Hydrocarbon Processing - June 2022 - 15

Supply Chain
P. LONG
Opportune LLP
Strategic cost management:
Uncover supply chain inefficiencies
Controlling costs is critical for any enCompanies
add capacity to expand
ergy company. Firms may spend to grow
through acquisition, develop new business,
gain market share or invest in new
opportunities. However, as a business
activity decreases following this period
of growth, what happens to the variable
costs? If companies have planned strategically,
their variable costs fall directly proportional
to their activities. Conversely, if
they have invested without careful execution
of the growth strategy, companies
may be stuck with higher variable costs
despite the lower activity.
This asymmetrical relationship can be
found through comparisons of selling, general
and administrative (SG&A) and cost
of goods sold (COGS) to a comparison of
sales. If the decrease in SG&A and COGS
is not proportional to the decrease in sales,
then it is worth investigating to uncover
the costs in the supply chain. According
to the The CPA Journal, costs will typically
be sticky if adjusting capacity downward
in response to a decrease in sales is more
challenging. This statement in the context
of hydrocarbon supply chain management
is further examined here.
Adding capacity: A supply chain
dilemma. Firms add capacity during
periods of growth for many reasons. According
to one Morningstar analyst,
" Consolidation makes sense-economies
of scale will enable firms to lower
supply costs; less fragmentation will
ensure more efficient response to price
signals and inventory constraints. " This
line of thinking was held during the early
phase of the pandemic by Devon Energy
and WPX Energy. They announced a
merger in late 2020 to build a dominant
position in the Delaware Basin so neither
had to slog through the demand uncertainty
on their own. A larger economy of
scale combined with a rationalization of
activity helped to control initial costs.
their networks to reach new markets or
capture greater margins. One company,
PBF Energy, looked to broaden its reach
of selling finished goods beyond just its
West Coast Torrance Refinery. In February
2020, it completed its acquisition of
the West Coast Martinez Refinery, which
added to the existing capacity in Southern
California. The economics can be
quite favorable to add value by delivering
the finished product to locations closer to
customers. By enhancing an existing network,
options were now available to optimize
cheaper feedstocks from overseas.
The acquisition also brought with it additional
deepwater marine facilities, product
distribution terminals and product
storage facilities. The expansion offered
more optionality to marketers with increased
production, logistics and storage.
Businesses also add capacity because
of the specialized logistics that may be
required to move a particular product.
Crude refiners and specialty chemical
manufacturers share this burden. Railroads
are not going to provide free railcars
that are specialized for hauling the
products. So, a high-volume shipper must
decide whether to lease or purchase its
fleet. Most downstream companies with
substantial volume operate fleets of railcars.
Though the railroads own some
cars, the pendulum has swung to companies
owning and leasing fleets of their
own (FIG. 1). The typical railcar lease is
7 yr; the typical ownership timeline is approximately
30 yr. These are major capital
outlays to support a supply chain strategy.
Managing the supply chain. In the
case of supply chain management, it
may appear that expansion and control
over your supply chain and logistics are
counterintuitive to strategic cost management.
As presented in the examples
above, that can indeed be the case. In
29% Rail
71% Private
FIG. 1. U.S. freight car by owner. Source:
FreightWaves.
each of the examples, management
teams weighed the pros and cons of contracts
vs. leasing vs. owning. In the end,
control of the inventory and movement
of the products won out over cost management-the
reason is the overall importance
at the time that refiners placed
on having complete control over their
shipments of cheap crude domestically.
However, this is not to say that you cannot
have your cake and eat it, too. It is possible
to have strategic cost management if
you recognize the vision and strategic imperative
behind certain costs. Before you
act on expansion, it is important to evaluate
the processes that the company will be
taking on. For example, when Calumet Superior
built a $10-MM rail facility across
the street from its refinery, it suddenly entered
rail and railcar management.
According to the refinery manager,
the movement of crude was " never intended
to be a major part of operations. "
Ask yourself:
* Do you have the core competency
and skills needed to perform the
necessary functions in both the
short- and medium-term?
* Is this a competency that your
company wants to develop and
grow over time?
* Will it continue to be a
competitive advantage, or is the
expansion opportunistic and
fleeting and will it need to contract
Hydrocarbon Processing | JUNE 2022 15
Hydrocarbon Processing - June 2022

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