The Road To A Post COVID-19 Recovery: Avoiding The Bullwhip Effect
will the downstream energy sector be able to accommodate forecast increaseed fuel demand in a post-covid-19 world, avoiding a bullwhip effect within the supply chain in the process?
By Patrick Long
With “stay at home” orders now expiring, states are starting to reopen in a patchwork manner, with Texas and Florida leading the way after shutting down temporarily due to COVID-19. Understandably some of the hardest hit areas on the East and West Coast are still under “stay at home” orders. Other areas, though hard hit, are reopening regardless. Though there are federal guidelines in place for how to reopen businesses in phases, states are pursuing their own guidelines. Pressure is mounting on returning to the “next normal”.
Irrespective of the rationale, the primary factor that underlies the reopening of the economy—either on a statewide or nationwide basis—is that everyone wants to get the economy moving again. Can’t we just hit the “Do Over” button and forget that March and April never happened? Increasing the numbers of people outside of homes heading to local businesses, shopping, commuting and trying to return to normal will eventually cause demand to increase for transportation fuels—most notably gasoline and diesel.
Idled cars parked in garages will get a workout as people exercise their freedom to travel and go about their daily lives. This should be a boon for the downstream energy sector. However, the jury is out on whether the energy supply chain can pick up on subtle cues and manage this new demand. If it fails to do so, what will be the likely consequences?
Economics 101: Supply & Demand
The story during the pandemic has played out across the country and the world. As infection rates increased, governments issued orders to “stay at home” and to shut down non-essential businesses. In doing so, demand for transportation fuels was essentially destroyed.
The TIBCO graphs below illustrate the rise of the COVID-19 outbreak. Depending on your area of the country, the rate of infection varied. More rural areas enjoyed slow to no growth and spread, while highly populated urban centers seemed to be breeding grounds and the hardest hit. Population density seemed to play a role in the slope of the curve.
As the virus spread from early to mid-March and onward, fuel consumption demand plummeted. Quite simply, people were staying home and not driving or taking public transportation. Based on a mid-April report from the Houston Chronicle, U.S. oil demand fell to 14.4 million barrels a day (MMbbl/d), a 30% drop compared to pre-crisis levels. A U.S. Energy Information Administration (EIA) trend analysis shows the drop in gasoline demand from March through the end of April.
Even as refiners cut run rates significantly on fuels production, or even shut down (as was the case of Exxon’s gasoline unit in Baytown, TX), the inventory stocks continued to increase. Overall U.S. gasoline supplies grew above the forecast in April, thereby pushing up the days of supply to levels not typically seen.
The culmination of demand destruction, increased supply and little hope of a short end to the pandemic in sight created huge downward pressures on price. Both retail gasoline prices fell, as well as futures prices for the commodity on the New York Mercantile Exchange (NYMEX).
Since few could prophesize all the factors that got us to this point, some argue that this event was a Black Swan – rare, unpredictable and catastrophic. Nassim Taleb, author of “The Black Swan”, disagrees with this assertion calling the pandemic something completely predictable with many numerous signs – all ignored until too late. However you view the events and rate them, we quickly got to a point of demand destruction quickly in a “perfect storm” of factors that culminated altogether.
Glimmer of Hope with Reopening?
The demand destruction cannot last forever. Politics aside on perhaps reopening too fast or too slow, the truth of the matter is that states are reopening. People are beginning to get out of their homes and apartments. They’re getting back to driving and using public transportation. Headlines appear to showcase huge crowds on the move and out of their homes. Crowds are flocking to beaches in states even slightly reopening. Does this portend the bringing of good news? Does this support an ever so slight uptick in demand?
The data is still too new to know exactly what this means in the near- or long-term. What will the slope and shape of the demand graph be? Slight gradual increase, interspersed with plateaus of gradual ramp-up? Will it be a spike and then another free-fall attributed to a potential “second wave” of the pandemic?
Consulting the Oracle of Delphi
There are too many uncertainties right now to know exactly what’s in the “tea leaves.” Does (ever so slightly) increases in gasoline and diesel futures contracts, especially for outer months, foretell of new optimism and need for ramped up fuel production? What of the heightened inventory levels going into the pandemic? How long will those last to fill the uptick in demand? What about a second wave? What impact does politics play into returning to normal and getting people back in cars and moving again? Do some geographies return to “normal driving patterns” for this time of year quicker than others? Will the nation as a whole recover in time for Memorial Day, the traditional kick-off to the summer surge in driving?
Planning for production runs in a refinery is based on reading signals in local and regional markets. Price is a huge factor. Weather can be a factor. Judging inventory levels is another signal. So are hundreds of other regional and local data points that should be taken into consideration for an economic planning model.
