Opinion: Consider Hedging On-Road Fuel Costs
By Tom Wolfe
Director of Strategic Fuel Procurement
Maxum Petroleum
This Opinion piece appears in the July 25 print edition of Transport Topics. Click here to subscribe today.
Perhaps your company already has explored myriad ways to reduce the cost of on-road fuel — improving driver behavior, optimizing routes, truck-stop chain discounts, auxiliary power units, maintaining optimal tire pressures, keeping up on truck/trailer wheel alignments, etc. But have you considered hedging the cost of your on-road fuel?
Right now, you are probably thinking, “I might as well go to Vegas because we tried that before and lost a lot of money. Our company is conservative; we’ve never done it before and have survived so far. And anyway, I don’t understand hedging,” and on and on.
Before you turn this page, I’d like to provide an introduction to hedging and help you understand what hedging is not, what hedging is and why it may be a good tool for your fleet.
First, let’s understand what hedging isn’t: It’s not a way to reduce costs and outperform the market. It’s not implemented to make money, nor is it evaluated as a profit/loss item.
What is hedging, then? It is:
• A process implemented to reduce the effect fuel-price volatility will have on your business.
• A management tool used to control a cost, net revenue and net profit into the future.
• A plan put in place to control a cost over which you otherwise have no control or influence.
• A means of freeing you to manage the costs and events you can influence.
• A technique you can use to gain a competitive advantage.
Many fleet owners and managers assume their fuel surcharges adequately protect them from unpredictable fuel price spikes. With that in mind, let’s consider the reality of fuel surcharges.
Most fleets bill their surcharges based on the U.S. Department of Energy’s national average, which itself is based on the previous week’s fuel prices (see p. 30). If the price of fuel goes up on Wednesday, you can’t change your surcharge until the following Monday, and you are already behind.
Even if all your shippers pay 100% of your fuel surcharge, you can be about 25% short because you are buying gallons of fuel that cannot be billed toward a fuel surcharge — gallons burned on out-of-route miles, empty miles and idling.
Some of you have had customers go from a 5-1 ratio in fuel surcharges to 7-1, so instead of getting 1 cent for every 5-cent increase in diesel, you are getting only 1 cent for every 7-cent increase.
Stated bluntly, volatile intraweekly fuel-price spikes have a negative effect on your business. Your fuel surcharges don’t even come close to returning to you the total effect of a fast increase in fuel costs. And you probably are losing more money on surcharges when prices go up than recouping it when the process goes the other way.
Now, let’s examine the fuel-hedging process and begin by noting the importance of viewing your fuel-procurement process as a financial management issue.
Hedge programs must be used strategically, so begin by forming a brainstorming team. Gather your president, chief financial officer and the others most involved. Then kick-start the session by asking these questions:
• What is the effect of fuel price volatility on our company’s financial position?
• How many gallons of fuel are we buying each month that are not billable toward a fuel surcharge?
• Which of our customers would be interested in removing fuel-price volatility from their transportation costs?
As your team answers these questions, keep in mind that there are two basic methods of hedging fuel: “wet” (physical delivery) and “paper” (purely financial). With wet hedging, you would enter into a contract with a fuel supplier, while with paper hedging, you would enter into a contract with a financial institution.
Here’s how it works: With a wet gallon hedge, you agree to buy a specific gallon amount from your fuel supplier at a specified price during a specified time frame. You will take physical delivery of the product. With a paper hedge, you do not have to take physical delivery of the product.
The finer details of each method — wet or paper — are beyond the scope of this article, but here are three common types of hedge contract:
Fixed firm — A contract that offers a fixed price for a specific quantity of fuel during an agreed-upon time period
Ceiling with a floor — A contract that provides a ceiling that the fuel price will not exceed and a floor that the price will not go below. This also is known as a “collar.”
Ceiling without a floor — A contract that provides a ceiling price yet also allows the client to participate in all downward movements in fuel prices.
Many of you reading this article do not work for a large fleet and may think that only large fleets have the people and resources needed to develop these hedging strategies. Not so. There are hedge programs available for small, medium and large fleets.
Finally, whether you pursue wet gallon or paper hedging, the key is to partner with a company that understands the issues you face and can develop a fuel cost-control plan that’s been tailored to your operations.
Maxum Petroleum, Greenwich, Conn., is a national marketer of petroleum products that also helps customers with fuel procurement.