SUPPLY CHAIN RESOURCE COOPERATIVE

Socialization: An Important Dimension of Supply Chain Relationships

May 8, 2012
by: handfield
categories: Business Process Outsourcing, China Supply Chain, Customer Relationship Management, Strategic Sourcing, Supplier Relationship Management, Supply Chain Strategy

The ability to capture value from your business relationships is increasingly seen as critical differentiator in firm success (Cousins et al., 2006). Much of the strategic purchasing literature addresses the role of spend analysis, supplier selection, leveraging, negotiation, and contract management – yet there is a critical element of strategic supply management that occurs after these elements:  relationship management. Some of the prior empirical work I’ve done with my colleagues at Manchester Business School showed that it is not enough for a firm to possess a strategic purchasing orientation; they must also create conditions that allow the buyer and supplier to contribute and develop the relationship

Much of the existing research has focused on the importance of and causal relationships between relationship variables such as trust, commitment, dependency, relational norms, joint action, communication, and performance. To a far lesser extent, academics have focused on varying intensities of relationship management, and the use and accumulation of different types of interaction between business partners and the value that is generated through that relationship. This ‘social process’ between individuals of different organization is an interesting and relatively new perspective in research on effective management of supplier relationships, from an academic as well as a managerial perspective. How to balance between formal and informal ways of interacting? How to anticipate and refine your socialization mechanisms to rapidly changing standards for communication and information sharing? To what extent is the maturity of business relationships important in understanding the required interaction for effective coordination in the relationship? Is there sufficient understanding of the process of building relationships across different cultures?

There is also evidence that socialization takes time to occur, driving a need to further the understanding of influence of relationship lifecycle and socialization: is it because in later stages of relationships trust, commitment and other relationship variables tend to be somewhat lower, that the use and effectiveness of socialization decreases as well, or the other way around: because socialization is “forgotten” or not the right balance of socialization is used in the relationship, the relationship is likely to move quicker through the relationship life cycle?

For example, a semiconductor firm we interviewed decided to outsource its production to a contract manufacturer in China.  The initial process of strategic purchasing and supplier selection was simple.  However, once production began, quality problems became rampant, until the firm formally committed to establishing on-site operational personnel to resolve these issues.  Relationship management thus played a critical role in cementing the benefits associated with the outsourcing decision.  Increasingly, supply chain managers need to be thinking more about relationships management as a strategic element in their sourcing relationships, and not just base them on financial business plans based on numbers (which are often using assumed values that fail to capture the true underlying dynamics associated with the underlying relationship that exists!)

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Talent Management Insights from SCRC Meeting

May 1, 2012
by: handfield
categories: Supply Chain Management, Supply Chain Strategy, Supply Chain Talent

A number of great presentations from today’s SCRC meeting focused on how different organizations are thinking about managing their talent supply chain.  I helped to set the stage by applying Peter Capelli’s “Talent on Demand” model and thinking about the four key elements that drive talent management.  Many of these focus on utilizing common supply chain principles to the idea of “people as product”, and thinking of them in the say way!  For example, Capelli talks about “make” (internal development) versus “buy) (external hires), and the importance of evaluating the costs of this.  He also discusses the importance of building better talent forecasts through portfolio models on talent, improving the ROI on internal development through focused development projects, and developing a pipeline of talent based on modeling and challenging assignments.

These themes were developed further by Dan Stanton from CAT Logistics, who applied these very same concepts to CAT’s talent pipeline.  He also shared CAT’s university logistics talent recruitment strategy, which involves recruiting at different universities based on varying placement requirements.

Today, Rob Sweetland from BP shared insights on the extensive pipeline development and learning process for the PSCM organization.  He shared the “fishbowl” view that illustrates the path taken by individuals who move between different functions that lead to a career in procurement.  He also discussed the importance of creating challenging assignments and on-going development as a key in employee retention at BP PSCM.

Other insights by Jason Schenker from Prestige Economics provided guidance on the relative changes in the global economy and the impact on global labor markets.  Schenker declared “cautious optimism”  based on his insights, and believes 2013 will be a better year in terms of economic growth.

