BP Oil Demand Forecasts Have Capacity Planning Implications

 

BP PLC, released its annual energy outlook today.  An important part of BP annual energy outlook is the main future scenario in which BP analysts forecast the expected demand for oil.  As the debate over, and the uncertainty of, the growth of renewables has escalated in recent years, oil-and-gas giants, such as BP have traditionally released very conservative estimates concerning the forecasted demand for oil.  However, citing the surge in renewable energy sources, BP’s report estimates that the demand for crude oil will peak by 2035—a significant change from BP’s previous estimates that suggested demand would not peak until the 2040’s (WSJ).

In the context of Operations Management, BP’s forecasts have important implications regarding planning capacity.  Capacity refers to the maximum rate of output of a process or system, and managers are responsible for ensuring that their firm has the capacity to meet current and future for demand (Krajewski, et al 136).  In today’s energy environment, capacity planning is especially challenging for managers at firms such as BP.  As the energy mix (share of oil, natural gas, coal, renewables) continues to evolve, managers must make difficult timing and sizing decisions.

The capital-intensive nature of oil and gas industry makes timing and sizing decisions more difficult.  For instance, let’s say that BP decides to become less involved in the exploration, development, and production of crude oil.  In order to decrease their position in this industry, they could lower their capacity cushion, by shutting down or selling off exploration, development, and production assets and facilities.  (Note: a firm’s capacity cushion is the amount of reserve capacity a process uses to handle sudden increases in demand or temporary losses of production capacity.)  In theory, this would be a good idea: lowering this capacity cushion could help BP cut costs in the downstream oil segment.  Further, studies have indicated that businesses with high capital intensity achieve a higher return when the capacity cushion is low (Krajewski 139). Conversely, this decision means BP is less insulated against sudden changes in demand or the temporary loss of current capacity.  For example, demand for oil in India could increase more quickly than anticipated, or a hurricane in the southeast United States could temporarily stall exploration activities and close production facilities. In either of these scenarios, BP’s decision to lower their capacity cushion could adversely affect their oil business in the short-term.

Another interesting aspect of the WSJ cited that majority of the demand for oil should come from developing economies like China and India (WSJ). This creates another interesting dilemma for BP’s management: should they employ an expansion strategy or a wait-and-see strategy in these developing economies? An expansion strategy would call for BP to stay ahead of demand and potentially minimize the chance of sales lost to insufficient capacity. Conversely, utilizing a wait-and-see strategy would call for lagging behind demand. A benefit of the wait-and-see strategy would insulate BP from over investing in its oil business if oil were to become obsolete in these economies due to the presence of cheap natural gas and renewable sources.

Traditionally energy giants are at a crossroads: Do they continue to invest and grow their oil businesses in the face of cheap natural gas and renewables sources? Do they expand, maintain, or shrink their capacity? In a global economy, some markets might have better or worse growth prospects for the oil industry, and how should companies like BP plan, partition, and build their capacity to best take advantage of the uneven growth and demand?

WSJ Article: https://www.wsj.com/articles/bp-oil-demand-is-going-to-peak-in-the-next-20-years-1519137000

 

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2 thoughts on “BP Oil Demand Forecasts Have Capacity Planning Implications

  • February 21, 2018 at 4:38 pm
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    Andrew,

    Your analysis of energy companies and the dilemma they face is very interesting. To me, the biggest threat to oil companies and companies based in non-renewable resources is the continual improvement of renewable resources and the effect that will have on non-renewable resources. For example, commercial grade solar panels are only about 40%-50% effective, while residential, cheaper solar panels drop to about 15%-20% effective. Yet, there is still a growing market for these products because for many people, the price is worth the savings they will receive. The scariest part for oil companies is the fact that there is so much room for improvement in the renewable resource arena. This should be a big part of the planning capacity decisions for an oil company and should even drive them to reconsider making an entry into the non-renewables market.

    In addition to the points you made, there is another huge part of planning capacity for oil companies. For many large companies, they buy futures contracts for their oil in order to lock in a price. This does protect them from sudden increases in oil prices, but also prevents them from profiting off sudden decreases. Clearly, this is a huge decision facing these companies because they must predict future market events while still being able to find a fair market price. For oil companies, they not only have to be concerned about the outlook for their individual business, but also the market environment as a whole. The huge oil companies that have lasted this long are clearly masters at planning capacity because they have been able to survive. However, the future will put them to the test as they determine what parts of the business need to develop, while some might have to be cut out.

    Source for solar panel efficiency: http://www.pvpower.com/howefficientissolarenergy.html

  • February 21, 2018 at 1:17 pm
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    Andrew,
    Forecasting what BP should do in today’s world is probably incredibly difficult. Besides all the reasons you mentioned for uncertainty in crude oil, there is also advances in technology that cannot be predicted. Take Tesla for example, the company that is at the forefront of electric car technology yet still has not turned a profit. (https://www.quora.com/What-makes-Tesla-technology-so-far-ahead-of-its-competitors) It is plausible that they make another breakthrough in electric car technology and drive the demand of crude oil even further down. Maybe by some weird turn of events nuclear power demand begins to rise. BP can’t predict everything and even the predictions they have may not turn out to be true. If they were to expand crude oil, they could lead demand with incremental expansion, make one large expansion to cover future demand, attempt to have an average capacity with incremental expansion, or lag behind demand then expand to meet demand. Otherwise they could decrease crude oil production, by lowering the capacity cushion and still maintain current demand. They would lose their ability to adjust to unexpected demand increases but they would be able to cut costs and still maintain their current demand.

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