RESEARCH PROJECT: INVENTORY MODEL FOR A FUEL COMPANY

Done by Xavier moyo Applied Mathematics Department

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ABSTRACT

Fuel has and always will be a necessity for most if not all entities of this world. The demand for fuel has always been high and it has maintained its status regardless of the economic challenges that Zimbabwe has been facing. A state owned petroleum company in Zimbabwe that supplies fuel to a number of service stations and organisations around Zimbabwe. The company operates under two Regional offices, that is Harare and Bulawayo, and has been struggling to meet this demand thereby resulting in a lot of shortages.

The EOQ model was used in this project to help in the solution to these shortages. It was discovered that the procurement officer was not keeping track of the stations inventory to make sure he orders in time before the fuel actually runs out. It was also discovered that the company was sometimes ordering more than enough fuel in anticipation of a high demand, thereby losing a lot of money in storage fees and transportation charges. The procurement officer was sometimes ordering too little fuel which was not sufficient to cater for the demand of the product.

From calculations of the EOQ model, results were established to give the procurement manager a guideline of how to manage the companys inventory. The results gave the amount of fuel that is supposed to be ordered each time and the level of fuel that is supposed to trigger a new order (reorder point). A conclusion was made that the model would work for this company and recommendations were made on how to implement the results of the EOQ model.

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ACKNOWLEDGEMENTS Special thanks goes to the National Oil Company of Zimbabwe (NOCZIM) Southern Region Stock Control Manager, Mr. Musunda for allowing me to do a research of the companys product. Special thanks also go to the NOCZIM staff in the Bulawayo office, for providing the information necessary for my project.

I would also like to thank my family members and fellow classmates, David Zimmerman for his help and support during the research process and also for giving me ideas on how to go about in doing my project. Thanks also goes to my lecturer Mr.tino for his tireless efforts in teaching the concepts that were required to be able to come up with my project, his efforts are greatly appreciated.

A last but not least thanks goes to the Lord Almighty for his guidance and protection throughout the course of my study of the project

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Contents
ABSTRACT ........................................................................................................................... 1 ACKNOWLEDGEMENTS ...................................................................................................... 2 1. 2. 3. 4. 5. 6. 7. 8. INTRODUCTION ............................................................................................................ 4 LITERATURE REVIEW .................................................................................................. 5 METHODOLOGY ........................................................................................................... 5 DATA COLLECTION ...................................................................................................... 8 DATA ANALYSIS .......................................................................................................... 9 RESULTS ..................................................................................................................... 14 CONCLUSION .............................................................................................................. 16 RECOMMENDATIONS................................................................................................. 17

APPENDICES ...................................................................................................................... 18 REFERENCES ..................................................................................................................... 20

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1. INTRODUCTION National Oil Company of Zimbabwe (NOCZIM) is a state enterprise responsible for national procurement, storage and distribution of fuels and lubricants.

NOCZIM procures Petrol and Diesel from IPMG in Kuwait, Middle East, and supplies the whole of Zimbabwe. Supplies are divided into two groups: i. Retail these are supplies to service stations like Elangeni Energy, BP, etc, for resale to other motorists. ii. Commercial these are direct sales to organisations like Telone, National Railways of Zimbabwe, Kukura Kurerwa, etc

The NOCZIM Harare office is the companys central distribution centre. All fuel procured from IPMG is stored in the companys depot and then distributed to other depots as per their order. The other depots then supply customers with fuel.

The NOCZIM Bulawayo office is responsible for supplying all customers in the Southern Region. The Southern Region covers Bulawayo, Masvingo, and all cities and towns in Midlands, Matebeleland North and South Provinces. However, NOCZIM does not have a depot of its own in Bulawayo. Therefore, it makes use of BP depot and pays for all fuel stored there belonging to NOCZIM.

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Since most large fuel supplying companies cannot import fuel in their own capacities, they have had to rely on NOCZIMs fuel supply. This has increased the demand for fuel.

From analysis done by the Inventory Manager at the Bulawayo office, it seems one of their major problems is that some of the customers cannot be predicted their buying behaviour. This results in a difficulty to forecast the consumer demand for fuel and hence difficulty in knowing how much and when to order from the Harare office. This caused run-outs occurring time and again. With such a trend, current customers and other prospective customers may be lost.

