How The Price Of Oil Affects The Bottom Line

The chief executive of a well known global consumer products company was constantly being asked by his shareholders and investment analysts "If oil prices go up by another $10 a barrel, how will that affect next year's profits?" Unfortunately, nobody in the company knew the answer since there was a lot of myths, disagreement and confusion as to how the cost of goods bought in were driven by the price of oil.

The company spent over $250 million a year buying in plastic packaging for the products it sold. Plastics are made from materials known as resins such as Polypropylene and Polyethylene. In turn resins are derived from crude oil. Oil prices had risen to record levels since 2004, so it was imperative to find the precise relationship between the price of oil, resins and plastics.

Why the Company Came To Me & What I Did For Them

In the end, they decided enough was enough and turned to me for advice. They knew that I had the expertise to find answers and the ability to present results in a way that everyone could understand and make use of them.

I found out that many economists had studied this relationship but they invariably based their conclusions on only 2 years worth of data. I knew straightaway that using so little data led to unreliable results. By using 20 years of data, I proved that 90% of the time there was a strong relationship between the prices of oil, resins and plastics but every now and again, this would break down completely.

I used my findings to build an Excel-based scenario model for the company's buyers to use. This allowed them to input an oil price scenario for the next 12 months and to see what the impact would be on the cost of the plastic packaging they would be buying over that time.

                      What Happened Next                            

The company was delighted with my results and how easy the model was to use. For the first time the chief executive would be able to give intelligent answers to any oil-related questions. More importantly, the company now knew what the impact of future oil price rises on their cost base would be, broken down by region and type of packaging. With this information, they could budget more intelligently for contingencies, identify those suppliers pushing for unjustified price increases and pro-actively develop buying strategies to minimise their exposure to the price of oil. A modest investment in my services had paid big dividends!