January 1, 2008
special report | The End of Cheap Oil

The end of cheap oil: Are you ready?

The end of cheap oil: Are you ready?

Supply chain managers must take action today to prepare for the end of the Oil Age tomorrow.

By Charles L. Taylor

CSCMP's Supply Chain Quarterly

The recent run-up in oil prices has put logistics and supply chain managers on notice that they can no longer depend on abundant supplies of cheap fossil fuels. In this article, which first appeared in the Quarter 2/2007 edition of CSCMP's Supply Chain Quarterly, author Chuck Taylor argues that world oil production will soon peak, and that supply chain managers must take action today to prepare for the end of the era of cheap oil.

This article represents the type of thought-provoking, analytical stories featured in the Quarterly. Those interested in reading more can visit www.SupplyChainQuarterly.com. Subscriptions to the Quarterly can be obtained by joining the Council of Supply Chain Management Professionals (CSCMP's annual membership includes a free subscription) or for $89 a year.

A few years ago, I discovered "Hubbert's Peak," a theory that the world's oil production will decline in this decade as oil becomes harder to find and extract from the ground. That discovery made me realize that my profession for the last 35 years, supply chain management, was woefully unaware of and unprepared for a development that would change the way we do business forever.

My discomfort started around the time oil prices increased from $34 per barrel in January 2004 to $53 per barrel in October of that year. During that same period, I attended two of the premier educational events in the supply chain world. Of the 300-plus breakout sessions offered at those events, not a single one discussed the oil situation and its potential impact on the supply chain.

My perspective on the looming oil crisis may be unique because of my family background and birthplace. I was born into a railroad family and began my supply chain career as a railroad clerk at age 16 in a rail yard in Dallas, Texas. Growing up in Texas brought me into contact early with the oil "bidness," as we say in my home state. I remember seeing gas flaring off oil wells at night, and the smell of petroleum wafting in the air. Back then, Texas pumped more oil than any other region in the world. The state was so influential in the oil industry that the Railroad Commission of Texas, which regulates oil production in the state, was the model for today's Organization of the Petroleum Exporting Countries (OPEC).

But what most profoundly shaped my view was my experience in 1973, when I was working for a tank-truck carrier in Houston and saw oil prices triple as a result of the Arab oil embargo. I watched as rising oil prices and shortages caused high inflation, recession, unemployment, rationing, plant closings, transportation equipment shortages, and long lines at gas stations. At that point, I knew at a gut level that oil is the lifeblood of our economic system; that high oil prices have an undeniable impact on that system; and that as a supply chain professional, I should know what was going on in the oil patch.

I am now convinced that, unlike the events of 1973, the situation we face today is not a short-term predicament. It's a multifaceted problem. It is unlike anything we've encountered before. It is non-negotiable. It will not be easy. It will change everything.

The time to prepare is short because reducing our dependence on cheap oil will take decades. Supply chain professionals will have to examine alternatives to current practices and consider new strategies in preparation for the end of the era of cheap oil.

To put it bluntly, the wolf is howling outside the door and may already be in the room.

Hubbert's Peak is about what goes on underground, but global demand, geopolitics, the health of the oil industry, and the environment are aboveground factors that add complexity and risk. This article will look at each of these factors, examine alternatives, and suggest mitigation strategies in the context of supply chain performance.

Hubbert's shocking prediction
On March 8, 1956, in a speech to the American Petroleum Institute, Dr. M. King Hubbert, a geologist working for Shell Oil at the time, painted a broadbrush picture of the world energy situation. He had observed that the increase, peak, and decline of oil field production always followed a similar pattern, and he proposed that the growth stages of oil extraction represented a bell curve that could be used to predict when the rate of growth would peak before turning negative. This analysis became known as "Hubbert's Linearization," and the concept of "peak oil" was born.

In that same speech, Dr. Hubbert predicted that oil production in the United States' "lower 48" states would crest between 1965 and 1971 and that global production would peak about the year 2000. The United States was at that time the undisputed king of world oil production, and Hubbert's forecast provoked shock, consternation, and denial in parts of the petroleum industry, and he was widely criticized by some economists.