2. LITERATURE REVIEW

3. METHODOLOGY Many companies in the world have experienced shortages in the products they supply due to poor management of inventories. Other companies have suffered losses due to large unnecessary inventories which are also due to poor management of inventories. The application of operations research techniques in the area of inventory management has helped the business world to gain a competitive edge in the market.

Inventory management involves:

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1. Formulating a mathematical model describing behaviour of the inventory system 2. Seeking an optimal inventory policy with respect to the model. 3. Use a computerised information processing system to maintain a record of the current inventory levels 4. Using this record of current inventory levels, apply the optimal inventory policy to signal when and how much to replenish inventory.

Economic order quantity (EOQ) Model is the level of inventory that minimizes the total inventory holding costs and ordering costs. EOQ determines the point at which the combination of order costs and inventory carrying costs are the least. The result is the most cost effective quantity to order. In purchasing this is known as the order quantity, in manufacturing it is known as the production lot size.The EOQ model is applicable where you have repetitive purchasing or planning of an item, demand for a product is constant over the year and each new order is delivered in full at one time when the inventory reaches zero.

The model to be used in this particular project is called The Economic Order Quantity Model (EOQ). The objectives of this model are to determine: a) How much to order when the level of inventory drops b) When to order to avoid shortages

The EOQ involves a continuous review of the following attributes:

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1. Demand- This is described as the number of units that will need to be withdrawn from inventory for some use ( e.g. Sales) during a specific period 2. Cost of Ordering- this is the cost of ordering a given product, the cost comprises of transportation costs incurred per order. This cost is regarded constant regardless of the order quantity. 3. Holding Cost- this figure represents all the costs associated with the storage of the inventory until it is sold. By virtue that NOCZIM does not own its own depot in Bulawayo it stores its products in BPs depot. Therefore the holding cost is charged by BP. This project will be dwelling on all the attributes of the EOQ model to help the NOCZIM (Bulawayo office) determine how much to order to minimise its inventory costs and to determine the reorder points to avoid shortages. For convenience sake, this project is only going to focus at the NOCZIM Matshobana service station in Bulawayo. 1. Formulas i. Determining how much to order when inventory level drops at the same time minimising the total inventory costs I =annual holding cost rate C = unit cost of inventory item Ch= annual cost of holding one unit in inventory Ch= I C Q= order quantity D= Demand (constant)
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Co= cost of placing one order (constant) Annual Holding Cost= QCh Annual Ordering Cost= (D/Q) Co Total cost= QCh + (D/Q) Co

Q*= Amount to order to minimize costs Q*= 2DCo/Ch

ii.

Determining reorder points to avoid shortages

r = reorder point d= daily demand m= lead time (Time between inception of order and delivery) r=dm

4. DATA COLLECTION 1. Choice of data to be collected The main problem here is to determine the demand for fuel and the amount of inventory required at the depots tanks in order to meet the established demand. Therefore the following data is to be collected: a) Daily fuel redemption at the station for the month of December and January
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2. How to collect data a) Fuel reconciliation is done each day to show the amount of litres available, sold and lost. Then a monthly report is done (see Appendix 1 and 2) b) A fuel requisition form is filled by customer when ordering c) A loading instruction form is filled by NOCZIM Bulawayo office going to depot to instruct supply of fuel.

5. DATA ANALYSIS

PETROL US$ Cost 1.18 Cost

DIESEL US$ 1.05

Transport Transport Cost Total 0.03 Cost 1.21 Total Ordering Ordering Cost Fig1.1 1.21 Cost 1.08 0.03 1.08

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Monthly demand of Petrol

300000 259209

250000
192423 200000 December January 100000

150000

50000

0 Petrol

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Monthly Demand of Diesel

370000 360000 350000 340000 330000 320000 310000 300000 290000 280000 308383 December January 358146

Diesel

Total demand for fuel in the two months

700000 600000 666529

500000
400000

451632

Petrol 300000 Diesel

200000
100000 0 December & January

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The total demand in the two months is 451632 litres of petrol and 666529 litres of diesel. Calculations Average Daily Demand: Petrol: 451632 62 = 7284.387 Diesel: 666529 62 = 10750.47

To the nearest litre this gives us an average daily demand of 7284 litres for petrol and 10750 litres of diesel.