Finally, Chrystal Finney from Duke Energy shared some of the challenges that exist at Duke relative to their aging workforce, the proposed merger with Progress Energy, and other issues in the energy industry.  The move to a more centralized procurement approach will also increase the demand for category management approaches in the future.

Overall, a great set of insights with plenty of ideas for people to think about as they go about managing talent globally.

Are you interested in providing some feedback on talent management?  Please click on to our talent management survey and fill it out….we’ll provide a summary of the results in my next blog!

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SCM Talent Management: Creating the Next Generation of Superheroes!

April 25, 2012
by: handfield
categories: Category Management, Forecasting, MBA Supply Chain Programs, Supply Chain Management, Supply Chain Talent

Our upcoming SCRC meeting  (April 30-May 1 in Raleigh, NC) is one that I am sure will peak a lot of interest in today’s supply chain professional.  The theme of this meeting focuses a topic that is at the top of almost every company I speak with today – supply chain talent management.  As organizations seek to transform their procurement, operations, and logistical capabilities in the supply chain, there is widespread recognition that one of the most important ingredients in this equation is “having the right people on the bus”, as Jim Collins, the author of “Good to Great” noted.

This is particularly true in all areas of the supply chain. A recent Hackett Group study found that supply chain management functions in organizations polled are working concurrently on nearly 10 initiatives deemed as “critical” or “strategic” to the enterprise.  As such, people with Project/Program management skills, solid business acumen, analytical capabilities, and an ability to manage relationships are in short supply.  To drive any transformation initiative, it is imperative that companies keep their staff engaged in those areas that are resource intensive and value-added in nature.  This means not only retaining the people who are key in leading these initiatives, but also building a pipeline of talent that will fill the emerging gaps in capabilities that are starting to appear in the organization.  Establishing the right mix of new talent, seasoned veterans, and mid-career hires is a delicate balancing act that must be aligned with the right HR strategies to support this effort.

But what kind of people are needed?  When I talk to supply chain managers, the list I get varies and grows every time we have the conversation.  Some of the skills I hear companies are looking for in supply chain managers includes:

•Relationship management

•Leadership

•Ability to work in teams

•Learning agility

•Great communicators

•Excel spreadsheet proficient

•Business acumen

•Independent thinkers

•Cost modeling and managerial accounting

•Market analysis

•Decision support tools

•Stakeholder engagement

•Build internal network

•Great negotiators

•Process thinking

•Problem solving

•“Soft skills” to influence •

Analytics

•Technical & Engineering proficiency

•Multi-lingual

•And the list goes on…..

In short, we want Supply Chain Superheroes – who can do it ALL!

The risks of not having a well-developed strategic resource plan are significant.  We need to be thinking about not only “what new positions do we need to recruit for”, but also “what positions will we need to be recruiting for given our current growth trajectory, and different levels of attrition that are bound to occur?”   The upcoming meeting them “Managing the Talent Supply Chain” will explore some of the key issues in this space and bring to bear different insights on the talent management challenge from a number of industry experts.    We have encouraged many of our SCRC partner members to invite their colleagues from Human Resources who may wish to learn more in this space as well.

Some of the questions that we expect to cover at the meeting include:

  • What types of talent forecasting tools are organizations applying to build a view on future talent needs and requirements?
  • What is the role of HR and supply chain line managers in creating talent management programs that foster learning and development, including elements such as mentoring, rotational programs, employee career planning, and training and development?
  • What is the right mix of internal recruitment, university hires, succession planning and mid-career hires are most productive to fill new positions?

With speakers from BP, Duke Energy, Prestige Economics, and Caterpillar all talking on the subject of talent management in supply chains, I am sure we will hear some great insights!