History proved him right, however. In 1970, oil production in the lower 48 states reached its peak of 10.6 million barrels per day, and it never produced that much oil again. Figure 1, which shows annual oil production in the continental United States from 1930 to 2005, provides a perfect representation of Hubbert's Peak.

Today no serious geologist, scientist, or oil analyst disputes the peak oil concept. Most regard oil as a non-renewable, finite resource that was produced during just two geological periods—and only in a few unique places (most long since explored) where seven very specific conditions occurred. Geologists have applied Hubbert's model to individual oil fields as well as to all regions of the world. Most now predict peak global oil production will occur between 2005 and 2018, give or take a few years. The debate now is about "when," not "if."

"The world's oil gauge is broken"
Peak oil does not mean the world is running out of oil. After the peak has been reached, half of all oil ever found will still remain in the ground. Reaching peak means that production can no longer increase and will inexorably decline. The issue is not "running out;" it is what will happen when the world reaches its all-time production peak and starts down the depletion slope while demand for oil-based energy continues to increase. In other words, what will we do about the resulting gap between demand and our capacity to produce?

At best, the era of cheap, readily available, liquid fossil fuels is gone forever, and there are no viable alternatives to oil as a fuel for transporting goods in the foreseeable future. At worst, the world will enter a crisis period, as noted in the February 2005 U.S. Department of Energy report, "Peaking of World Oil Production: Impacts, Mitigation and Risk Management," which says: " … as peaking is approached, liquid fuel prices and price volatility will increase dramatically, and without timely mitigation, the economic, social, and political costs will be unprecedented." (Emphasis added.)

According to the report, mitigation efforts need to begin at least 20 years before peak oil occurs if we are to avoid serious supply shortfalls. The study forecasts catastrophic economic and human consequences if mitigation is delayed until the fuel crunch arrives.

The widening gap between demand and supply must be filled with new conventional oil, unconventional oil (such as tar sands and oil shale), non-petroleum sources, and conservation. All can play a role in addressing the supply/demand conflict. But they all take a considerable amount of time, money, and effort to put in place—and they require decisions and actions that have not yet been sufficiently contemplated, much less made. Moreover, any decisions about oil alternatives must be made only after assessing their impact on other areas, as we have seen in the case of corn ethanol, which has already affected food production and prices.

The timing and magnitude of the supply/demand gap are complicated by a lack of reliable data. As Matthew Simmons, chairman of the energy investment firm Simmons & Company International, puts it: "The world's oil gauge is broken."

Indeed, the world has no way of knowing the dire extent of its situation. We will only know that peak production has occurred by looking in the rearview mirror. The true status is impossible to determine because OPEC, whose members include the most important producers in the world—Saudi Arabia, Venezuela, Iran, Iraq, the United Arab Emirates, and Kuwait—carefully guard true production and reserves numbers.

Figure 1
Figure 2
Figure 3
Figure 4

As Simmons pointed out in a February 13, 2007, speech at the International Petroleum Week meeting in London, in the mid-1980s those OPEC countries increased their proven reserves by almost 300 billion barrels. Since then, individual members claim the size of the reserves has stayed the same or has grown. Meanwhile, about 130 billion barrels have been pumped out of the ground and no significant discoveries have been made. That led Simmons, along with Dr. Colin Campbell, an international exploration geologist, and Dr. Ali Morteza Samsam Bakhtiari, the recently retired senior adviser for the National Iranian Oil Company, to suggest that Middle Eastern reserves are probably overstated by 50 percent.

With no realistic data available, we can only estimate based on what happens on the ground. The signs are not good. Today the world consumes five times as much oil as is being found. As Figure 2 clearly illustrates, the numbers are overwhelming.

Twilight approaches
The world's biggest oil fields have already been discovered. In the decades leading up to the 1970s, oil companies found eight big fields that produced between 500,000 and one million barrels a day. During the 1970s and 1980s, only two new fields were found. Only one—the Kashagan field in Kazakhstan—has the potential to top 500,000 barrels a day.