The problem is that we’re in uncharted territories. If you think this is a White Swan event, you’ll look to predictable queues to forecast production. If you think this was a Black Swan event, you may brush aside some factors as “once in a lifetime” and fail to understand their true significance. With a virus that has no known vaccine, how do I plan for future months in a nation that’s opening at different rates with differing demand profiles? There’s clearly volatility in demand. Initially, people had a knee-jerk reaction to travel, flock to beaches and get out. Will that last? Is it a flash in the pan? Will people heed the advice of the government and get back to work and normal routines quickly? Or, will people be reticent and slowly increase demand?
"The successful companies will be those nimble enough to take advantage of the dislocations in the market and arbitrage situations."
\On the supply side there’s still an oversupply situation with which to contend. How long will it take for consumers to use up regional gasoline and diesel supplies? How can refiners gauge regional and localized supply profiles for their products? If supplies are depleted quickly, can refiners ramp up production to avoid the pendulum swinging the other way? Adding to the complication of the task is that a barrel of crude today does not magically become gasoline tomorrow. It takes time to plan production runs. Also, of importance is the nuance that the product in the current value chain for refiners likely may still be winter spec. Additional time is needed to convert and run for summer specifications. How does a refiner navigate these constraints for seasonal products and weigh the opportunity cost of an abbreviated summer season (based on uncertain demand)?
Price is another strong signal. It can prompt people to top off tanks for their cars and trucks now that “stay at home” orders are gradually lifting. However, price is not the sole factor. Many people are price inelastic at this point since they’re tepidly returning to normal driving patterns. If they could return to normal driving ratably would they embark on the traditional summer driving season with the same intensity as past years? One recent article foretold of vacations being local, arguing that if a family drove somewhere, they would have to quarantine and would be unable to enjoy the destination. Will this remain a policy? How long will it last? Will it have a lasting effect on consumers?
Likewise, how does a refiner plan for an optimum yield of products when the demand profiles differ significantly now than a few months before? While gasoline is making a slow comeback jet fuel, on the other hand isn’t and is exhibiting signals more reminiscent of post-9/11 for recovery. Thus, will there be an entire new demand profile? Crudes are purchased to optimize models to produce the right mix of products. How does a refiner re-factor cuts and production schedules with crude slates that may be less than optimal?
Let’s not forget the human factor and additional lead times required. Safety and health are critical factors and cannot be overlooked. Additional personal protective equipment (PPE) will be required. That will require time for individuals to don the correct gear, wash and disinfect thoroughly and slow the transition throughout the supply chain from point to point. So, even if a refiner wanted to ramp up quickly, would the other participants allow it based on following new health policies and guidelines?
Where’s Cassandra When You Need Her?
The Greek mythological character is cursed with uttering true prophecies. However, the catch is no one would ever listen and heed her advice. Coming out of COVID-19 and returning to the “next normal” could take different paths. Even if we had such an oracle, would we follow the advice?
On one hand, refiners individually make determinations to return to higher levels. The collective decision of concentrations of refiners in the same area would increase production more quickly than anticipated. That could be devastating if regional supply overtook and surpassed regional demand. Like the movie "Groundhog Day", this would mean more of the same of depressed prices with overproduction in the current environment.
The flip side is refiners maintaining low production and missing or failing to pick up on the differing demand profiles. The result would be a quicker than expected depletion of existing supplies without the means to restock and get back to a consistent supply chain. That could potentially lead to outages and sensationalized news coverage, reminiscent of hurricanes – broadcasting shortages, leading to topping off fuel tanks and “making a run on fuels” thereby causing more panic in the short-term.
"Those [refiners] that can move barrels between regions quicker and more easily will profit over those that have stranded barrels."
Inevitably, there’ll be dislocations in the supply chain. This is not a command economy with top-down planning. Each refiner will have to read their own “tea leaves” and pick which factors are in their forecast model to determine appropriate production levels.
The successful companies will be those nimble enough to take advantage of the dislocations in the market and arbitrage situations. Those that can move barrels between regions quicker and more easily will profit over those that have stranded barrels. Success will be enjoyed by those that are constantly “listening” to signals, analyzing and taking a novel approach to managing their overall supply chain. Those refiners will be the ones that have the right systems and processes in place to support quick decisions.
Opportune has experience helping companies achieve success through digital transformation. Whether it's an upgrade of capabilities linking inventory and logistics with commercial deals or focusing on a specific mode of transportation, we understand supply chain problems. While we are all new to the pandemic, you don’t have to “go it alone.” We specialize in the implementation of implement practical fit-for-purpose solutions to improve your decision-making criteria and bridge the gap with the human element of supply chain networks.
About the Author:
Patrick Long is a Director in Opportune’s Process & Technology practice. Patrick has over 20 years of experience in providing clients with energy trading and risk management, packaged software implementation, trading and risk processes and business process automation. Patrick leads the BI initiative within the firm. He focuses on applying BI tools (e.g., Spotfire and Tableau) to client data in order to allow proper insight for management around both upstream and downstream business issues. Prior to joining Opportune, Patrick worked in the energy consulting trading and risk systems practice at Accenture where he managed multiple project teams through the entire process of software selection to successful implementation of trading and risk management systems for energy trading entities.