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The Global Phosphate Supply Market: Risky and Getting Riskier

April 24, 2012
by: handfield
categories: Category Management, China Supply Chain, Commodities forecasting, Global Supply Chain, Supply Chain Management, Supply Chain Risk

An MBA student team in my supply market intelligence class  this week presented their supply market intelligence study on phosphate production.  One of the key points was the volatility of Morocco as the major supplier of phosphate.  Based on current reserves and production trends, Morocco will play a very important role in the world of phosphate in the future. By 2100, many countries will have run out of reserves. Therefore, the world will be mainly relying on a single country, Morocco, which is forecast to produce 80-90% of global phosphate demand through the year 2030.  Other global reserves will continue to shrink during this period.   Other regional players such as Algeria, China, Jordan, Syria, Iraq, and South Africa are minor players.  The region is under the rule of King Mohammed VI, and is a virtual monopoly run by OCP, the country’s largest state-owned company which produces almost 80% of the world’s phosphate.

Phosphate prices spiked in 2008 started a movement towards recycling phosphate – but when prices came down, the trend went down somewhat.  But as prices are going up there is renewed interest in diverse sources of phosphate.  In 2030, global demand will exceed supply.  Morocco will need to significantly ramp up production by 2017 to be able to meet this demand curve.  Other countries could ramp up production in time to meet demand – but the burden will fall on Morocco.  They have decided to invest about $5B into the Morocco region over the next ten years, but the capability might not be there in 20 years to increase the output.  Re-using phosphate and water will become more important.  PotashCorp imports phosphate rock the Western Sahara via the government of Morocco. According to the United Nations Western Sahara is a territory illegally occupied by Morocco. PotashCorp, among other companies, has been criticized for helping fund this occupation by buying Western Saharan resources from Morocco

Biofuels are another important element in the equation.  Biofuels are important inputs, and there have been large plantings of corn in the US.  And in 2011 for the first time the major demand for corn was biofuels, not feedstocks for animals.  Biofuels are driving up the demand for phosphate fertilizers.  In 2008, prices spiked for phosphate due to the fact that there were a lot of policies and incentives for companies to get tax breaks to use more biomass elements, which drove up prices.  Many companies are driving tax incentives in 2008, and use of biofuels increased, as policies have been put in place for private companies to use biomass products.  That is part of the reason you are seeing increased elements.

China is becoming a net importer of phosphate, and have imposed 150% export tariffs on exports of phosphate.  Sinofert, China’s state-owned phosphate company, has tried to buy out companies such as Potash of Saskatchewan, and is seen as the best link to OCP, the largest state run company for phosphate manufacturing in Morocco.  BHP and  Sinofert have both tried to buy Potash of Saskatchewan, one of the only public companies that has a relationship with OCP as their major supplier.  They ran out of mining capabilities in the US, and have a public relationship.  BHP tried to acquire them because of the relationship, but received a lot of backlash due to a country with a Western Sahara issue. Sinofert has also been trying to buy local companies.

There will also need to be better processes to refine phosphate.  There are many impurities such as traces of arsenic in organophosphate fertilizers, but no one is going out there to address these issues.  Bayer Crop Science banned the selling of organophosphates for that region, a directive form its board.  A local professor at NC State  in agriculture noted research is starting to look at getting plants to grow in soils with lower phosphate contents.  So there are also changes in the way that the eventual reserves may be altered to make crops more efficient, and allow plants to grow in these climes.  This will be a major factor in demand.  Chris Gibson, one of the students on the team, noted that “…even after 15 weeks of studying phosphate, we still haven’t come up with a clear picture of what the demand and supply picture will be for phosphate going forward!”  This is clearly a situation where supply risk and market intelligence will be critical for managing costs and supply risks in this global market.

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Building the Integrated Delivery System at Honeywell Aerospace

April 18, 2012
by: handfield
categories: Aerospace Supply Chain, Inventory Management, Sales and Operations Planning, Supply Chain Strategy

I had an opportunity to meet with the executive team at Honeywell Aerospace in Phoenix this week, and learned a great deal about the interesting challenges that exist in the aerospace supply chain.  As can be expected, Honeywell has only a few major customers (Boeing, Airbus, Embraer, etc.) in commercial, and a slightly larger amount in defense.  The development cycles on products is very long, and once the product is delivered and installed, the product life cycle is also very long (in some cases, up to 40 years of after-market support services are required).  This makes for some very interesting inventory and supply challenges.