This failure to discover new oil sources is but one ominous sign of the trouble ahead. The declining production of the world's biggest fields is just as worrisome. Nearly a quarter of the world's daily oil output of 85 million barrels is pumped from the 20 largest fields. Dominating them are the so-called "supergiant" fields. The four reigning supergiants were discovered decades ago: the Burgan field in Kuwait, the Daqing in China, Cantarell in Mexico, and Ghawar in Saudi Arabia. These four were responsible for 14 percent of the world's oil production; all except Ghawar have been officially declared past peak by their own governments.

In particular, the situation in Mexico, the United States' third-largest source of oil imports (after Canada and Saudi Arabia), bears close attention. Last year Pemex, the Mexican national oil company, declared its supergiant field to be past peak and in decline. Cantarell, the second-largest oil field in the world, provides 60 percent of Mexico's oil production and 100 percent of its oil exports. From January 2006 though February 2007, Cantarell lost 20 percent of its production, with daily output falling from 2 million barrels to 1.6 million barrels. The crash of Cantarell means that in just a few years, Mexico will have no surplus oil to export to the United States. Mexico is the proverbial canary in the coal mine. Keep an eye on it.

Some of the last great oil discoveries, in the North Sea and on Alaska's North Slope, are now past peak and in depletion. Russia, despite its current high levels of post-Soviet-era production, peaked in the 1980s. Iran and Venezuela also are past peak. Indonesia, an OPEC member, became a net oil importer last year. These aren't the only countries to find themselves in that situation: According to Chevron's full-page advertisements in major U.S. newspapers on July 25, 2005, "Oil production is in decline in 33 of the 48 largest producing countries."

Although an estimate of the world's total oil reserves remains murky, geologists using straightforward mathematical models have determined that the world is roughly at the same point relative to all-time production as the lower 48 U.S. states were in 1970, when the United States passed its production peak. At that time, Texas was the Saudi Arabia of its day, producing three out of every 10 barrels in the lower 48. Texas' production peaked in 1972, two years after continental U.S. production peaked.

The effect on pricing quickly became apparent. Between 1962 and 1972, the price of crude increased from $2.97 to $3.56 per barrel, a 20 percent increase in 10 years. Production increased by 41 percent. Between 1972 and 1982, the price of a barrel of oil increased from $3.56 to $35.00, an increase of 983 percent. Yet despite increased drilling, new technology, and exploration, production decreased by 45 percent during that same period. Once a region peaks, supply trends downward—no matter how much the price increases or how much new technology is introduced. This runs contrary to the arguments by some economists that higher prices will encourage the production of more supply. Geology, not economics, will set the limits for this finite resource on our planet.

At present, Saudi Arabia produces one out of every 10 barrels of crude oil consumed in the world, and it claims to hold 260 billion barrels, or approximately 25 percent of the world's proven oil reserves. While the country's actual production numbers and reserves are shrouded in secrecy, there are eerie similarities between what happened in Texas in 1972 and what is happening now in Saudi Arabia. Unlike Texas with its thousands of oil wells, Saudi Arabia produces 95 percent of its oil from only six fields. Ghawar, the largest, accounts for 60 to 65 percent of Saudi Arabia's total oil production. It is more than 50 years old.

During the first half of 2007, estimated Saudi production dropped from 9.5 million to 8.5 million barrels a day, despite the fact that the amount of drilling in Saudi Arabia exploded in 2005. The Saudis proclaim that all is well and that their capacity to produce oil will soon reach new heights. But what if production continues to drop and prices increase significantly during 2007, yet the Saudis do not increase production? One can then conclude that world oil production has peaked and that we've entered the twilight period of the Oil Age.

The daunting task ahead
The world produces and consumes approximately 85 million barrels of oil per day. For the past two years, coincidentally, the oil industry has been unable to produce any more than 85 million barrels a day. World oil production is giving every indication of reaching a plateau, if not actually declining.

