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Information about cic

Published on January 23, 2008

Author: Domenica


Competing in Commodities:  Competing in Commodities The markets for hydrocarbons and strategies for advantage A presentation based on a doctoral dissertation to be defended at the University of Twente, 5 June 2002 Erik Jarlsby May 2002 Slide2:  Theory of strategic positioning (M.Porter)....... - Choose cost leadership, differentiation or focus - Firms to provide unique value propositions to customers - Lack of differentiation + Scale economies => Strong industry concentration ! ...... seems out of line with certain real-life observations: - Large aeroplane manufacturing: Two producers globally (Boeing, Airbus) - Oil refining: 39 producers in W-Europe ( + many others elsewhere) Leading to general questions for research: => How can a large number of producers attain viable competitive positions in markets for largely undifferentiated goods that are traded globally ? => How do such markets actually function ? Slide3:  1. The Hydrocarbon Industries: Description and Characteristics 2. Location and Flexibility 3. Contracting Strategy: Transaction costs and Unique Resources 4. Research and Empirical Observations 5. A View on Competitive Advantage Slide4:  1 The Hydrocarbon Industries Description and Characteristics Slide5:  Simplified value chain: From oil & gas in the ground to consumer fuels, plastics and chemicals World oil production: USD 650 billion (year 2000) = 2% of Gross global product World trade in crude oil: 5% of all world trade Slide6:  Competing in Commodities May 2002 Erik Jarlsby Oil & gas exploration & production: Moving into costly, risky, challenging environments Slide7:  Competing in Commodities May 2002 Erik Jarlsby Oil Refining: A capital intensive, high-volume, low-margin industry Converts crude oil into useful products. Products are mostly fuels, but also lubricants, solvents, asphalt, and feedstock for chemicals. Main process area of a modern oil refinery (Malaysia). The many tall structures are distillation towers and other process units. Source: Conoco Slide9:  Competing in Commodities May 2002 Erik Jarlsby Crude oil production and consumption have different geographical distributions, necessitating trade. Crude oil is more widely traded than refined products Slide10:  Competing in Commodities May 2002 Erik Jarlsby The prices of a bulky commodity differ with quality, location and delivery time Example of same-day variations in oil prices US Dollars per barrel of crude oil Origin (Quality) Delivery location: Time of delivery: Price on 1.07.1996 Physical trade: WTI *) Texas (Midland) August $21.34 WTI Oklahoma (Cushing) August $21.49 WTI Oklahoma (Cushing) September $20.56 Brent UK (Shetland) Within 15 days $19.62 Brent UK (Shetland) Rest of July $19.80 Brent UK (Shetland) August $19.34 Brent UK (Shetland) September $18.76 Ekofisk UK (Teesside) 10-30 days ahead $20.05 Iran Light Egypt (Sidi Kerir) 10-30 days ahead $18.41 Iran Heavy Egypt (Sidi Kerir) 10-30 days ahead $17.66 Dubai Arab Gulf (Dubai) 10-30 days ahead $17.69 Oman Oman August $18.30 Futures - New York Mercantile Exchange: Light sweet crude Oklahoma (Cushing) August 1996 $21.53 Light sweet crude Oklahoma (Cushing) September 1996 $20.60 Light sweet crude Oklahoma (Cushing) December 1996 $19.00 Light sweet crude Oklahoma (Cushing) January 1998 $17.70 Futures - International Petroleum Exchange (London): Brent UK (Shetland) August 1996 $19.47 Brent UK (Shetland) September 1996 $18.83 Brent UK (Shetland) December 1996 $17.73 *) WTI: West Texas Intermediate. Sources: Platt’s; exchanges Slide11:  Competing in Commodities May 2002 Erik Jarlsby The price of oil has shifted sharply on several occasions Triggered by events associated with OPEC or its members Oil price development 1960 - 2000 Nominal and real (2000) US dollars. $0 $10 $20 $30 $40 $50 $60 $70 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 In nominal USD Oil price is US refiners’ acquisition cost for imported crude (Domestic first purchases before 1968). Based on data from the EIA (USA) In 2000-USD $39.00 $67.60 $2.80 $9.40 Slide12:  1. Physical commodities Transport costs; substitutable 2. Capital intensive and long lived production assets Scale economies on site level. New sites rarely established in Europe 3. Feedstock intensive (downstream of E&P) 4. Maturity Most products have slow consumption growth in Europe 5. Large margin variations OPEC and politics in oil; capacity balance downstream 6. Impact on the physical environment Extractive; global climate issue; local pollution & safety Slide13:  2 Location and Flexibility Market flexibility as a source of competitive advantage Slide14:  Four lines of theory on how geographical space matters in competition: Weber (1909): Locate plant so as to minimize transport cost Hotelling (1929): Stability in competition across space and varieties Brander (1981): Cross-hauling identical product between nations Porter (1990): Competitive advantages associated with industries in regions Slide15:  Key assumptions: - Given market location - One or more (complementary) given feedstock sources - Transportation cost proportional with weight & distance Problem: Find the plant location that minimises combined cost of transporting feedstock and output Slide16:  Competing in Commodities May 2002 Erik Jarlsby Hotelling: Distance stabilizes competition compared to perfect competition, where low bidder captures entire market Key assumptions: - Market described as a straight line, customers spread evenly - Producers located at discrete points - Each producer charges same