One example discussed was the situation where airlines are holding onto the planes for much longer than expected due to the post-9/11 economic impacts of capital investment in the air transport industry.  In some cases, airlines need to support cockpits with 40 year old technology.  They have to find ways to support planes with cathode ray tubes and 486 chips!  One manager shared with me that they were now “harvesting” 486 chips from older aircraft, and prying them off the boards.  The integrated circuit boards for some of these planes is even more challenging to source for the aftermarket replacement parts.

HQ is also in the process of redesigning their supply chain to ensure a more integrated delivery system.  We discussed maturity models around the DESIGN SOURCE MAKE DELIVER SELL SERVICE framework within SCOR, and talked about the current and best in class practices around each of these elements, and how they applied to the air electronics industry.  The team was especially interested in some of the best practices around design for manufacture, target cost management, SKU complexity reduction, and other opportunities to improve delivery systems across the extended value chain.  These are areas that will continue to become more important with the growth of the aircraft industry going forward.

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How to Read the Inventory Tea Leaves…

April 10, 2012
by: handfield
categories: Commodities forecasting, Forecasting, Inventory Management, Supply Chain Management, Supply Chain Strategy

An article in the WSJ provides an interesting set of perspectives on what increasing or shrinking inventory numbers might mean in terms of an organization’s supply chain performance.  As I noted in an earlier blog, inventory is often an indicator used to measure how efficient supply chains are, as is considered a key component in the methodology used by AMR in rating its top 25 supply chains.  But the WSJ article suggests that many other factors are responsible for variance in inventory numbers.

To begin with, lean inventories can mean demand is stronger than forecast or that companies want to sell what they have on hand before ordering more goods.  Some companies are ramping up their supply chains and building up inventories in anticipation of rising demand.  It may also be an indictor that demand is tailing off, and thus inventories are creeping upwards.

One way to “read the tea leaves” is to apply the DIO metric – or “days inventory outstanding”.  This is the  number of days it would take a company to eliminate its inventory at the current pace of sales.

But there are other economic reasons as well.  For instance, some companies will hold inventory as a protection against increasing commodity prices.  Others may also boost inventory if a product is a “last time buy”, or if they perceive increased risk in the supply chain that could cause disruptions.  For instance, I wouldn’t be surprised to see companies hold larger inventories of hard drives coming out of Thailand!

Companies will also play the numbers game.  In the fourth quarter, companies try to artificially reduce inventories, to make the balance sheet look favorable.  However, the biggest item in my mind is the rise in commodity prices.  According to the Institute for Supply Management, the prices of most commodities rose in March. Building inventories now could save a ton of money later in the year if commodities and oil continue at their current clip…

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Random Thoughts on the Impact of Frugal Innovation on the Supply Chain

April 4, 2012
by: handfield
categories: Category Management, Global Supply Chain, Strategic Cost Management, Strategic Sourcing, Supply Chain Innovation, Supply Chain Management, Supply Chain Strategy, Supply chain Relationships

In this week’s Economist, an article by Schumpeter provides some interesting views on the emerging concept of “frugal innovation”.  He cites the example of the Tata Nano, a $2,000 car  developed in India, which makes a new car within reach of ordinary Indians and Chinese.  He also cites a new book, Jugaad Innovation” by Navi Radjou, Jaideep Prabhu and Simone Ahuja, that develops some radical thinking around this concept.  Jugaad is a Hindi word meaning a clever improvisation. Another book —“Reverse Innovation” by Vijay Govindarajan and Chris Trimble, and co-written by Jeff Immelt, GE’s CEO, also develops the same themes.  The books show that frugal innovation is flourishing across the emerging world, despite the gurus’ failure to agree on a term to describe it. They also argue convincingly that it will change rich countries, too.