The U.S. Energy Information Administration projects that world oil demand will reach 98 million barrels per day by 2015 and 118 million barrels per day by 2030. In particular, demand from China and India is expected to increase significantly in the years to come. Right now, China's annual per-capita oil consumption is estimated to be 1.8 barrels, while India's is 0.9 barrels. By comparison, U.S. per-capita consumption is 25.6 barrels.

A 2004 analysis by Exxon Mobil shows the magnitude of the problem and the daunting task ahead. If production stays at the current 85 million barrels per day and existing fields are depleting at a rate of 5 percent, by 2015 the oil industry will be producing about 55 million barrels per day from those fields. According to Exxon Mobil's calculation, world demand is increasing at a rate of 2 percent per year, for an estimated demand of 100 million barrels per day in 2015. If that scenario proves true, then the world will have to produce an additional 45 million barrels per day to meet demand. This is the equivalent of finding five new Saudi Arabias in the next eight years.

Not even the oil industry's own experts believe that will happen. On April 8, 2007, The Times of London ran the headline: "World cannot meet oil demand." The story's first sentence read: "The world lacks the means to produce enough oil to meet rising projections for demand for fuel." The source was Cristophe de Margerie, head of exploration for the French oil company Total. The story quoted Margerie as saying, "Numbers like 120 million barrels per day will never be reached, never."

Oil availability still appears to be adequate for rich nations because poor countries can't afford to buy oil. As the gap between supply and demand widens, the already rich and the rapidly developing nations will bid against each other for stagnant or decreasing production, and only the rich nations will be able to pay for oil.

Political instability changes the game
Exacerbating the problem of peaking oil production is political instability. There are more than 40,000 oil-producing fields in the world, but 94 percent of all known recoverable oil remains concentrated in 1,500 giant and supergiant fields. The majority of that oil can be found in the Middle East, particularly in the "Golden Triangle of Energy" shown in Figure 3. This region supplies 25 percent of the world's daily production and has 62 percent of the world's proven reserves.

This concentration has become even more troubling now that political tension and the potential for terrorist activity in Saudi Arabia, Iraq, and Iran threaten to disrupt supply at any time. On April 25, 2007, Saudi authorities announced that they had rounded up 172 Al Qaeda operatives and sympathizers along with a substantial number of weapons. They claimed that the cells were on the brink of carrying out a plot to assassinate members of the royal family and destroy oil facilities. This sounds similar to the disrupted attack on the Abqaiq oil complex in February 2006. Some observers see this as spillover from the chaos of Iraq and fear that it eventually will lead to a significant event that will sow chaos within Saudi Arabia and harm economies worldwide.

The future of Iraqi oil exports depends on the course of the insurgency. Iraq exports about 1.5 million barrels a day, with the United States currently getting about 400,000 to 500,000 of those barrels. As long as the various insurgent groups are able to steal a share of the oil or the associated revenue, nobody seems inclined to blow up Iraq's pipelines and oil facilities. However, should the recently announced U.S. crackdown on oil theft be successful, we are likely to see more attacks on oil infrastructure, precipitating a drop in both production and exports.

Iranian authorities, meanwhile, have publicly stated that if attacked, "not one drop of oil will flow from the region." While some of this is surely bluster, they undoubtedly have plans to attempt to close the Strait of Hormuz, a narrow channel that provides the only sea passage connecting the Persian Gulf with the open waters of the Gulf of Oman. Some 20 percent of the world's oil supply passes through the strait daily. Closing it would be difficult, but not impossible.

Three other countries contribute to the precarious geopolitical landscape: Nigeria, Venezuela, and Russia. These three supply 18 percent of the world's daily production (15 million barrels a day) and have 15 percent of the world's proven reserves.