ExWorks price to all buyers - Buyer pays ExWorks price + distance dependent freight cost Producer A Producer B Customers spread evenly along market Customers’ costs Implications: - Producer who lowers price, captures only a few customers - Applied also for product varieties (Differentiation) Price ExWorks Slide17:  Key assumptions: Two countries; one producer in each (Can be expanded) Each facing downward-sloping demand (Monopoly power) Scale economies in production Costly transport between countries Cournot behaviour: Each takes the other’s action for given Exports allows the producer to charge higher price (B) at home than if he did not export (A). Increased profits from higher price can outweigh transport cost of export. Producer in other country doing the same thing - no mutual influence recognized (Cross hauling) Slide18:  Explaining how certain industries remain strong in certain regions over long time Examples : Ceramic tiles in Northern Italy Printing machines in Germany Slide19:  Discrete alternatives for plant location (not anywhere, as with Weber) Transport costs not linear with distance: Suez canal fees, harbour costs Plant relocation is very costly Plants use mainly one type of feedstock, produces multiple products Feedstocks and output products traded in alternative markets Relative prices vary over time Active trading requires capabilities, costly Slide20:  Location alternatives with known market and feedstock source Transport of feedstock Transport of product Feedstock source A B C Market Alternative location Alt.A Alt.B Alt.C Alt.C Solution: Locate at A if feedstock transport is cheaper than product transport, otherwise at B. C is an unlikely location based on transport cost alone. Regional conditions (Porter) can change the result. Slide21:  A B Market Feedstock source Alt.A Alt.B E D Feedstock source Market Alt.B Alt.A Market flexibility: The possibility of alternating trade between distant markets Slide22:  Assuming one manufacturing plant with limited capacity 1. Static: Downward-sloping demand function in each market (Brander) 2. Dynamic: Price relationship between markets changing over time Slide23:  Competing in Commodities May 2002 Erik Jarlsby Price relationship between markets changing over time Same-product price differences with trendlines, 1988-1998, USD/tonne Slide24:  Facing downward sloping demand in both markets. Although E is the higher priced market, some sales will also be made in A in order to avoid too strong downward pressure on prices in E. Slide25:  Relative consumption of main refined products 0 % 20 % 40 % 60 % 80 % 100 % USA EU Japan Gasoline Jet fuel Gasoil Fuel oil By weight, 1998. Calculated from IEA data. Oil refineries produce several products in inflexible output ratios. Upside to market flexibility: Relative attractiveness of geographical markets can differ between products. Example: Supply gasoline mainly to USA, gasoil mainly to Europe or Japan Slide26:  1. Variation in time of price difference between markets for output product 2. Variation in time of price difference between markets for for feedstock 3. Multiple outputs and inputs with degree of independent price variation 4. Producer’s established capacity to serve each market 5. Threat of entry - credibility of deterrence 6. Trading capabilities - Seaport location - Large storage capacities - Logistical capabilities; efficient shipping operations - Organisation adept at physical trading - Risk management policy & capabilities Slide27:  3 Contracting Strategy Transaction costs and unique resources in firms’ interaction with markets Slide28:  Institutional economics: Transaction Cost Economics Issues: - How to organize economic exchange - Boundaries of the firm - Long or short term contracts - Complete or incomplete contracts - Economize on cost of transacting - Protect against opportunism - Deal with bounded rationality Contributors: Williamson, Masten, Pirrong, Joskow Competitive strategy: Resource Based View of the Firm Issues: - Unique resources as basis for competitiveness - Value, Rareness, Imitability, Organi- zation - ”Strategic” resources difficult to trade Contributors: Wernerfelt, Barney, Peteraf, Cool, Dierickx Slide29:  Intersect between firm and market 8 components of contracting strategy Slide30:  Period Period Stock evolution for feedstock and output product with ship based logistics Constant production rate, varying intervals and sizes of ship arrivals Feedstock empty or output product full: Production must stop. Feedstock full or product empty when ship arrives: Demurrage cost. REMEDIES: Larger tank (Costly); smaller ships (Costly); Trading strategy (Risk implications) B. Output product A. Feedstock Tank top Undrawable Undrawable Slide31:  Market for individual ship cargoes (or other consignments) to be delivered 0 - 3 weeks ahead 1. Price formation Outright deals as basis for formula pricing in term contracts 2. Supply optimization Facilitate a good match of product available, product destinations and ships with respect to: - Quantity and timing - Product quality (grade differences) - Transport distances & costs - Terminal facilities Slide32:  Asset specificity: Value of an asset strongly dependent on another asset e.g. two plants located together, one supplying feedstock to the other TCE1) theory: Long term governance required (Vertical integration or long term supply contract) Temporal speficicity: Dependence due to time & space constraints e.g. need to secure ship for spot trade within narrow time window Argued by Pirrong (1993) to favour long term shipping contract Alternative view of temporal specificity: Spot market fulfils important function of optimizing cargo flow in presence of temporal specificity Ongoing supply optimisation of cargoes. 