprised by the ability and willingness of natural gas producers to lift production to rebuild stocks. At the beginning of the year, many analysts, myself included, felt that $5 per mcf would need to be sustained in order for natural gas producers to lift drilling rates in the face of natural gas prices that, after climbing to well over $6 per mcf at Henry Hub for a brief period during the extremely cold first quarter, fell below $5 in March where they remain today.

There is a chance that they could rise close to $5.00 by years end, but this depends entirely on the weather.

At this point it bears mentioning that natural gas drilling rates have not risen. In fact, they have declined another 5% from year-ago levels. So the nearly unprecedented build-up this summer is a testament to gains that producers have made in recent years.

SCMR: How should shippers protect themselves from sudden spikes in pricing in 2015?

Andreoli: The main strategy is to be efficient, but this is a strategy that should always be pursued. Fuel price spikes are more like jabs than knock-out punches. Shippers need to be efficient, and this will help them roll with the punches.

SCMR: Will near-shoring or on-shoring mitigate risk?

Andreoli: At the macro-level, near-shoring and on-shoring doesn’t register in global trade flows. Undoubtedly, in some markets, near-shoring or home-shoring makes great business sense, but the actual cost of ocean shipping is just one, somewhat insignificant component of the location decision. Obviously labor prices have been, and will continue to be a greater influence on the location decision process, but there are political and exchange rate risks to also be considered, along with market strategies.

On a per-container basis, the ongoing up-sizing of container ships has resulted in much lower fuel costs per slot, and ocean carriers are struggling with overcapacity that will persist for years. As a consequence, carriers have become, and will remain, price takers. Consequently, their main focus is to reduce costs and increase efficiency. This will work to the shippers’ advantage and diminish any small advantage that high fuel prices grant to near-shoring/home-shoring.

SCMR: Will there be more or less volatility in energy sectors?

Andreoli: The fundamentals of supply and demand strongly suggest that there will be less volatility in petroleum prices this year than last year. On the one hand, prices almost certainly won’t continue to decline like they have over the last six months, and it was this downward movement in prices that has driven recent volatility. On the upside, there would need to be a significant supply disruption to drive volatility on the upside. This is because surplus production capacity - the ability to ‘open the tap’ - is finally out of the red-zone, and a somewhat comfortable cushion has developed. Thus even a relatively significant disruption could be managed without dipping back into the red-zone, which seems to be somewhere around 1.5% of global liquid fuels consumption. We are currently hovering around 3.0%.

SCMR: Finally, how will “sustainability” be measured in the future?

Andreoli: I think the answer to the question depends on who is answering the question. From my personal perspective, everyone’s goal should be to move toward efficiency, whether it be efficiency in energy use, investment, labor productivity, etc. No matter where we find ourselves, there will be a vocal group proclaiming that we are not doing enough, and another group arguing the opposite - that sustainability should not come at the cost of jobs.