One of the most interesting hypotheses advanced by these books is that multinationals will begin to take ideas developed in (and for) the emerging world and deploy them in the West. Schumpeter provides some examples of where this is already happening.  Harman, an American company that makes infotainment systems for cars, developed a new system for emerging markets, dubbed “Saras”, the Sanskrit word for “flexible”, using a simpler design and Indian and Chinese engineers. In 2009 Harman enrolled Toyota as a customer. GE’s Vscan, a portable ultrasound device that allows doctors to “see” inside patients, was developed in China and is now a hit in rich and poor countries alike. (Mr Immelt believes that these devices will become as indispensable as stethoscopes.) Walmart, which created “small mart stores” to compete in Argentina, Brazil and Mexico, is reimporting the idea to the United States

My friend and colleague, Tim Cummins, CEO at IACCM, wonders how this will impact the supply chain.  For instance, will this impact procurement role and behavior and also organizational design? Does it point to the basis for future cost cutting, with suppliers selected for their demonstrated capabilities in ‘frugality’? Or might it mean less outsourcing to overseas markets, but an expansion of captive operations so that a company can draw on ideas from within its own organization? Might it also suggest that supply chains will once again become more localized so that there can be collaborative teams working together on new ideas?

My own thoughts on the subject is that this requirement will require that organizations hone their skills in what I call “Strategic Cost Management”.  This concept, developed largely by the Japanese and described in detail in Robin Cooper’s books “Design of Cost Management Systems” and “When Lean Enterprises Collide”.  These concepts refer to the important concept of developing a “target cost” as an INPUT into the design process, and not as an output.  This requirement means that organizations need to completely re-think the way in which they design products, and define value and functionality very carefully.  Most organizations are not good at this, as it is a highly cross-functional process, which also requires close collaboration with suppliers to drive cost savings innovations.  Collaboration isn’t something that most companies count in their list of strengths.

It will be interesting to see how organizations begin to develop these capabilities for frugal innovation in the future.

Have any thoughts or examples of frugal innovation?  I’d love to hear your views!

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What Will the Role of the CIO Look Like In the Next Five Years?

April 3, 2012
by: handfield
categories: Category Management, Contract Management, Strategic Sourcing, Supplier Relationship Management, Supply Chain Systems, Supply chain Relationships

I recently spoke with Todd Taylor from Apptivo, who is writing a book on IT technology management.  Apptivo provides IT business technology management, and is focused on transparency of IT application usage.  Todd is also affiliated with the CIO Technology Council, and is writing  book on current trends in IT.  He notes that CIO’s are increasingly starting to think about IT in terms of supply chain principles, and are thinking about the changes associated with this transformation.

Traditionally IT has been focused on tactical elements such as enterprise application management, and has been quick to adopt new technologies whenever demand from a business emerged.  Todd points out that in sourcing decisions, the IT functional owner is often things to put them (ei.e. Aptivo, the software vendor) at an advantage.  Vendors often have much deeper knowledge of the market, and are often brought in with comparatively little market intelligence activity by IT, putting them at an advantage.  Other CIO’s acknowledge that IT is often unprepared when it comes to negotiating, contracting, and market intelligence skill sets, and are confident that their technical expertise will carry them through the sourcing decision.

This is starting to change. Although IT leaders perceive a bureaucracy exists in procurement and that procurement should be avoided, more and more IT is finding that they are going to have to begin partnering with procurement, using a process known as category management.  In category management, a scorecard is defined very early in the software/hardware specification cycle through a collaborative process with the business owner, the functional owner in IT, and supported by procurement.  This needs to happen early in the negotiation, before the selection of vendors, primarily because the scorecard forms the basis for the selection itself.  Elements on a scorecard might include features, maintenance agreements, functionality, and (by the way), life cycle cost…

The other application of supply management principles to IT is in the area of Demand Management.  In IT, the first step here is to understand spend, and develop a reliance on transparency.  This doesn’t mean constraining spending, but a first step is to collect spend data and reflect the overall impact on the business unit’s budget.  This could reflect, for instance, IT support chargebacks or shadow bills back to business  partners, what are they spending on services, and showing consumption levels.