Nigeria is the world's eighth-largest oil supplier and is the United States' fifth-largest supplier. Elections in April initiated a wave of violence by groups of well-organized and well-supplied rebels. Before the elections, attacks by insurgents had already brought oil production down by about 600,000 barrels a day. Since the elections, kidnappings of foreign workers and attacks on facilities and pipelines have increased at an alarming pace, and production losses now amount to 900,000 barrels per day. The insurgents have demonstrated that they have the capability of shutting down most, if not all, of Nigeria's oil production.

Venezuela is now the seventh-largest oil exporter in the world, with proven reserves of more than 80 billion barrels and an estimated 235 billion barrels of crude reserves locked in the sands of the Orinoco tar belt. Venezuela provides 1.3 million barrels, or 11 percent, of U.S. daily imports. President Hugo Chavez recently expropriated about $30 billion worth of oil companies' processing facilities and is now negotiating the terms under which the oil companies will remain in Venezuela. After the expropriation, Chavez declared a victory against the United States and a giant leap toward a new energy policy that would diversify the market for Venezuelan crude to include rising powers like China. The Chavez government ships 300,000 barrels a day to China, with a goal of providing 800,000 barrels daily as early as 2009. Chavez has promised to cut off oil shipments to the United States if the U.S. military attacks Iran. Clearly, civil unrest or further deterioration in relations between the United States and Venezuela could have a quick and painful impact on oil prices and supply.

Finally, Russian nationalism and President Vladimir Putin's desire to use energy resources to regain his country's superpower status further complicate the already complex geopolitical chess match. Russia has become the number-one producer of natural gas and the number-two producer of crude oil in the world—even though much of its vast energy assets are still under exploration. Each uptick in oil prices pumps billions of additional dollars into the Kremlin's coffers. Moscow, like Caracas, has made good on its goal of bringing Russian oil back under its control. However, a scaled-back role for the international oil companies can only lead to reduced investment and delays in the development of Russian oil and gas deposits.

Russia is not reluctant to use raw power to further its energy agenda and has already achieved some success with such tactics. On April 21, 2007, Russia's giant oil company, Gazprom—for the second time in less than a year—threatened to shut off Europe's only major source of natural gas. And just one month earlier, a desperate Britain surrendered its energy sovereignty to the European Union in hopes of getting better energy prices at the end of Russia's natural-gas supply line.

Infrastructure emergency
To be blunt, the world's oil infrastructure is breaking down. Wrong assumptions and false price signals in the past three decades led to underinvestment in every aspect of oil infrastructure. The result: shortages of people, refinery capacity, drilling rigs, yard space, equipment, raw materials, and transportation.

The current gasoline price spike offers a good example of the problems caused by underinvestment. At this writing, the United States has exceeded a national average of more than $3 a gallon again. The problem seems to be systemic because the United States simply can't produce or import enough gasoline to keep up with demand.

There have been no new refineries built in the United States in more than 30 years. In 1980 there were 350 refineries, but by 2005 there were but 150. Fires, leaks, and unplanned outages are some of the major reasons for higher prices and inability to meet demand. Additionally, the country lacks facilities to process the heavier crude that is now more readily available than the light, sweet crude the refineries were originally built for. There is simply no slack in the system.

Figure 4 shows the estimated average age of key components of the world's hydrocarbon delivery system. That system is rusty, old, and subject to outages and breakdowns at every stage of exploration, production, and distribution. Couple that situation with an economy that depends on just-in-time inventories, and you are looking at a system that's on the verge of an emergency.

The coming tsunami
Although U.S. presidents since Jimmy Carter have set goals to reduce America's dependence on imported oil, the United States still imports more than 60 percent of its petroleum needs—more than it did after the second oil shock in 1979. There appears to be no energy policy in the United States other than Cheap Oil.

Three recent reports tell the story in unvarnished language. These include the already cited U.S. Department of Energy report, "Peaking of World Oil Production: Impacts, Mitigation and Risk Management," by Robert L. Hirsch, et al. (Hirsch Report); the September 2005 Department of the Army report, "Energy Trends and Their Implications for U.S. Army Installations" (Army Report); and the U.S. Government Accountability Office (GAO) report of March 2005, "Crude Oil—Uncertainty About Future Oil Supply Makes it Important to Develop a Strategy for Addressing a Peak and Decline in Oil Production" (GAO Report).

