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 Energy prices are rising at an eye-watering rate, but what does this mean for the international food and grocery industry, and what can be done to cope? James Walton, Chief Economist, IGD investigates.
Goodbye To Cheap Energy
The early years of the 21st Century have been characterised by rapid and consistent increases in the prices of fossil fuels, as well as growing concern over the environmental impacts of utilising such fuels.
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| Fuel costs are continuing to rise | |
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Oil has seen particularly strong inflation, with world prices for crude oil more than tripling over the last five years due to soaring demand - originating primarily from the emerging economies of Asia - combined with static or declining output.
In view of these economic and environmental pressures, it would not be unreasonable to state that the era of inexpensive fossil fuels for energy is gradually drawing to a close.
Oil Rich Diets May Prove Unhealthy
The grocery industry cannot expect to remain unaffected by these changes, as any increase in energy prices has serious implications for the profitability – and even the viability – of all grocery businesses.
For example: in the UK, fuel accounts for about 35% of the total cost of running an articulated truck, meaning that a 3% increase in fuel costs results in a 1% increase in total cost. Bulk diesel costs in the UK increased by 22% in 2007 alone, implying that the cost of running a large vehicle rose by 7% before any other cost changes are considered.
(Source: Freight Transport Association, March 2008)
Worryingly, some aspects of the international food and grocery industry have become less energy-efficient over time. This has been caused, in part, by:
- More out / more in - The “Green Revolution” of 1940s to 1960s delivered substantial improvements in yields for most crops, but only through increased commitment of energy, water, chemicals and other inputs.
- The need to feed – Continued population growth is likely to result in pressure to achieve still higher yields from the limited agricultural land available and it is reasonable to expect continued intensification of agriculture.
- Shift to more processed products - Consumers in developed markets now enjoy a wide range of “added value” and “convenience” products which invariably involve the input of considerable energy at the manufacturing stage.
- Internationalisation of the supply chain - The importation of exotic or out-of-season products, is now seen as a key activity by retailers in developed markets and this transport implies additional energy consumption.
- Changing supply chain practice – New supply chain disciplines such as “flow-through” and “stockless” management trade off greater fuel consumption against the benefit of reduced capital costs. Where fuel is inexpensive, this is rational, but the rising financial and environmental cost of transport may cause companies to reconsider.
The Consumer Angle
Consumers, like businesses, are exposed to inflation in world energy markets, with increasing wholesale prices translating into higher retail prices for both motor fuel and domestic energy.
Historical periods of rapid energy price inflation, specifically the Oil Crises of the mid and late 1970s, were accompanied by extended periods of high general price inflation and a slowing of economic output in many economies, better known as stagflation. So far, most developed markets have not seen similar effects but rising world prices for energy and food erode the spending power of consumers, lending still greater urgency to competition for both suppliers and retailers.
Costing Carbon
The Kyoto Protocol has created mechanisms for limited trading in carbon emissions and EU nations have been proactive in giving effect to their commitments under the Protocol through the Emissions Trading Scheme (ETS).
The EU has indicated that ETS will remain in place indefinitely, irrespective of wider international agreements, meaning that businesses operating within the EU will be expected to pay for the right to emit greenhouse gases at a price fixed through a market mechanism.
From 2012, the emissions permits available will be reduced, penalties for exceeding the agreed levels will rise sharply and, most importantly all commercial activities will be covered, including grocery.
Certain members of the UK government have indicated a preference for the possible introduction of personal carbon allowances, tradable on a similar basis to commercial allowances, with a suggested target date of 2013.
All of these schemes – international, European and national - share the same conceptual basis, seeking to create a financial incentive for better environmental practice by adding significant cost to the production of greenhouse gases, an activity which was previously free of charge.
This means that, by 2015 at the latest, businesses (and maybe consumers) face the likelihood of paying twice for consuming hydrocarbon fuels: once to buy the fuel and once to burn it.
Possible Responses
IGD has identified a range of approaches which grocery businesses might adopt in response to rising energy prices, divided into two types, business practice and hardware solutions:
- Business practice
- Backhauling
- Eco-driving
- Local sourcing
- Out-of-hours delivery
- Transport collaboration
- Hardware solutions
- Alternative fuel vehicles
- Biofuels
- Changed engine specification
- Hybrid vehicles
- Larger vehicles
- Logistics system optimisation
- Low energy vehicles
- Modal shift
- Rolling equipment upgrades
- Vehicle telematics
- Zero energy buildings
Energy prices are rising with startling speed, creating the need for a rapid and decisive response from grocery businesses. The need to improve performance on sustainability criteria is also extremely pressing.
In view of the very short timescales, it is clear that most grocery businesses must frame an approach based upon existing technologies and existing inventories rather than relying excessively upon new equipment – the standard diesel truck is likely to remain ubiquitous for many years to come.
The Future
It is perhaps surprising that, so far, the grocery supply chain in most developed markets has not changed radically over recent years in terms of overall structure and operational concept.
However, it is clear that this relatively static state cannot be expected to continue indefinitely as energy costs continue to rise, eventually overcoming barriers to change.
In coming to terms with persistently high energy costs, grocery businesses worldwide face a management challenge of daunting proportions, perhaps equivalent to a major natural disaster or even a war. Mitigating the impacts of energy price rises may be a more realistic goal than avoiding them altogether. The future may therefore be characterised by compromise at all levels, from primary production to consumer.
Leading retailers will play a key role in shaping the grocery industry’s response to both rising energy prices and sustainability. The need for a rapid, effective and, above all, widespread response is clear.
The question is: how far can we go, and are consumers ready to follow?
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