Annual Demand: Petrol: Diesel:

7284 365 = 2658801

10750 365 = 3923921

(NB: 365 days is used for the service station because it is open every day of the year including holidays.) Weekly Demand: Petrol: 7284 7 = 50988 Amount of fuel to order: The objective of this section is to obtain the amount of litres that need to be ordered when the level of fuel drops, at the same time minimizing the total annual costs incurred by the company. The following equation is to be used: Q*= 2DCo/Ch
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Diesel: 10750 7 = 75250

From Fig 1.1 the ordering costs are calculated as: LCo = 0.03 Since BP Depot charges NOCZIM for storage cost, the holding cost is calculated as: Ch = 0.02 Petrol: Q* = (2DCo)/Ch = (226588011.21)/0.02 = 321714921 = 17936.41327021654 17936 litres

Diesel: Q* = (239239211.08)/0.02 =423783468 = 20586.00174876122 20586 litres

Re-order point:

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The lead time to order from NOCZIM Harare office is 3 days i.e. 1 day to sort out order papers and 2 day for the truck to travel from Msasa (Harare) to Bulawayo: Petrol: r = dm = 2658801 3 = 7976403 litres

Diesel: r = dm = 3923921 3 = 11771763 litres

6. RESULTS From the calculations done above, the results can be shown in the following table: Service Station Entity Q* R Petrol 17936 litres 7976403 litres Diesel 20586 litres 11771763 litres

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Q.*- This is the minimum order quantity, meaning that this is the amount of fuel in litres that the procurement officer needs to order each time an order for more fuel is made in order to minimize costs incurred by the company.

r - This is the reorder point, meaning that each time the level of fuel gets to this point in the tanks, the station manager is supposed to inform the procurement officer to start ordering more fuel.

With the results obtained we can see that NOCZIM had a problem of sometimes ordering too much fuel and sometimes ordering too little fuel. The procurement officer was not also taking note of when to order fuel thus resulting in ordering fuel before it is needed.

Sometimes fuel was ordered late and thus resulting in fuel shortages as one customer could come and purchase all fuel that was left. Thus the company will end up having a shortage.

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7. CONCLUSION

The conclusion thereby stands to say that National Oil Company of Zimbabwe was using a poor inventory management system resulting in large financial losses. The procurement manager should therefore use the results in the previous chapter to make decisions on how much to order and when to order more fuel.

This model will ensure that the stations never get dry, meaning there will always be fuel at all times for clients who want to purchase fuel. This will increase the companys efficiency resulting in increased customer faith and a greater competitive edge.

Ordering fuel before it is needed may result in failure to access storage thus resulting in an added cost of demurrage due to not offloading the product. Thus this model will also reduce the companys incurred costs and thus increasing the companys profit which is one of the major aims of any company.

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8. RECOMMENDATIONS

The procurement officer needs to continuously monitor the demand for fuel because although this model is for a constant demand, it is recommended that any changes in the demand be catered for in order to avoid further losses. The demand is likely to increase because of the increased customer faith resulting from better efficiency of the company, so the model will have to be recalculated using the new figures.

The station managers will need to be vigilant in keeping up to date with their balances of fuel to make sure they do not order before fuel is needed as it may resulting in demurrage costs. Keeping up to date with their balances of fuel will also ensure that they do not order after there is no more fuel. They should The procurement officer will also need to be ready at all times to order more fuel so as to minimise any delays in delivery which may cause run outs at the stations because the lead time will have been tempered with.

National Oil Company of Zimbabwe can also invest in a fuel management system that will manage the inventory of all the service stations in the Southern Region. The system will use swipe cards and will automatically tell the station attendant how much fuel is left in the tanks after each redemption. This will help the station managers to keep track of how much fuel is left and be able to keep track of the reorder point.

A manual with the results of this project must then be drafted and released in the procurement department and the stations so that even when new employees
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are contracted by the company, they will know how to manage the inventory to avoid losses.

