With interruptions to supply also likely to rise, it makes sense to assess and mitigate now the likely risks to your business.

Here is a simple process for doing so:

First, obtain a copy of your management accounts — the P&L you use to run your business. You will want enough detail to identify detailed areas within your business; a maximum level of around 80-100 line items. Use figures for 12 months, to include any seasonality. Make sure also that revenue is broken out where possible to identify income by customer group, by product or service type, or by the ‘channel’ by which the product/services is delivered to the customer. Five to ten categories should be adequate for a first pass here.

To these accounts, add two columns. The first is ‘Financial Impact’. The second is ‘Operational Impact’.

In the first column, write an estimate of what the change in revenue or expense figure will be, when (not if, when) the oil price reaches double what it is now in real terms. (For the moment, assume that oil is still in plentiful supply.)

Salaries, for example, are generally unlikely to be directly affected by a change in the price of oil; costs of travel, logistics, some raw materials, and direct energy* are likely to be affected an intermediate percentage, since the price of oil does not make up the full cost of these items; and revenues might be unchanged, or significantly shifted downwards, or upwards, depending on how a higher oil price would affect your customers’ available budget/disposable income and spending priorities.

(*If you expect that a higher market price for oil would lead to higher market prices for other forms of energy, you will want to factor that in as well.)

Completing this step, and totalling the figures, gives you a rapid assessment of how a doubling of the oil price would likely impact the profitability of your business.

It also identifies the key P&L line items that would most impact your business. This enables you to take action to mitigate those impacts.

In the second column, ‘Operational Impact’, rank the degree to which this line item would likely to be affected if supplies of oil were interrupted. You could rank this as 3/2/1 for high/medium/low. Or you could use a scale of 1-10. We recommend using a simple method you feel comfortable with to begin with, and then adding detail later if necessary. A good starting point might be to rate ’1′ for ‘little or no impact’, 2 for ‘slight impact’, 3 for ‘significant impact’ and 4 for ‘very significant impact’.

Notice that the operational impact is completely unrelated to the P&L impact to your business. An oil-based raw material might form a tiny part of your cost structure, and yet be absolutely essential to your operations. Or the supply of an inexpensive raw material could be heavily impacted by an interruption to the flow of oil.

Notice also that significant impacts could come from items that do not appear on your P&L, or are outside your control. Could employees get to work if there was a petrol shortage? Would customers switch from out of town shopping to the high street or the Internet?

EXAMPLE:
The National Trust owns a selection of properties across Britain. In the past much of its revenues have typically come from visitors travelling from other parts of the UK or from outside the UK. As the cost of oil rises, those visits are likely to become more expensive and so the National Trust can expect revenue from these sources to decline. The organisation has therefore implemented a new strategy, with an increasingly local focus. You can read it about here and here, especially on pages 10-13.

Having assessed the operational impact you can now combine it with the financial impact. In a third column, multiply together the figures in the first and second columns to give the Weighted Operational/Financial Impact.

Priorities

By now you will have identified several ways in which the price and availability of oil might affect your business over the next decade.

You will need to apply management discretion to decide which items to focus on :

• the items that would have the highest absolute P&L impact
• the items that would have the the highest percentage change in P&L impact (compared to current figures)
• the items that would have the highest operational impact
• the items that have the highest combined/weighted scores (third column)

Fourth Column — Timing and Likelihood

The tightening of oil supplies will not affect all areas equally or at the same time.

In the fourth column add some more detail to the Operational Impact: add your assessment of when the events in column two are likely to happen, and how likely they are.

You now have sufficient information to produce a chart like this, of the top risks your business faces from oil:

Each circle represents a line item you have identified.

The size of the circle represents its financial impact. The vertical position represents the degree of operational impact.

The horizontal position indicates the date when this risk is expected to happen. And the colour of the circle represents its likelihood (green is ‘possible’, red is ‘very likely’).

The same line item (revenue or expense) might appear with different probabilities and different impacts in different years. Each of these scenarios might require a different action plan.

Fifth Column — Action Plans for Mitigation

Having identified the likely priority areas for your business, the most important thing is to come up with an action plan to address each one.

If you have a standard risk management methodology, use that.

If you want an quick and dirty approach, try this.

