The dramatic fall in the price of crude oil over the past year has caused widespread distress across the oil and gas industry, affecting operators, service providers and suppliers. Oil companies around the globe have been forced to slash investment by reducing capital expenditure and exploration spending whilst simultaneously implementing a raft of cost cutting measures.

The adverse impact of oil price falls so immediately felt by the upstream producers has led to supply chain vulnerability with press reports indicating that large companies have been calling on suppliers to demand rate cuts of up to 20%, longer payment terms and, in some cases, postponement of payment. The pressure exerted has been reflected in recent job loss announcements and, in certain cases, corporate failure.

For the mining industry, the drop in crude oil prices has proved beneficial for those companies with significant fuel and freight expenditure as the reductions have been passed on and it has become cheaper to operate mines and equipment. However, mining companies already afflicted by instability in commodity prices generally should heed the salutary warning provided by what is now occurring in the oil and gas sector.

There can be any number of causes for business interruption: natural disaster, adverse weather, and product quality incidents amongst others, however, “supplier financial failure” was cited as the most commonly occurring risk by a report commissioned by Zurich in 2012 and the insolvency or financial distress of key suppliers continues to be a significant risk for businesses the world over.

The financial failure of key suppliers can significantly disrupt the smooth operation of normal business procedure. This can prejudice the timing and the budget for product delivery, impact on customer service, cause loss of revenue and reputational damage, and increase operating costs.

Following a worldwide survey of over 500 risk managers and corporate insurance experts, a report published by Allianz in January 2015 ranked business interruption and supply chain risk as the top danger currently faced by companies for the third year in a row. The same risks, however, barely registered when the same survey is addressed to senior corporate management teams, with supply chain risk ranked second only to cyber risk in a list of risks for which businesses are least prepared.

The integrity of the supply chain is of critical importance to businesses operating in the mining sector. Underestimating the risk of business interruption caused by the insolvency of crucial suppliers can come at a substantial cost. Failing to deliver against contractual requirements or customer orders can trigger significant damages claims that can dwarf the overall value of the relevant supplier contract. For a principal contractor this can mean material financial and reputational loss and can lead to additional irrecoverable cost and management time being required in order to mitigate the situation.

As a major acquirer of products or services, a principal contractor can exert significant commercial leverage over key suppliers, thus securing clarity on the financial integrity of the supply chain, the attitude of secured lenders and the potential trading dynamic for that supply chain member over the course of a contract. Contingency planning may include the negotiation of rights of access to suppliers’ books and records, building up an adequate amount of consignment stock to provide a cushion of time in the event a supplier were to go out of business and consideration of termination options, third party retention of title issues, loss mitigation and potential counterclaims. 

By recognising the importance of preserving supply chain integrity throughout the life of the contract, taking a proactive and robust approach to key suppliers from the outset and reacting quickly when supplier financial distress becomes evident, there is scope for businesses to significantly mitigate the risk and effect of supplier insolvency and reduce overall business and insurance costs.