Two liquids, one black and another white, quite unlike each other in appearance, provenance and usage have affected the fortunes of countries and millions living in there. The price of both crude oil and milk has swung wildly and has been mercurial. The prognosis is either grim or joyful, depending upon one’s location in the supply chain: the capriciousness and descent will continue.
In the previous decade, the crude oil reached its apogee at $145 in 2008 and hovered in $80-$110 band from mid-2010 to mid-2014. It took a steep dive from June last year until it touched $ 48 in January this year—marginally above the $43.9 low in February 2009. After rebounding mildly to $ 60, now it is again at $ 50 and headed downwards.
In a similitude, the FAO Dairy Price index almost quadrupled to 270 from 70 within a span of five years from mid-2002 to mid-2007 and again plunged sharply to 120 within less than two years. Since 2009, the roller coaster ride has continued as it stopped short of touching an all time high of 280 in 2014. At present, the index stands at 167.5 on a downward trajectory.
For now, the whimsical ‘invisible hand’ has smacked the producers, but caressed the consumers in the oil and milk chain. Owing to the shale revolution, the U.S. overtook Saudi Arabia as the world’s largest producer of oil a little less than two years ago and China became the largest importer of crude oil. But America is also the largest consumer of oil—a situation similar to India’s in the milk supply chain. After spanning the globe, the American crude oil supply chain is confined to its own continent; the sudden spatial shift has had far-reaching geostrategic consequences. If the turmoil in Middle East calms down, the oversupply of oil will only increase.
Amongst the countries hardest hit are the oil exporters—Saudi Arabia, Russia, Iran, Norway, UAE, Nigeria, Venezuela to name a few. Saudi Arabia cannot balance its budget, if the crude oil prices remain below $104, though it has enough reserves to cushion it from the impact for a few years. Others may not be able to bear the pain for long. Countries like Russia, Venezuela and Nigeria would need oil prices around $105, $117, and $122 for fiscal balancing. However, the cash costs to keep the oil wells running in these countries are much lower in the range of $ 40 to $ 50.
Therefore, Saudi Arabia as the de facto leader of the oil cartel, OPEC, decided not to reduce oil production but bank on American shale oil wells shutting down when their operating cash costs or breakeven costs for new wells go below the price of crude oil. But it is difficult to say who will wimp out first in this war of attrition.
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Till such time, these two heavyweights in the oil supply chain play the game of chicken, the countries downstream in the chain like India have a chance to reduce their budget deficits and build up their strategic reserves.
In certain other parts of the globe, the oversupply of milk leading to low dairy product prices has wreaked havoc. Unlike its more influential cousin, the oil supply chain, the global dairy supply chain does not have any geostrategic ramifications; yet it gained prominence as it affects countless farmer-producers across the world. Especially, the farmers in big dairy exporting countries—New Zealand, E.U., Australia, U.S., Argentina, Ukraine, Belarus and Switzerland—have been punched hard; and they are a powerful political constituency. The farm gate prices of milk in all major milk producing countries including India have dropped.
In New Zealand, for example, dairy exports comprise one-third of total exports; the precipitous drop in prices has worsened terms of trade and, in June this year, her central bank lowered interest rates for the first time in four years citing dairy sector—highly leveraged—as the reason. The Kiwi dollar plunged sharply against the American dollar. More rate cuts are on the anvil by the Kiwi Central Bank, if dairy prices plunge any further.
The Chinese as usual take a fair share of blame for the distress in the dairy supply chain as well—the piled-up inventories of Whole Milk Powder during the last three years suddenly curtailed demand, whereas the exporters had planned the opposite. The EU nations will sustain the glut as they did away with their production quotas; Russian retaliatory ban on E.U. and Ukrainian products will continue.
Many of the shifts in these supply chains seem to be structural instead of cyclical: in such a case, the low prices will stay on. Despite low prices, not all commodity supply chains, however, are undergoing structural shifts; nor are they in the big-league as crude oil and dairy. Oddly, though, due to complexity of global economic machine and second order consequences, an opportune position in the supply chain may still not translate in real economic growth for countries like India. If the tremors in the chains are too strong and last too long, even those who are faraway, perched in comfort may topple.
Prashant K Singh is a supply chain management and logistics professional with the Indian Air Force. The views expressed are personal
Twitter: @ZenPK