For each line item:

• Be clear about the size and nature of the potential risk (financial, operational, or both)
• Be clear about how the risk arises — identify ways to reduce the likelihood that the risk will happen, and/or to reduce the impact if it does
• Identify ‘disaster recovery’ plans, if appropriate
• Be clear about the role that each line items plays in your business model — identify ways to achieve the same ends by different means
• ‘Disaster Recovery’: Identify ways to recover

It is difficult to to be specific about what these might mean in practice. But in general they are likely to involve three possible options.

First is to gain control of resources in order to be able to continue with the oil-based business model. This works in the short term, but increases the risk to the business, since it becomes increasingly reliant on scarcer resources. It also leaves the business facing the same or larger need for change, once those resources run out.

The second option is to continue with the current business model but become more efficient, in order to reduce the amount of oil-based materials used. This buys breathing space and may work for some businesses. The key question is whether efficiencies can be achieved faster than the tightening of oil.

And the third is to finding alternative ways to achieve the same ends, without using oil. This route offers the greatest potential — both for resilience and for growth — since the whole world economy will be experiencing the same change.

A post next week will examine how to look for opportunities.

So here are two stories about how adaptation to life with less oil can proceed quite straightforwardly… and in fact is already doing so.

It is non-adaptation that is the difficult route.

Train not plane

This recent piece in the FT talks about how Eurostar “has effectively killed off the air travel market between London, Paris and Brussels”, since it launched in 1994.

This probably has less to do with fuel consumption or CO2 emissions, and more to do with the much faster journey times between city centres, and also the more comfortable and productive environment in which to travel.

Lower-fuel alternatives can also be more attractive to customers.

The good news is that Eurostar is now looking at adding up to ten new destinations in the next five years, into Germany,  the Netherlands, southern France and Switzerland.

And Germany’s Deutsche Bahn and at least one other high speed operator are expected to enter the cross-channel market at around the same time, placing downward pressure on prices, and extending the network of destinations that passengers will be able to reach by high speed train.

So long as we can generate enough electricity, high speed travel across Europe is still going to be possible without oil.

Island Life

With demand for oil set to rise faster than supply, the IMF piece clearly shows that there soon won’t be enough oil to go around. And in the short term at least, price will be the mechanism that is used to ration supplies.

One places where that is first likely to happen is the Pacific Island countries. Here prices are bolstered by the huge distances the oil has to be carried, and oil imports can account for up to 30% of each country’s gross domestic product.

Leaders of a number of small island states around the world last week made commitments to reduce their use of oil, switching instead to solar, wind, and coconut biofuel as sources of power.

Tokelau plans to become completely self-sufficient in energy this year. The Cook Islands and Tuvalu aim to get all of their electricity from renewable sources by 2020. St Vincent and the Grenadines (in the Caribbean) aim for 60% from renewables by 2020.

“We don’t see those targets as being difficult,” one prime minister said. “It is very inspiring and that is what is motivating us to get going.”

A palm beach, without the sound of a noisy generator? Sounds idyllic to me.

It concludes that:
a) the price of oil in real terms will most likely double over the next ten years,
and
b) there is a large degree of uncertainty in how things might actually turn out.

What the IMF working group did

Predictions about oil typically fall into two camps. First there is the ‘geological’ viewpoint, which says that there is a limited amount of oil in the ground and it will run out soon. You might call this the ‘doom and gloom’ scenario.

Then there is the ‘technological’ viewpoint, which says that higher prices will inevitably lead to innovations that solve the problem. This might equally be cast as the ‘naive optimism’ scenario.

The IMF, with its focus on international trade and sustainable economic growth, wanted to look objectively at the oil price, without pre-judging whether either of these views is correct.

The working group built an economic model that contains their best understanding of how increased demand for oil might drive production upwards, as well as their best understanding of how increased economic activity (and higher oil prices) would drive demand.

The working group’s conclusions

The result is a model that predicts historic price changes, “far better” than previous models do.

And the best forecast of the new model is that the impact of technology will only be a slight increase of world oil production (compared with the straight ‘geological’ scenario), and that there will be “a near doubling, permanently, of real oil prices over the coming decade.”

Key drivers

It seems that three key factors will determine how this turns out in practice. They are (paraphrasing):

1. How much recoverable oil actually turns out to be in the ground;
2. How much money people turn out actually to be willing to pay for a barrel of oil; and
3. The degree to which oil producers decide to raise production in response to higher prices.

None of these can be known until after the event, so there is a wide range of possibilities as to how things might turn out. (These are shown as dotted lines in the diagram above.)

