Price & Profit: Effects of the 2017 Oil & Gas Recovery

Categories : Procurement Stages | Assess Opportunity | Evaluate Supply Market | Negotiate | Set Strategy
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Published on : Mar 31 2017

By: IBISWorld Staff Writer, Sally Cameron

The new year has brought with it changing opportunities for businesses to take a more strategic approach to procurement. This is of particular interest in 2017, as the strengthening economy has prompted price growth across many markets — particularly those dependent on crude oil and natural gas, which have risen considerably in cost following a 2015 crash. Despite raising their prices, however, many suppliers are also suffering from falling profit levels that render them less willing to negotiate prices down or offer discounts. To soften the blow, procurement professionals can leverage their knowledge of key market characteristics to minimize costs and win strategic deals. Further down the supply chain, however, the effects of the oil and gas crash are less noticeable – even allowing for rising profits among these suppliers. Using its proprietary Procurement Data Wizard tool, IBISWorld has identified several markets where profit margins reflect their place in the supply chain, regardless of rapidly rising prices.

Oil Drilling Services

Following the crude oil price crash of the previous year, OPEC penned the November 2016 agreement to cut production, which has spurred a recent recovery in oil prices. Furthermore, recent cold weather and limited inventories have led to an uptick in the cost of natural gas. Because the production levels of these commodities are largely dictated by their market value, these recent price gains have reignited oil and gas production in the new year. This has led to stronger demand and higher prices for related oil and gas services in 2017; for example, underbalanced drilling prices will see a 16.9% increase, hydraulic fracturing prices are expected to grow 3.6% and the cost of well construction & production has forecast rises of 3.5%, according to IBISWorld.

Despite raising service prices, vendors in these markets are still suffering from falling profits due to heightened production expenses. Recent oil price and production gains are still recovering from historic drops in 2015 and 2016, and demand has not yet caught up to the cost of producing such commodities. As a result, many vendors of related services are struggling to justify production expenses in 2017. Nonetheless, the Energy Information Administration (EIA) expects domestic oil and gas production to continue growing, albeit at a slower rate than previous years, which should improve the profit outlook for suppliers in these markets during the next three years.

Fuels

Further down the supply chain, crude oil and natural gas are commoditized as fuels. Downstream fuel suppliers are also subject to the effects of high gas and oil costs that have resulted from the 2015 crash, and the subsequent decrease in revenue and production value has led to falling vendor profit margins and ballooning product prices. Particularly, the price of paraffins, used to produce fuels, is expected to jump a staggering 43.3% in 2017. This dramatic rise in price is the result of a recent spike in crude oil prices, continued supplier consolidation within the market and sustained demand for paraffins. Similarly, IBISWorld anticipates diesel fuel prices will rise 13.1% in 2017. In addition to skyrocketing demand brought on by an expanding population that needs access to running power, water and sewage, higher prices for crude oil and growth in European exports of ultra-low sulfur diesel (ULSD), a cleaner-burning diesel fuel, will further propel price growth. The average price of butane, a highly combustible hydrocarbon gas that is used in a variety of applications as a fuel and blended with gasoline or propane, is also expected to increase at a rate of 17.7% in 2017. This is the result of recent increasing oil and gas prices, a rising industrial production index and heightened federal funding for transportation, because gas-powered vehicles are increasing as municipalities and private fleet operators seek to limit greenhouse gas emissions.

Transportation Services

While fuel and oil drilling service vendors are subject to the brunt of crude oil trends, transportation services, which rely heavily on fuels derived from oil and gas, are far enough down in the supply chain that their profits are not negatively affected to the same extent. In fact, many transportation vendors are enjoying increases in their profit. This is because despite rising fuel costs, increasing demand has given transportation suppliers leverage to pass such expenses down to buyers. Moreover, stronger demand has given suppliers leverage to increase prices, while cost cutting initiatives have enabled vendors to expand profit. For example, vehicle transportation service prices are expected to grow 4.6% this year, and domestic air cargo transportation and rail cargo transportation will see rises of 3.7% and 3.6%, respectively.

While the restricted rise in oil and gas production has been hindering the profit margins of oil drilling and fuel markets, its effects have weakened by this stage of the supply chain. Transportation service providers are not reliant on raw oil and gas inputs for daily operations, and instead purchase fuels, mostly as a retail commodity. By the time raw inputs have reached the retail stage of the supply chain, they are readily available, and most price increases caused by fluctuations in their value have been absorbed by upstream buyers and suppliers. For instance, vehicle transportation vendors enjoy less market competition and provide specialized services that require unique equipment and specific training for employees, all of which ensure comfortable profit margins due to a lack of competition. The domestic air cargo transportation market sees healthy profit due to rising consumer spending and mergers and acquisitions among passenger carriers with cargo operations. Meanwhile, rail cargo transportation suppliers bolster their margins with greater economies of scale and the subsequent cuts to wage costs and overhead expenses.

How Will These Trends Affect My Negotiation Leverage in 2017?

Falling profit margins often mean that suppliers have less room to negotiate prices down and remain profitable, which prevents buyers from obtaining sizeable discounts. Suppliers that source a single or limited amount of inputs are less reliable, because they must constantly manipulate their prices or keep prices elevated to protect their profits, particularly if they are dependent on volatile inputs, such as crude oil or natural gas. Buyers should therefore plan their purchases from upstream suppliers more carefully, and consider locking in contracts early this year before prices spike. On the other hand, buyers who are patronizing vendors further down on the supply chain will have an easier time planning purchases, and more leeway in holding off for more favorable prices due to rising vendor profit.



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