This is particularly true when you consider the impact of mobile computing devices, which are rapidly escalating as the number one spend area for IT.   IT category management goes beyond a single device to a whole portfolio of devices where the complexity drives increased costs, security challenges, and other issues.  Organizations want to support technology choices of end users but need to balance with cost, complexity, and implementation needs.  CIO’s need to start having these conversations with business partners around standards for supporting these devices,  and once you have that framework, give further transparency to decision-making.  This needs to happen soon, as the number of apps for business support and authentication networks into the network continues to grow and will surely continue to escalate as a big issue.

Todd mentioned one of Apptivo’s big customers (and I mean really big!) and problems they had with escalating mobile phone costs.  The CIO knew culturally as long as they could give end users visibility to their costs and consumption, they could drive behavioral changes  All they had to do was show consumers what they were consuming  and give them incentives for stock options.  Once this happened, they drove change in behavior, which also led to renegotiation of mobile contracts.  Rather than rely on simple constraints, rules, and compliance, driving change was about leveraging costs and driving  transparency of costs to the business, and then letting the business make decisions about what they should be consuming.  This implies managing not just the numerator (cost), but all the rate of consumption (denominator) in the demand management equation.

Another part of the IT category management equation is around supply chain risk.  Loss of control is a theme more CIO’s are concerned with relative to Cloud computing.  Business partners are going more to Cloud computing not just for software, but using cloud providers for infrastructure.  There is a perception that cloud computing drives loss of control, and exposes the organization to yet another portals for computer hackers from China and India to enter.

There is no question that the move from a centralized authoritarian IT organization to a shared service working with procurement through a category management approach is the future vision of where IT is gong. What should a CIO be doing or technology leader be doing to earn control by providing value from being the intermediary?  Is there something they should be doing better to help manage the trend they see?  I believe that the need to drive transparency, employing category management approaches, adopting total cost of ownership toolsets, and working more in collaboration with procurement are all issues that CIO’s need to begin thinking about in the years ahead.  In the next 3-5 years, IT organizations will look very different than what they are today.

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Lean Aerospace Supply Management Developments

April 2, 2012
by: handfield
categories: Aerospace Supply Chain, Business Process Outsourcing, Contract Management, Forecasting, Global Supply Chain, Inventory Management, Logistics, Supplier Relationship Management, Supply Chain Management, Supply Chain Strategy

In a recent set of interviews, I had an opportunity to learn about some of the recent developments in the aerospace industry, that is happening in both commercial and defense sectors.  As organizations seek to drive inventory out of the supply chain and improve working capital, while simultaneously reducing leadtimes and customer responsiveness, they are turning more and more to their suppliers for assistance.

Last week, a senior procurement executive at a large aerospace company shared with me the changes in inbound supply strategy that are underway.  The individual I spoke with described this as follows:

“The model involved looking at where we are in the industry and the leverage we had.  We looked at how we aggregated and leveraged our spend for C-class parts.  (C-class parts include low cost, high volume commodity parts such as fasteners, sometimes called “Pan Stock”).  We realized that every site and every platform needs them.  We are using the same stuff!  So we decided to aggregate and put contracts out, so that we could have every part on one contract – regardless of whether they are shipped to a site on the West Coast, East Cost, South, etc.  Our initial objective was to drive to the lowest piece price.

So we went ahead and put the contracts out there – and the hardware sourcing was done.  But that’s when we had an epiphany and made an important decision –  “Let’s let someone else manage ALL of it!  Why – because we are NOT good at managing the inbound process for this stuff!  Why not let the people who make parts for us figure out how to get it to us when we need it?

This individual went on.  ”Certainly, we want the contracts to ensure our people buy off them and get a good price.  But in addition they [the distributor] can do the procurement, services, supply chain functions, material handling, storage, everything!  And they keep the inventory and own it – and we will pay you AFTER you deliver to us.  We keep the inventory in their forward stocking location close to each of the sites, and they provide us metrics, we utilize their IT, and so they are managing the whole thing.”