Uncertain impacts on the economy

The working group also finds it difficult to predict what the consequences of tighter oil supply and higher oil prices would be for the world economy.

Firstly, “This is uncharted territory for the world economy, which has never experienced such prices for more than a few months.”

Second, “there must be a pain barrier, a level of oil prices above which the effects on GDP becomes nonlinear, convex.” (Presumably this is similar to the way that rising levels of water would have a ‘nonlinear, convex’ impact on a person’s ability to breathe, once the water level reaches their nostrils.) The key question is, does that ‘pain barrier’ come after the real oil price reaches $200/barrel, or before? Again, the world economy has not experienced this before, so it is difficult to know.

And third, “the assumption that technology is independent of the availability of fossil fuels may be inappropriate, so that a lack of availability of oil may have aspects of a negative technology shock.” In other words, a lack of (cheap) oil may impede our ability to develop new technologies, and/or use existing technologies.

The bottom line is that, in terms of impact on the economy, “The macroeconomic effects… could be much larger, more persistent, and … would extend well beyond the oil sector.”

What to do

The working paper says that for the IMF, further studies “will be a priority of our future research.”

But it is clear that what happens between now and 2022 cannot be predicted. It is not set in stone but will depend on the choices we make now and the actions we take. How well we prepare.

We do not know how much world oil production is going to rise. But we do know that it  has plateaued since 2005 (despite historically high prices), and that demand is going to continue to rise more quickly than production. Someone, somewhere, is going to face a shortfall.

We also know that the price is headed upwards, in real terms, permanently. And that the impact on the economy (that is to say, on individual businesses) has the potential to be ‘nonlinear’ — if we do nothing.

But business leaders do not wait for 100% certainty before they take action.

And it will be much easier to quantify the likely effect on individual businesses, than to try and forecast for the whole world economy.

This report provides enough information to know that every business should now be taking steps to do four things:

1. Identify where and how the price of oil/availability of oil impacts their current business model.
   (As a raw material; in the supply chain and distribution; in core operations; in the ability of customers and employees to participate in the business; …)
2. Quantify and prioritise those risks, and develop plans to mitigate or manage them appropriately
3. Identify business opportunities that are likely to arise in a future, oil-constrained world
4. Consider the development of step-change business models

(Businesses might also find it instructive to carry out the first two steps for their customers, their suppliers, and their competitors.)

The IMF’s working paper report is available from their website here, as well as here.

Although 70 per cent of the Earth’s surface is covered with water, the report is focused on the “less than 0.5 per cent of the world’s water [that] is available for human and animal use as fresh [water] and ground water.”

The snapshot view is that a vital element which many of us (at least in the developed world) have taken for granted as being abundant and cheap is about to become both scarce and expensive. Navigating the way forward to better management and usage of that scarce key resource will require change from the way we do things today, and that in turn will require cooperation between several agencies.

A more detailed summary is included below, together with links to the full report.

“The future is not bright”

• Water quality and water supply are already reducing
• Human beings already “withdraw about 50 per cent of the globally accessible and renewable water on an annual basis”.
• Population growth and ageing infrastructure are exacerbating the situation
• Climate change is expected to increase demand for water, but also increase volatility of supply, and reduce quality

“The era of cheap water is over”

• The report calls for increased prices or ‘a better pricing system’ to address rising costs of chemicals, energy and labour costs.
• While more efficient usage must be part of the solution, the expectation that this would lead to reduced pressure on over-exploited water resources seems less than clearcut to this reader, given that water companies would then make higher profits at higher prices.
• Tiered pricing might be a solution. And it should not be forgotten that in England and Wales, for example, 20 per cent of water supply is lost through burst pipes.
• Water prices are already rising significantly in “a number of countries”, in response to drought and increased operating costs.

Energy uses water, requires energy, …

• Energy generation is a large consumer of water. (45 per cent of fresh water withdrawals in the USA.) As energy use is expected to grow (for example in emerging economies), so will water consumption — unless efficiencies are found.
• But while oil extraction (conventional and unconventional), thermoelectric power generation (including coal, gas, and nuclear), and even biofuels all require large amounts of fresh water, wind, solar and wave power do not. This
• Fracking technologies also degrade water quality, passing costs on to water utility companies.
• Current technological approaches to providing fresh water are themselves highly energy-intensive, creating a vicious cycle.
• Sewage waste can also provide a source of energy.

