On 17 October 1973 the Arab members of OPEC along with Egypt and Syria, triggered by the US involvement in the Yom Kippur War, pulled the plug on oil supplies to the United States and Europe. This was a scenario few had contemplated.
Fuel restrictions emptied the roads.
The embargo ended in March 1974. The price of oil had risen from $3/bbl to nearly $12. By the end of the decade the oil price had reached $30/bbl. The change is shown in a graph of prices compiled by TomTheHand.
The reaction of the oil industry is illustrated in investment decisions in refining. Since World War II demand for oil had grown at a rate of 6%.
6% was hard-coded into company forecasting. For two years after the embargo, companies grew refining capacity at 6% even though demand was had dropped. It took another five to six years for the industry to respond effectively. Losses due to overcapacity ran into billions.
The production of oil tankers was similar. With the closure of the Suez Canal in 1967, tanker rates had rocketed and tanker building boomed. Larger and larger tankers were built to trade around the Cape of Good Hope. After the 1973 crisis it took four years for order-levels to reflect demand.
Freight rates tumbled. Large numbers of tankers were laid up in anchorages around the world.
Not all of the oil companies were caught with their pants down
One company moved swiftly and changed their plans.
By the mid-60s planners at Shell had recognised the failure of forecasting. Everyone was trying to forecast the unpredictable. At Shell they acknowledged this. They embraced uncertainty. But if the future is 100% uncertain, planning is obviously a waste of time. Under the guidance of Pierre Wack, planning teams at Shell set out to separate the predictable from the fundamentally uncertain. They used uncertainties to chart different possible futures. The predictable, what they called ‘predetermined’, elements were described in the context of the story of each possible future. Each story was a ‘Scenario’.
Separating predetermined elements from uncertainties meant analysing causal relationships. Scenario planners examined driving forces.
In the early 70s the team considered the price of oil. They naturally assumed a continued worldwide demand of 6%. They considered Supply. The Middle East loomed large in their reckoning. With massive reserves and free access to drilling, they assumed free access. Predetermined supply. But Pierre Wack challenged the teams to look behind the obvious and technical. In the late 60s, governments in producing countries were asserting their sovereign authority over the companies managing production. Pierre Wack focussed his team on the people controlling the reserves. Those who would decide on production.
The planners at Shell questioned the soundness of a model in which producing governments continued to supply increasing demand with no restraint. Rather, they reasoned, producing countries would tailor supply to their own cash needs. The new scenario became known as the ‘Crisis Scenario’.
The 1973 oil crisis showed how scenario analysis had opened lines of conversation way beyond the possibilities suggested by traditional forecasting. Mental models had been truly stretched.
Forecasting produces answers
but scenario-based planning had made people ask the crucial questions
The benefit of scenario planning to Shell was dramatic. Shell rose from being one of the least of the ‘Seven Sisters’ (or were there eight) to being one of the most powerful.
In “Scenarios – The Art of Strategic Conversation” author Kees van der Heijden describes five key lessons Shell had learnt.
Scenario thinking leads to robust decision making
Scenario planning is very different from ‘‘predict-and-control’’. Scenario thinking is not a mechanism for Go/No-go decisions. Business cases for projects in Shell are designed to deliver positive returns under all of the specified scenarios. All futures are considered equally plausible. No scenario is considered more likely than another. Scenarios are information filters, conversation tools, for making decisions based on the benefits, costs and risks in each project.
Scenario creation stretches mental models which leads to discoveries
The team analyses causal relationships. They separate predetermined factors from uncertainties. As they work with causes and effects, the scenario team can pick up the weak signals of emerging trends.
Scenario conversation enhances corporate perception
People practising scenario-based planning interpret information from the environment differently from others around them. Executives at Shell interpreted persistent signals from the Middle East as an indication of the unfolding of the Crisis Scenario. They therefore changed their refining investment policies well before their competitors.
Scenario based design energises management
In Shell, big, future-related decisions were conceived and executed in projects. No project could be justified on the basis of a single forecast. All projects were evaluated against the defined scenarios. If a business case did not satisfy each scenario, it was rejected. Through this mechanism responsibility for evaluating projects was delegated to lower levels. Project champions engaged with the scenarios, enriching the strategic understanding throughout the organisation.
Scenario setting is a leadership tool
In Shell top management use scenarios to provide leadership. Environment and sustainable development became a big issue in the late 80s. The executive at Shell wanted to get off the back-foot. They created a ‘Sustainable World’ scenario. This impacted some large projects. Unfortunately not everyone in the company engaged. The project to dispose of the Brent Spar buoy was handled badly. There was a run-in with Greenpeace causing boycotts throughout Northern Europe damaging Shell’s profitability and brand. There have been other incidents. In 2013 after a Dutch court ruled that Shell was using discredited and misleading information in blaming the majority of oil spills in the Niger Delta on saboteurs and is liable for the pollution in the Niger Delta.
And here is a sixth learning:
Scenario analysis may highlight unintended consequences
Today Saudi production of oil swings the oil price. At the end of 2014 it seemed the Saudis had held prices high enough for long enough for shale frackers and the solar industry in the US to gain a stable foothold. In November 2014 the Saudis flooded the oil market with crude to drive out these new entrants. One wonders if they had a “Shale Producers Resolve” scenario in their planning filters. The drop in the oil price seems to have triggered further technology improvements and radical cost cutting in the US shale fracking industry. A year later, a cursory review of the state of play shows shale producers under pressure to survive. However some commentators mention that as soon as the price rises, shale oil will be back.