Although this approach (often called “Vendor Managed Inventory”) has been around for years, it is a dramatic change from the past for aerospace.  It requires very strong supplier capabilities, which many have not developed in the past.  As one individual noted, “You need to have a very good understanding of the product!  Even though it is a 50 cent washer you can shut down a major assembly operation  and don’t want to stop a commercial line!   If you are NOT tied into that vertically integrated commodity, that won’t fly, as you not allowed to run out.  You really need to understand the commodity and have a full depth of knowledge and understanding before you make that leap on going full-on VMI.  I don’t think many aerospace suppliers are there yet personally – it is not a core competency of theirs, and they may not want to do it!”

There are indications that the VMI model may be just getting started in aerospace.  The manager I spoke with emphasized that “It is a model that can be used in other commodities and that is what I am excited about.  I see other opportunities within the general procurement sphere to plug this model with some tweaks.  It involves reducing inventory cost and risk management, and all of that stuff.  I hope we have hit the tip of the iceberg and deploy this through other areas, and we are doing an investigation on it, and putting together the business case to ensure it makes sense.  In the old days, we would give them a forecast, and we went out and bought the stuff, put it on our shelf, and held onto it in cases when the forecast was way off!  We’re realizing now that many of our C-class distributors are doing this with other non-aerospace companies, and the were doing a lot of this already and the relationship with the OEM’s of C-class products is bigger than our buy alone!   They are involved with other companies and buying in larger volumes than we were!  And when we looked at it that way, it became a no brainer:  it eliminated us as someone who needed to be involved and started a paradigm shift on how we do will be doing business from here on in!”

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Prediction: More volatility in oil and commodities

March 22, 2012
by: handfield
categories: Commodities forecasting, Global Supply Chain

There appears to be more unrest in the world this week, which of course brings with it the increased nervousness of analysts and speculators.  One of the real questions arising is whether India will abide by the US call for sanctions to buying Iranian oil.  According to a Bloomberg report, Oil Minister S. Jaipal Reddy, Finance Minister Pranab Mukherjee and Foreign Secretary Ranjan Mathai have said India will continue to buy Iranian oil to meet its growing energy needs. While the Indian government has an excellent record of enforcing United Nations sanctions on Iran, India has objected to unilateral U.S. sanctions, according to U.S. officials.  The report goes on to note how the latest shipping data shows India and South Korea sharply increased oil purchases from Iran in January, according to a report released yesterday by the International Energy Agency in Paris. China halved its imports from Iran, from 550,000 barrels a day in December to 275,000 barrels a day in January, following a dispute over pricing terms that has now been resolved, the report said.

On the commodities front, an even more interesting picture is emerging that could dramatically shift the volatility of commodities.  A Reuters report notes that the banks are now locked in deep debate with the Fed, according to multiple sources. Goldman and Morgan Stanley argue the right to own such assets is ‘grandfathered’ in from their lightly-regulated investment banking days, or that at least they should be allowed to retain them as “merchant banking” investments, kept segregated from the trading desks.

Many people are unaware that these big banks stockpile commodities in oil in massive storage tanks and warehouses.  For example, Goldman owns Metro, a Detroit-based metals warehousing business, while JP Morgan owns a metals warehousing business Henry Bath.  Jason Schenker (a speaker at our next SCRC meeting April 30-May 1), notes that this is not surprising given the need of these banks to speculate in these markets.

“The truth of it is that having access to the physical markets is about optimization and knowledge – it gives you the visibility of the market to make far more successful proprietary trading decisions in both physical and financial markets,” Schenker notes.

“That’s why for many years the most successful traders had access to both markets, and why we’ve seen little sign they’re moving quickly to divest these assets now. It’s trading with material non-public information – the difference compared with equity markets is that it’s perfectly legal.”

Should these banks lose the debate, the result may be the biggest shake-up in commodity markets since the early 1980s, when Wall Street decided to enter the speculative opportunities that presented themselves in crude oil cargoes, copper stockpiles and power plants.  (Remember Enron?)

The loss of these assets due to regulation would be a blow for the banks at the worst possible moment, with their proprietary trading desks shut down, commodity merchants trying to poach their top traders and new Basel III capital regulations requiring them to further build capital reserves.

The impact on the commodity markets would no doubt be substantial as well, although there is no way of knowing the impact up or down…..all we know is that more volatility is on the horizon!

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