Over the past several years, carriers have made a valid case for issuing fuel surcharges: Carriers must be compensated for rising fuel prices if they expect to remain in business.
Today, most carriers – and shippers – accept this basic fact of life. With the exception of the chronic rate-cutting carrier, there probably isn’t a credible trucking operation out there today that doesn’t issue a fuel surcharge.
However, over time, fuel surcharges may not be our industry’s best solution for addressing fuel price volatility.
The current era of fuel surcharges
Our current wave of fuel surcharges has been with us for a while: since the spring of 1999 in fact. To address what was assumed to be a “temporary” problem, some carriers began to issue a “temporary” fuel surcharge.
Soon, more carriers were forced to face the black and white reality of running in the red and, as a result, decided that they too had to pass rising fuel costs on to their customers in order to stay in business.
Well, almost seven years have passed since this most recent round of “temporary” fuel surcharges was first issued.
And as each year has brought ever-higher fuel costs, those temporary fuel surcharges have now become a standard – and substantial – part of most carriers’ invoices.
This by itself is not the problem. The problem is that fuel surcharges don’t actually eliminate fuel price volatility for carriers and their customers.
The current solution cannot continue indefinitely
Many carriers now feel we’re nearing a point where this model of ever-increasing fuel surcharges cannot continue. Shippers must manage their quarterly budgets just as carriers must. As a result, many shippers are beginning to look harder for cost stability wherever it can be found. And the variable fuel surcharge is fast becoming an attractive place for shippers to look.
Some carriers might be tempted to lower, or at least stabilize, their fuel surcharges under pressure from shippers.
However, that simply won’t solve the problem. By not recouping increasing costs, carriers would simply find themselves right back where they started – exposing their business to fuel price volatility.
A better way is needed
We all know the trucking industry has fundamentally changed when we now find ourselves tracking Middle East geopolitics and U.S. Gulf Coast weather patterns as a normal part of running a trucking company.
Fuel price volatility is getting wilder with each passing year. A better solution to volatile fuel costs is needed.
And that solution may be a financial tool called fuel hedging.
Fuel hedging is a financial tool that’s been used successfully for decades by the airline, rail, shipping and agricultural industries. One particular type of hedging solution – known as a call option – seems to be particularly effective for these industries and may be effective for trucking too.
A call option caps fuel prices over a set period of time – say, six months or a year.
When fuel prices exceed that cap, a reimbursement is issued for the difference. A call option therefore has the effect of stabilizing rising fuel costs over a set period of time. It’s important to acknowledge here that, for carriers, a call option is not designed to be an investment, since call options are designed simply to reimburse your operation – dollar for dollar – when fuel costs rise.
What happens when fuel prices fall?
Hedging fuel costs with a call option does not require you to pay a set price for fuel and thus lock yourself out of benefiting from falling fuel prices at the pump. Yes, you have paid a price protection fee to hedge against rising fuel prices.
But just like other efficiencies and protections you take to benefit your operation, the costs of a call option should be seen – and managed – as an operating expense.
And at a cost of less than four cents per mile – versus fuel surcharges that have risen by more than 20 cents per mile in 2005 for some carriers – that’s a lot of protection for a modest price.
Of course, hedging fuel costs wouldn’t be necessary if you knew for certain that fuel prices will remain constant or will consistently drop over the next year.
However, given every factor that influences the price of fuel in North America and around the world, you need to ask yourself whether flat or falling fuel prices are a likely scenario – and, if not, whether you are managing fuel price volatility for your company and customers.
– Jim Burr is vice-president of FCStone Trading LLC, a leading US-based commodity risk management and trading company. Jim will be a featured speaker of Let’s Talk about Managing Fuel Price Volatility, a presentation series sponsored by Transportation Media Research in partnership with Markel Insurance. For more information or to book your attendance, please visit: www.markel.ca/letstalk.