Increasing supply: “Technology in the driving seat”

• The water industry is described as not being innovative, due to being in public ownership, low customer prices and the long life of its key assets.
• The report argues that new technology is the way to use water more efficiently (for example in agriculture), monitor/reduce usage and spot leaks, increase supply (for example through new technologies for desalination and waste water recycling)
• Other, low tech, solutions such as local rainwater capture, and purification to different standards for different purposes are not mentioned.

Sources of Funding:

• The report expects that private companies will play an increasing role in financing, owning and managing the water industry.

Water as the next ‘hot commodity’

• Although water is a “highly political and emotional issue”, and transport of water is difficult, the report expects increased price-driven trading of water and rights to extract water, probably based on local conditions.
• “With demand for clean water potentially outstripping supply by as much as 40 per cent by 2030″ in some parts of the world, and given our cultural assumptions, this seems likely.

Water stewardship — the way forward

• “For many companies water is emerging as the next critical risk”, threatening business operations, supply chains, business continuity and even brand and withdrawal of licence to operate (if a company is seen to have poor water stewardship).
• “Water quality regulations … will directly lead to increased costs” — while likely this is not strictly true, since savings from alternative process approaches could outweigh increased costs of regulation.
• Water reporting is expected to increase, and there are already signs that it is doing so (in the same way that carbon reporting has increased).
• And finally, solving these water issues will require co-operation between different organisations, and so ”More efficient water usage not only results in cost savings, it also forges stronger relationships with investors, regulators, local communities and employees… [and] can have a positive impact on a company’s reputation.”

The full report can be downloaded from several Deloitte web pages around the world, including this one.

At the same time it would mitigate climate change, and alleviate rural poverty.

States and donors must take a leading role in making this happen, the report says, since “private companies will not invest time and money in practices that cannot be rewarded by patents and which don’t open markets for chemical products or improved seeds.”

Sustainable solutions to some of the problems we face already exist.

But two barriers that exist to implementing those solutions are:

1. The need to change from existing practices
2. It is against the interest of our current money system to solve the problem — it is in the interest of our current money system to allow the problem to get worse.

You can download the report and its accompanying press release here.

And Gregory Bateson pointed out, “The major problems in the world are the result of the difference between how nature works and the way people think [it works].”

The world today faces several major problems, in economy and business, in energy, environment, food, water…

As we plan how to respond, our actions are driven by our beliefs. So it makes sense to be open to the idea that those problems may have been caused by mistakes in our very thinking in the first place. Rather than making things better, our ‘solutions’ may be making the problem worse.

This linked article describes how a different approach is having better results.

It proves that the received wisdom can be wrong — wrong to the extent that it actually has the opposite effect to the one intended.

And it shows that strong, healthy nature can coexist side-by-side with better results for humans.

You can read the full article here, and a brief extract below.

What we call ‘problems’ are actually an opportunity to improve our understanding of how the world really works.

In Africa and in West Texas, the standard technique for reinstating overgrazed land is to allow that land to rest. But this leads to desertification, something that the arrival of man has done since ancient times.

What is needed instead is a tight herd of grazing animals. This concentrates their fertilising manure and urine into a relatively small space, and churns it into the ground with their feet. In nature this happens when large herds of grazing animals (such as wildebeest) face healthy numbers of predators (such as lion).

A cattle farm in Africa has been mimicking nature’s way. Cattle are managed in tight herds, and the result over 45 years has been to increase the number of cattle the farm can support from 100 to 500 animals. That improves the land for wild animals, which are then kept in herds by predators, again improving the soil. Even elephant are useful — they push over trees during the dry season, eating some foliage and leaving the rest as fodder for the cattle.

The result: “A successful cattle operation, depending for its success on masses of wildlife – it flies against all common livestock management techniques.”

Meanwhile a piece of rangeland on the farm that has been managed according to orthodox techniques is turning slowly into desert.

The world today needs to question orthodox approaches and beliefs.

And the most fundamental belief of all that needs to be reintroduced is to realise that good quality human life and good quality natural life can coexist.

The article explains how crop yields there have been falling dangerously low, and how the traditional approach of ‘adding more fertilisers’ is no longer working.

A new approach, called ‘agroforestry’, involves working more closely with nature — and is having great results. In this particular example it involves the planting of ‘fertiliser trees’: trees that protect the soil from the sun, and increase both its moisture and its nutrient content.

This is interesting for two reasons.

