Oil price volatility

December 15, 2010
by Robert Maxim

PURCHASINGB2B MAGAZINE, OCTOBER 2010: Energy security and energy management are increasingly important business factors in a world of peak oil and global warming.

Managing energy risk and reducing carbon emissions by improving the energy efficiency of equipment and buildings is seen as critical to an increasing number of businesses, but unless there is also a process to manage the energy use embedded in supply chains there will still be an unknown exposure to energy risks. If 10 percent of your costs are energy-related a doubling of energy prices will not just be a 10 percent increase in your costs, but also an increase in your suppliers’ costs, and at every stage of your supply chain at the same time.

These costs will ultimately get passed down the supply chain to you. The exact increase in costs as a result of this embedded energy exposure will depend on how many stages there are in your supply chain, the portion of your suppliers’ costs that are energy- and oil-vulnerable and how much of the increased operating costs each stage is willing and able to absorb.

Fortunately the knowledge and expertise to deal with this already exist within the disciplines of energy management, carbon accounting, quality assurance and life-cycle analysis. A solution is to implement an energy management system using the ISO 9000 series management system to assure energy management of supply chains and foster a culture of continuous improvement in energy efficiency. The more widely such a system is adopted, the more effective the system becomes at reducing the energy exposure risk of business and wider society. The International Standards Organisation is releasing an energy management standard, ISO 50001, that will hopefully do just this.

What can you do while we wait for such an energy management system to become as ubiquitous as quality management? First, get an understanding of the basics of energy management. Second, when qualifying suppliers you should be asking about their energy management plan and how they manage the exposure of their supply chains.

A typical energy management plan should look at the direct energy use from equipment and buildings (the efficiency and how they are operated), with more detailed plans looking at business operations, energy contracting and personnel behaviour.

All energy management plans must have some form of energy audit. The American National Standards Institute (ANSI) gives four levels you should look for:

Level 1 is a scoping study and typically involves looking at historical energy data to find energy indexes such as energy cost per square foot and energy cost per unit production and comparing these to industry benchmarks.

Level 2 is a walk-through looking at the building envelope and major equipment.

Level 3 is an energy/resource survey.

Level 4 is detailed analysis of capital intensive projects.

If a supplier is participating in Greenhouse Gas (GHG) reporting, this can be useful in place of or in addition to an energy management plan as it is effectively a measure of fossil fuel based energy use, which is the type of energy use resulting in the highest risk.

A scope 1 study looks at emissions from direct energy use; a scope 2 study looks at emissions from how the energy (electricity) used is generated and a scope 3 study looks at transport and the supply chain. Suppliers that have on-going scope 3 GHG reporting studies and continuous improvement will therefore also be indirectly reducing your embedded energy exposure risk.

Even if a supplier does not have an energy management plan or perform greenhouse gas reporting you may still be able to gauge their exposure risk by considering their business in terms of oil vulnerability pathways, as suggested by the work of Simon Snowden from Liverpool University’s Oil Depletion Impact Group. The pathway looks like this: Liquid fuels (transport fuel) ‡ Energy (burning oil) ‡ Petrochemicals ‡ Man made materials (e.g. plastics) ‡ Components (plastic window frames)

The nearer a component of supplier cost is to the start, the higher the volatility (risk) due to the higher proportion of oil-based costs and cost movement lag. The most important suppliers to be considering are those that have a high proportion of their costs falling within the categories of the oil vulnerability pathway. It is foreseeable that suppliers with high proportions of costs near the start of the pathway will have to begin adding some form of energy cost surcharges into their supply contracts. As energy costs rise and become increasingly volatile, this will further necessitate the need for procurement specialists with a knowledge of energy and oil vulnerability analysis.

Dr. Robert Maxim is a certified energy advisor and experienced educator. He conducts research on energy management systems and the development of train-the-trainer programs. Email him at maximr@shaw.ca.