Figure 5 provides a synopsis of each report and paints a vivid picture of the current reality and challenges they identified.

Figure 5

All of these reports came to the same conclusion: There is an economic "tsunami" headed our way. Before the wave of a tsunami crashes, things are deceptively calm, and people are unprepared for the shock when it arrives. Similarly, we as a nation are wasting valuable time and risking our future by not preparing for the crash.

In large measure, the blame lies with the American legislative system, which is influenced by legions of lobbyists dedicated to maintaining or enhancing their clients' profits. There is rarely a thought about the common good.

If you think not, consider this: The U.S. government could wipe out the need for five million barrels a day of imported oil by requiring the domestic automobile industry to increase the fuel efficiency of autos and light trucks by a mere 2.7 miles per gallon.

It will take a sudden and unpredictable crisis like those of 1973 and 1979 to bring about any change in government policy. How that will happen is unknown, but the candidates are legion: a sudden, irreversible plunge in production in Saudi Arabia; a terrorist attack on Saudi oil fields; an attack on Iran; major breakdowns at refineries, and hurricanes—to name just a few possibilities. Once the pain is great enough, a consensus will form around the need for decisive actions that will upset the status quo. Congress will pass sweeping bills mandating all sorts of changes in the way we use energy and transport people and freight.

Time to take a fresh look
Although it may take a crisis to prompt the government to action, supply chain managers should be proactive and start preparing for the end of cheap oil right now. Yes, there are many examples of smart companies that already are working to reduce energy and transportation costs. That is just good business. However, companies will have radical adjustments to make when they come to the realization that cheap oil is gone forever, that substitutions may take years to implement, and that shortages and economic pain lie immediately ahead. It's best to be prepared. What will happen to your company if oil goes to $100 a barrel? Or $200? Or if you can't get a supply of petroleum at any price?

Take a fresh look at everything and apply fact-based analysis and smart software tools to develop "what if" scenarios. Ask yourself what will be the impact on the supply chain when sales and pricing policies, service levels, order quantities, packaging, the number of stock-keeping units (SKUs), and inventory strategies all have to change in a world without cheap oil? What about networks, modal selection, plant and distribution center (DC) operations, and sourcing strategies?

In a high-cost energy environment, the keys to success will be to rethink, reduce, recycle, reuse, and reward innovation. Conservation and eliminating waste in the system offer our best chance to minimize the early impacts of the next oil crisis. Fortunately, there is a proven system for doing just that.

At the end of World War II, Japan was devastated. It was a time of shortage and necessity. In 1950, Toyota managers visited Ford's River Rouge plant and took to heart what Henry Ford said: "If it doesn't add value, it is waste."

The absolute elimination of waste lies at the center of the production system that Toyota subsequently developed. The world began to notice Toyota's system after the first oil crisis in 1973, when Japan's economy, which imported all of its petroleum, collapsed to zero growth. But although Toyota's profits, like those of its competitors, suffered that year, the automaker sustained greater earnings in 1975, 1976, and 1977 than did other companies. The widening gap made people wonder what was going on at Toyota.

What was going on was the development and refinement of the Toyota Production System, or "lean" as it is now known. Toyota may be the only large company in the world that understood and learned from the 1973 oil embargo. It is now the biggest and most profitable automobile company in the world, with market capitalization larger than that of GM, Ford, Daimler/Chrysler, Honda, and Nissan combined.

In the late '80s, I had the opportunity to work for the third-party logistics supplier to Toyota's first U.S. plant in Georgetown, Kentucky. I never forgot what I learned.

Lean principles are based on common sense: Reduce and eliminate waste through continuous process improvement while always considering human and social relationships.

Many companies have tried to implement lean, and some have been successful. However, my experience is that rather than implementing the entire concept, they usually implement only a few of the lean tools (for example, just-in-time inventory, visual controls, quick changeover, level loading, process maps, and so forth). All of these are good as far as they go, but lean is more than that. It is a flexible but robust way of doing business based on strict discipline and a learning orientation.

