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Opportunity Issue 96

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Opportunity, endorsed by the South African Chamber of Commerce and Industry (SACCI) is the mouthpiece for business in Southern Africa. The aim of the publication is to inform potential investors both nationally and internationally of the most relevant business news: trade, investment, financial, market-related information for each business sector, as well as to inform of the latest developments in business legislation from both the public and private sector.

OIL AND GAS The big

OIL AND GAS The big blitz Capturing value from lower prices When the cost of feedstock goes down, the cost of many downstream chemicals can also change. A proactive procurement department can help capture a wealth of savings. Oil and gas prices are at an all-time low – dropping nearly 55% and 35% respectively in the first half of 2020. Because crude oil and natural gas, including natural gas liquids, are feedstocks to many raw materials used in the downstream petrochemicals and speciality chemicals industries, the prices for those hydrocarbon raw materials should also go down, depending on the amount of oil or gas input. But have your company’s prices for these raw materials dropped enough in the past few months? A PORTION OF THE POTENTIAL Calculating the potential savings of raw materials is not always straightforward. When feedstock prices fall, every raw material will be impacted differently because of the varying production technologies, feedstocks and regional factors. The region where your methanol is produced can affect the potential price reduction when natural gas prices drop. Feedstock quantities are readily available for the most common commodities and materials. But further down the chain to more speciality materials, it can be harder to identify the impact that oil and gas have on the total cost of the materials, requiring more complex cost models and stoichiometric equations. Transportation fuels such as bunker and diesel are major contributors to the landed price of raw materials. Because inbound freight is often supplier-managed, companies should also ensure that their suppliers are being transparent with passing on fuel savings when oil prices fall. For materials that are more than one step downstream from oil or gas, the potential benefit depends on both the stoichiometry and market dynamics in each step of the value chain. 32 | www.opportunityonline.co.za

OIL AND GAS CAPTURE MORE VALUE In the quest to capture savings when oil and gas prices go down, buyers face four scenarios, depending on the price dynamics of the raw material they are purchasing and the underlying feedstock used to make the raw material (see figure). WHEN OIL AND GAS PRICES FALL, PROCUREMENT COULD FACE FOUR SCENARIOS Scenario 1: The raw material price and the underlying feedstock prices are not declining Materials are often made from different feedstocks. A technology route that does not use a feedstock related to oil or gas will not see lower prices when oil and gas prices go down. For example, while most methanol is produced from natural gas and will benefit from natural gas price declines, coal-based methanol production will not see this cost-benefit. Unfavourable feedstock market dynamics could limit price decreases in certain geographies and markets. In this scenario, procurement should investigate if any other production routes use feedstocks derived from oil or gas to capture the tailwind from falling prices and if so, evaluate how to capture those savings. The time and costs associated with switching suppliers depend on the type of raw material. Both are often significant because of potential qualifications, registrations and volume commitments with incumbents. If switching suppliers is not feasible in the short term, procurement can gauge incumbents’ willingness to concede some price relief. Because they are aware that their products are not competitive in the market, threatening to switch could be seen as a realistic possibility. Be prepared to offer the supplier an incentive in exchange for price relief, such as a contract extension. _____ __ ___ __ _ _ Transportation fuels such as bunker and diesel are major contributors to the landed price of raw materials ___ __ ___ __ _ _ _ _ Scenario 2: The underlying feedstock price is www.kearney.com declining, but the raw material price is not Falling feedstock prices might not translate to lower raw material prices because of two factors: fixed-price contracts that don’t automatically adjust based on feedstock prices or demand-supply dynamics for the raw material that supports higher prices. If there is a major drop in the feedstock price, procurement should talk with the supplier about an interim price. If there is a fixed-price contract, then try to renegotiate the price. Moving to formula pricing could be considered if it fits the strategy for that raw material, but renegotiating the fixed-price contract is easier if the feedstock price change is drastic or the company has strong buyer power. If the raw material price is not declining because of unfavourable demand-supply dynamics, then procurement should evaluate ways to improve the cost position within the flexibility of the contracts. For example, if there’s a volume-tier benefit and the supply-security constraints allow for it, then consider concentrating purchases for raw materials with fewer suppliers. Another option would be to investigate buying raw materials from other regions where prices are going down. Scenario 3: The raw material price and the underlying feedstock price are declining This situation is linked to raw materials purchases being tied to formula pricing or spot market transactions. For formula pricing, procurement should quickly perform due diligence on the underlying contract to make sure that formula pricing proportionately captures the drop in feedstock price and that the supplier is charging the more favourable prices. If any of these conditions are not met, then negotiate with the supplier to make sure the benefits are captured. ___ __ The oil and gas industry is cyclical: major price changes are not unusual. www.opportunityonline.co.za | 33

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