First, because the shift to a more sustainable system approach to farming is creating new opportunities for businesses in these areas. In this case the demand for seeds of these ‘fertiliser trees’ is outstripping supply.

And second, because our whole western economy is facing problems similar to the farmers in sub-Saharan Africa: our traditional approach to add more fertiliser (‘increasing the existing money supply’) simply is not working. Our ‘land’ is drying up.

We need the economic equivalent of a ‘fertiliser tree’. What would one look like?

Finding it would be like finding the natural equivalent of a money tree…

Excerpt:
Across the drylands of the Sahel, close to the edge of the Sahara, crop yields are falling as increasing demand from growing populations mean the soil is not given the dozen or more years it has traditionally been allowed to lie fallow before being planted again.

Fallow periods have dropped to two years or less, sapping the land of the organic material that makes it fertile, and creating a concrete-like surface that cannot absorb the rain when it does come.

Artificial fertilisers allowed this new, more intensive, system to work for a while. But now the rising price of oil is making those fertilisers unaffordable. And the outlook is that millions of rural poor will migrate to the cities, or even into Europe, pushing down the price of unskilled labour (wherever they turn up), just as the price of food continues to rise…

But in some parts of Mali, close to the Sahara desert, farmers reaped a bumper crop last year. And villagers now have enough food to take them through the dry season.

The reason? They have been following the advice of the World Agroforestry Centre and planting trees — trees that fertilise the soil (both by dropping leaves, and by bringing nutrients and water up from deep below the surface), protect it from the sun (so that raint that falls is more easily absorbed back into the ground), and so reversing years of soil degradation.

Yields from farming this way can be two to three times higher, and the ‘fertiliser tree’ approach is being applied in Malawi, Ethiopia, Tanzania, Rwanda and Zimbabwe.

What would it take for business to do the same?

Full Story:
http://souciant.com/2012/02/fifty-million-at-risk/

http://www.ted.com/talks/lang/en/clay_shirky_on_institutions_versus_collaboration.html

This is not good news for US citizens, or business. People who are rioting do not make good customers, or employees. And sales may increase for companies in the ‘personal security’ industry, a climate of civil unrest is likely to make things even worse for the rest of the economy.

As a man who escaped first Nazis and then communists in his native Hungary, and then went on to make $1bn in a single day from the collapse of the ERM, his opinion surely deserves to be listened to.

This piece on Russian news site rt.com summarises the Newsweek article and adds some supporting evidence of its own:

• Two thirds of adults questioned in a recent Pew Research survey apparently said that they agreed “strong” or “very strong” conflicts exist between America’s elite rich and the poor.
• And while the passing of the recent National Defence Authorisation Act makes it lawful for the US government to indefinitely detain and torture American citizens suspected of terror crimes without ever bringing them to trial, the proposed Enemy Expatriation Act would allow the US government simply to revoke citizenship without trial from anyone deemed a threat.

Back to George Soros.

“The situation is about as serious and difficult as I’ve experienced in my career,” he tells Newsweek. “We are facing an extremely difficult time, comparable in many ways to the 1930s, the Great Depression. We are facing now a general retrenchment in the developed world, which threatens to put us in a decade of more stagnation, or worse. The best-case scenario”, he says, “is a deflationary environment. The worst-case scenario is a collapse of the financial system. …At times like these, survival is the most important thing.”

As Newsweek explains, “He doesn’t just mean it’s time to protect your assets. He means it’s time to stave off disaster.”

‘Staving off disaster’ means saving the financial system from collapse, retaining the euro as an economic unit and zone, and removing the “evil” he sees in the financial system.

It also means, in our view, that once we have stepped back from the edge we need to point the world in a direction that takes us away from the place that we have got to. And since equality is one of the key measures he uses to identify the problem, reducing equality is one of the solutions.

The traditional response has been to form an institution.

The newly-emerging solution (in 2005) is to enable cooperation through infrastructure tools — essentially internet 2.0.

What Clay explains is that the days of the traditional solution are numbered — because they fail to capture some of the potential value that is created by the looser, cooperative model, and they add extra costs (of management control).

The changes this will bring will arrive “one arena at a time”. How it will turn out is unclear. But you could argue that the ‘Arab Spring’ and ‘Occupy’ movements of 2010 were a natural outcome of the process he is describing.

And the exciting thing is that the underlying change will be to shift our organisations from being obstacles to becoming enablers of value creation.