Lean calls for lower inventories, not because inventories are bad, but because inventories cover up problems. Some people have posited that higher transportation costs may lead companies to maintain higher inventories and thus wash away the gains they made with lean. This is based on the wrong assumption that lean supply chains depend on cheap transportation to operate just-intime systems and reduce inventories.

Actually, lean relies on disciplined transportation that may or may not be cheaper. Lean looks at overall costs. In fact, transportation is one of the seven wastes identified in lean thinking. The lean ideal would be to eliminate all transportation.

Although that's impossible in the real world, we can get closer to that ideal by locating facilities as close to suppliers and customers as possible.

It is beyond me how someone can claim that a 12,000-mile supply chain with a three-week lead time and inventory stretched halfway around the world is lean. When Toyota builds a plant in the United States, it builds a supplier network close to the facility. A true lean system operates as locally as possible.

I have often wondered if we really know the true costs of extended supply lines and globalization. Federal Reserve Bank Chairman Ben Bernanke recently gave a speech at Stanford University in which he said, "Increased trade with China has reduced U.S. inflation, now running at about 2 percent, by only about 0.1 percent." Bernanke noted that even as emerging economies have added to the global supply of manufactured goods, they are also adding to the demand for oil and other commodities. "There seems to be little basis for concluding that globalization overall has significantly reduced inflation in the U.S. in recent years," he said. "Indeed, the opposite may be true."

I am sure Bernanke is not even considering the added supply chain costs—transportation, inventory, administration, and so forth—that go along with globalization. Take that into consideration, and it seems inevitable that higher energy costs will add to the pressure to look at closer sources of supply. At the very least, a dual sourcing strategy should be considered.

Redesign to reduce risk
There are many untested assumptions in today's rush to globalization that will be challenged as oil supplies tighten. Peaking of world oil production will call into question all networks that are based on cheap, available transportation. It therefore makes sense to proactively redesign your supply chain to manage risk. If globalization is suspect, does it make sense to have six plants in China, the United States, and Mexico, and six worldwide DCs with 80 days of inventory? Or would three plants in the United States and Mexico, four DCs in the United States with 30 days of inventory, and a solution that employs multiple modes and carriers work better in an uncertain world?

Supply chain professionals should also take a hard look at outsourcing. There are now good third-party operators who have the systems, expertise, carrier contracts, and dense networks to consolidate loads, balance lanes, and adjust to capacity needs. Unless a company is big enough, it will be hard to go it alone. Density and balance in truck lanes will be more important than ever in an era of scarce oil. Initially, there will be a push to switch from trucking to rail. However, the rail system is capacity-constrained, so our only real option will be making more efficient use of trucking.

Private fleets may find that they are constrained by fuel rationing or shortages. In fact, heavy reliance on private fleets might be costly and dangerous. One possible way to mitigate those constraints would be to follow a hybrid strategy, where the private fleet is also used as a common carrier under lease to a trucking company or third party.

Private fleets and for-hire carriers can also expect to operate their rigs at slower speeds. Within four weeks of the 1973 oil embargo, the national speed limit was reduced to 55 miles per hour. A University of Houston study showed that the 55-mile-per-hour limit led to marked improvements in fuel efficiency for both passenger and freight transportation. Trucks, for example, showed an improvement of 10 percent in gallons per hundredweight. When the speed limit was raised in 1996, passenger cars maintained the 25 percent improvement in miles per gallon achieved under the slower limit, probably because of a dramatic increase in the number of cars that were getting better gas mileage. Now, eleven years after the repeal, trucks are getting 16 percent fewer gallons per hundredweight than they did in 1996.

History could repeat itself should this country find itself in a dire oil emergency. The just-in-time trucking system is already plagued by driver shortages and congestion in major metropolitan areas. What would happen if the federal government mandated another reduction in the speed limit? How would reducing highway speeds by 18 percent affect the delivery of goods now?