1) TCE: Transaction Cost Economics Slide33:  Firms can fill different functions in spot markets based on trading capabilities Level of trading capabilities: Limited Strong Trading goal Secure stable Benefit from trading flow of product opportunities Feedstock purchase mode: CIF FOB Output sales mode: FOB CIF Resale of purchased product: Seldom Frequent Use of tenders Issuing tenders Bidding on tenders Contract length Mostly term Term & spot Shipping capacity Limited (COA) Substantial (TC,COA) Use of non-physical trading instruments Limited Extensive Developing capabilities is costly. Scope for different positioning in terms of contracting strategies. Slide34:  Firms in broadly similar circumstances choosing different contracting strategies: Exxon vs Shell, BP (Not trading oriented) (Extensive trading) Saudi Aramco vs Kuwait Petroleum - Selling term, FOB - Selling CFR, innovative logistics - Non-operating minority partner in - Sole owner of European Western refining systems refineries, Q8 brand Contracting strategies result not only from transaction-cost economizing, but also from the development and deployment of strategic capabilites by the firm Slide35:  Transaction Cost Economy Competitive Strategy EFFICIENCY in value creation POSITIONING in imperfect markets Economise on direct transaction costs Avoid distributive disadvantage Achieve valuable distinctiveness (Uniqueness – Trade-offs – Coherence) Sustain competitive advantage (Limits to competition) MARKET Contracting practices FIRM Competitive strategy Firm’s contracting strategy Slide36:  4. Research and Empirical Observations Slide37:  Selected markets for 13 hydrocarbon products encompassing the industry value chain from crude oil to polyolefins Describe competitive environment comprehensively; allow comparison between markets Defined 110 descriptive variables of ordinal data quality, in 5 categories: Asset structure, Volumes, Commercial structure, Commercial conduct and Prices. Defined precisely the criteria for each value assignment. Assigned values to each variable and product (13 x 110) based on data sources. => A comparable and comprehensive description of 13 markets => A basis for testing propositions of association between different market characteristics Slide38:  1. Structured interviews with market participants with emphasis on commercial conduct 2. Written and electronic open sources - Public agencies (IEA, EIA, other national agencies) - Price series from market reporting agencies: Platts, Argus, ICIS - Price series from futures exchanges: NYMEX, IPE - Plant capacity data from Oil&Gas Journal surveys, ICIS, annual reports - Trade press and online report services Slide39:  Competing in Commodities May 2002 Erik Jarlsby Long range ocean freight cost DEFINITIONS: : Based on port-to-port transport Middle East Gulf (Dubai) – Japan (Tokyo bay). . Except for containerised transport of polyolefins, freight rates are not current market rates, but calculated from amortisation of ship newbuilding costs over 25 years, operating costs, insurance, bunker and port costs over round trips at economical speed at 1997 prices. . Ship’s costs and cargo sizes are based on ship types commonly used in long range trade: Crude 300.000 MT. . Refined products 50.000 MT basis gasoil, adjusted for specific gravity. . LPG 78.000 m3. . Ethylene/propylene 12.500 m3 LNG 130.000 m3. . Ammonia 55.000 m3. . Resulting rates were compared to spot rate fluctuations over past several years where available and found to be within extremes of observed spot rates. . Rates for polyolefins based on quotations from a liner operator and verified against a full-cost estimate and trade press reports. Slide40:  Competing in Commodities May 2002 Erik Jarlsby What is the size of a market ? Slide41:  Competing in Commodities May 2002 Erik Jarlsby Products with low freight costs are traded most across borders The causality goes in both directions Fuel oil PE PP Crude LPG Naphtha Natural gas Ammonia Propylene Ethylene Gasoline Gasoil 0 % 20 % 40 % 60 % 80 % 100 % 0 % 5 % 10 % 15 % 20 % 25 % Freight Dubai-Japan, relative to landed value European cross-border trade, relative to consumption Slide42:  Competing in Commodities May 2002 Erik Jarlsby A composite variable of the trading orientation of markets Trading orientation strongest in crude and refined products, weakest in polyolefins and natural gas Slide43:  5. A View on Competitive Advantage Relevant for the hydrocarbon industries Slide44:  Assets in this context: Manufacturing plants & sites with long duration Asset investments are irreversible in the physical sense, but assets are occasionally bought and sold. => Consider entry & exit barriers separately on asset level and firm level => Also consider competitiveness separately on asset level and firm level A competitve asset: Ability to generate positive cash flow (Plant and site) under foreseen & downside business conditions A competitive firm: Ability to generate more value by owning and (as participant in the industry) developing its assets than by selling them A competitive firm is not the firm that owns the best assets, but the firm that is the best owner of the asset that it owns Slide45:  In contrast to Williamson (1991): ”Economy is the best strategy” Slide46:  Competing in Commodities May 2002 Erik Jarlsby Some important prerequisites for good economy Slide47:  Competing in Commodities May 2002 Erik Jarlsby Elements of Distinctiveness Requiring trade-offs in the sense of Porter

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