APPENDICES

Appendix 1: Daily fuel Reconciliation for the month of December

Date 1/1/2010 1/2/2010 1/3/2010 1/4/2010 1/5/2010 1/6/2010 1/7/2010 1/8/2010 1/9/2010 1/10/2010 1/11/2010 1/12/2010 1/13/2010 1/14/2010 1/15/2010 1/16/2010 1/17/2010 1/18/2010 1/19/2010 1/20/2010 1/21/2010 1/22/2010 1/23/2010 1/24/2010 1/25/2010 1/26/2010 1/27/2010 1/28/2010 1/29/2010 1/30/2010 1/31/2010 TOTAL Opening Stock Received Redeemed Balance PETROL DIESEL PETROL DIESEL PETROL DIESEL PETROL DIESEL 1743 36175 28608 0 7995 3865 21890 32310 21890 32310 29077 0 17259 9066 33700 23244 33700 23244 14950 29434 7290 3103 40991 49800 40991 49800 14420 0 13549 5567 42224 44200 42224 44200 0 0 10962 4804 31458 34400 31458 34400 28742 0 11378 17066 49066 20287 49066 20287 0 0 6810 9785 42266 12724 42266 12724 0 59241 6161 26527 36325 47725 36325 47725 0 0 7059 5274 29276 39590 29276 39590 0 0 3533 8272 25943 31456 25943 31456 0 0 6737 11767 19276 19615 19276 19615 0 0 8146 4216 11343 15395 11343 15395 0 29525 4809 27066 6593 17875 6593 17875 29027 29491 4815 10078 30683 37460 30683 37460 0 0 5073 11669 25295 25676 25295 25676 0 0 4900 6106 20261 19610 20261 19610 0 29900 3139 3640 16743 44912 16743 44912 28601 0 3612 8577 42460 36575 42460 36575 0 0 3407 20418 39325 15991 39325 15991 0 29775 4279 14658 34968 31125 34968 31125 0 0 3266 10415 31785 20925 31785 20925 0 29975 4577 8486 27793 41466 27793 41466 0 0 4667 4290 23293 37316 23293 37316 0 0 3195 4348 20226 32966 20226 32966 0 0 5833 6905 14393 25500 14393 25500 0 0 13770 4146 943 20150 943 20150 28950 0 2700 5705 24287 15450 24287 15450 0 35688 2733 20231 24287 28526 24287 28526 0 29754 3664 17735 20653 40473 20653 40473 0 0 3948 7412 16774 33023 16774 33023 0 0 3157 7186 13737 25965 202375 302783 192423 308383

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Appendix 2: Daily fuel Reconciliation for the month of January

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Date

Opening Stock PETROL DIESEL 36175 32310 23244 49800 44200 34400 20287 12724 47725 39590 31456 19615 15395 17875 37460 25676 19610 44912 36575 15991 31125 20925 41466 37316 32966 25500 20150 15450 28526 40473 33023

Received PETROL 28608 29077 14950 14420 0 28742 0 0 0 0 0 0 0 29027 0 0 0 28601 0 0 0 0 0 0 0 0 28950 0 0 0 0 202375 DIESEL 0 0 29434 0 0 0 0 59241 0 0 0 0 29525 29491 0 0 29900 0 0 29775 0 29975 0 0 0 0 0 35688 29754 0 0 302783

Redeemed PETROL 7995 17259 7290 13549 10962 11378 6810 6161 7059 3533 6737 8146 4809 4815 5073 4900 3139 3612 3407 4279 3266 4577 4667 3195 5833 13770 2700 2733 3664 3948 3157 192423 DIESEL 3865 9066 3103 5567 4804 17066 9785 26527 5274 8272 11767 4216 27066 10078 11669 6106 3640 8577 20418 14658 10415 8486 4290 4348 6905 4146 5705 20231 17735 7412 7186 308383

Balance PETROL 21890 33700 40991 42224 31458 49066 42266 36325 29276 25943 19276 11343 6593 30683 25295 20261 16743 42460 39325 34968 31785 27793 23293 20226 14393 943 24287 24287 20653 16774 13737 DIESEL 32310 23244 49800 44200 34400 20287 12724 47725 39590 31456 19615 15395 17875 37460 25676 19610 44912 36575 15991 31125 20925 41466 37316 32966 25500 20150 15450 28526 40473 33023 25965

1/1/2010 1/2/2010 1/3/2010 1/4/2010 1/5/2010 1/6/2010 1/7/2010 1/8/2010 1/9/2010 1/10/2010 1/11/2010 1/12/2010 1/13/2010 1/14/2010 1/15/2010 1/16/2010 1/17/2010 1/18/2010 1/19/2010 1/20/2010 1/21/2010 1/22/2010 1/23/2010 1/24/2010 1/25/2010 1/26/2010 1/27/2010 1/28/2010 1/29/2010 1/30/2010 1/31/2010 TOTAL

1743 21890 33700 40991 42224 31458 49066 42266 36325 29276 25943 19276 11343 6593 30683 25295 20261 16743 42460 39325 34968 31785 27793 23293 20226 14393 943 24287 24287 20653 16774

REFERENCES

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