The government could impose other restrictions that might slow down operations. For example, the United States wastes 2.3 billion gallons of fuel because of traffic congestion. This fact could prompt a proposal that trucks can only operate during noncongested hours in major metropolitan areas, further impacting supply chain productivity.

Get involved in government policy
In the days of regulation, transportation and supply chain professionals were actively involved in influencing government policy. Since deregulation, they seem to have backed off, but soon they won't be able to sit back and watch from the sidelines. Managing the effects of peak oil will require heavy government intervention because of the economic and social implications. All interested parties must be involved in developing policy.

Ultimately, I believe that a nationwide, electric passenger and freight rail system will prove critical to building an alternative supply chain system that frees this country from dependence on a finite resource we won't have for long. In conjunction with rail revitalization, infrastructure spending and consumer protection must be addressed as we move away from highway transportation. We must, for instance, ask ourselves how we would structure this new rail system to protect competitive access.

Issues of size and weight laws on the highway will also take on greater importance. Are there quick ways to safely improve highway productivity? Who will get priority access to fuel in the event of a major, prolonged crisis? How will conflicts between federal, state, and local initiatives be worked out? For example, if state or local governments limit truck operating hours, would that constitute interference with interstate commerce?

All of these and many other issues will require input from those who manage the nation's commerce, and supply chain professionals should take a seat at the table when these policy discussions take place.

A win-win approach to the oil challenge
The idea of "win-win" solutions, which benefit both sides in a relationship or a negotiation, has been around a long time. Win-win challenges the belief that life is a zero-sum game with winners and losers. My own experience shows that win-win is a better way. When your job is to get people inside and outside your company to cooperate so that your customers receive the lowest possible costs and the highest possible level of service, you quickly learn that there should always be mutual benefits for all parties.

Win-win has always seemed like a good philosophy to me simply because it worked. But I've also seen scientific evidence that proves not only that it does work but also how it works. In the 1970s, the University of Michigan organized a tournament using computer simulation to identify characteristics of behavioral strategies that tend to win most often in the long run. The contest received 62 entries from mathematicians, philosophers, and game theorists from six countries. The most successful strategy was the simplest, and to everyone's surprise, it achieved the best results through cooperation.

The most successful strategy had four characteristics: First, it was "nice." It never initiated the first win/lose action. It always started out aiming for the win/win result.

Next, it was "provocable." By that, the event organizers meant that it would respond to provocation by immediately responding to a win/lose action with another win/lose action. It did not stay "nice" when someone exploited its "niceness."

Third, the program was "forgiving." As soon as the other party returned to a win/win approach, it did the same.

Finally, it was "easily readable," unlike many of the other entries, which were complex mathematical game theories.

In the course of the game, the win/lose strategies won some of the time. However, they ultimately tended to create lose/lose situations in which other players would not trust them long enough to cooperate. Every win/lose program ultimately was overwhelmed by win/win strategies.

Experiencing the power of win/win relationships helped me see that values like integrity, trust, openness, and credibility might be more important to people than winning every time at someone else's expense.

And that is why I believe that cooperation, honesty, and integrity will be paramount if we are to successfully manage through the consequences of peaking.

These will not be easy times. They will try the nation's soul. Staying balanced and focused, thinking carefully before acting, and doing the right things will be more important than ever. If peaking occurs before significant mitigation, the impact on society and the economy could be severe. In any event, the world as we know it will change forever.

President George W. Bush was correct when he said that America is addicted to oil. Breaking an addiction of this magnitude is going to be hard, and it's going to be time-consuming.

Courage and reality-based thinking will be the order of the day. This will be a test unlike any since World War II, and it could rival the Great Depression or the Civil War in its impact. We survived as a nation through all of those tests, and with courage and determination, we will survive this challenge, too.

About the Author

Charles L. Taylor
Chuck Taylor, head coach of Awake! Consulting, is a senior turnaround executive, executive coach, author, and speaker on supply chain issues.

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