Only compete on cost if you really are the lowest cost supplier.
I like to read sea adventure stories and one of my favourite books is Fifty South To Fifty South the story of the Wander Bird’s journey under sail around Cape Horn in 1936. One of the things I like about it is how it describes exactly how to deploy oil, from a small barrel hung over the ship’s side, to calm waves in a gale.
Oil, and concerns about energy security, dominates international affairs and the US have recently asserted themselves by developing “shale oil” reserves in an effort to readdress the balance with the Middle East’s economic stranglehold on supply. The trouble is that with all these new reserves coming on-stream the price has crashed.
In spite of my efforts over many years as a business advisor, I still find it hard to persuade people that they shouldn’t put so much emphasis on competing on price, so it is nice to find an example that demonstrates why. Although you might not think that the international oil market has lessons for your business, bear with me, it really has.
In response to the fall in oil prices OPEC could easily have reduced production to raise them again but at the cost of losing market share to this new US production. They have decided not to do that because in terms of the oil market they hold the key card – they really are the lowest cost supplier of oil. In the Middle East there are enormous pools of the stuff underground that flows out easily if you drill a fairly low-tech oil well.
The per barrel cost to produce oil varies greatly: it is about $10 in the Middle East; it is vastly more once you have to drill offshore (the North Sea), in very deep water (Gulf of Mexico), or you need to do more to get the oil out of the ground (shale oil and other enhanced recovery techniques, like “fracking”). If you try and do all this at once, offshore, in deep water, and with enhanced recovery techniques, the cost is enormous. US oil shale production costs are in excess of $40 per barrel, probably a lot more in some cases.
The next year or so will be fascinating as OPEC try and “burn off” this much more expensive oil coming onto the market. Simple economics would say that OPEC are in complete control and that is the lesson for us all: if you are the cheapest supplier of any product or service, and it is not easily substitutable, you can always compete on price to destroy, or limit, the competition. If you aren’t, then price competition will surely lead to the assured mutual destruction of everyone concerned.
My guess is that global oil production will stabilise at a level that constrains US production, even with government goodwill and subsidies, at about the $50 per barrel mark, so I’d be surprised to see it rise above that for a while. This won’t stop shale oil production but it will constrain its development and allow OPEC to optimise its economic returns.
If you don’t have the market control that OPEC has you should not rely just on price to compete. This doesn’t mean to say that price isn’t important, it alway is, but the other bits of the “marketing mix” are more likely to provide you with a means to differentiate yourself and enable you to get a better return on capital.
It wasn’t this sort of oil that was used at sea; it was often fish oil and that attracted the sharks and the birds. I’m personally not too sure if I’d like to be doing that if there was any risk of the ship actually sinking! A very thin layer of this oil would spread out several tens of yards from the ship and the surface of the sea noticeably smoothed out; it really did have an effect on the waves and made some of these South Atlantic gales less dangerous for the ships that used it. OPEC is pouring oil onto its tyro shale oil competition at the moment and it is working for it too.
Mark
