That’s How We Roll

by Passenger Service: State troopers ride-along with truckers in crash study

It used to be, not so long ago, that a single-day $2 swing of a barrel of oil would be front-page news. Now, as En-Pro senior analyst Roger McKnight quips semi-sarcastically, "it gets put somewhere at the bottom of the comics pages."

It’s amazing what you get used to, eh?

It might still leave a bitter aftertaste, but the near-daily price convulsions in the on-road fuel market — like rusted brake shoes or EPA-mandated engine overhauls — is just another one of those cost-of-doing-business things you’ve learned to swallow.

The fuel forecasting game has drastically changed. Five years ago energy analysts could still give a decent projection based on the "fundamental factors" of inventory levels, refinery runs, consumer demand, and to a certain extent, geopolitical issues.

Today, it seems there aren’t any rules — or at least, there’s less emphasis on the traditional ones — as currency values and speculators cherry-picking commodities markets (not to mention the economic rumor mill) all play significant roles.

"It used to be that the price of crude was a function of how happy or sad the stock market was," explains McKnight, whose Oshawa, Ont.-based firm is one the premier energy market consulting companies in Canada. "That has since switched to the strength or weakness of the U.S. dollar versus the Euro and commodity-based currencies like the loonie." 

Lower fuel prices as of late chased fuel buyers
away from hedging and into the spot market
sandbox. But that will soon change once again.

The lower US dollar is considered by stock market speculators as inflationary. "So," continues McKnight, "to protect their portfolios they invest in commodities such as crude oil and gold, thereby driving up prices. The reverse happens when the U.S. dollar shows strength as this lowers crude prices and investment then goes back to equities."

Complicating matters further is that spikes or dips in the greenback are also being triggered by the "faintest rumors" dealing with the U.S. economy, however obscure the source may be. 

As fuel prices became extremely volatile this decade, companies have looked for new fuel purchasing strategies that mitigate pricing turbulence and keep cash flow steady. Hedging or buying fuel contracts, while still not as popular in trucking as it is in other equipment-intensive industries (in part because truckers are leveraged somewhat by fuel surcharges), is slowly gaining traction among roadway carriers, albeit mostly larger, big-bulk buying fleets.

Contrary to what some people think, hedging isn’t a negotiation between carriers and their fuel supplier for a fixed supply price. Like the name suggests, "hedging" is like insuring your fuel costs. A carrier buys or "locks in" to a certain amount of contracts or "futures" on the commodities market for delivery at a "future" date, except there is no actual delivery. The inventory is only on paper and whatever gains or losses you take based on market prices is the difference you can apply when actually buying fuel on the spot market.

Enno Jacobson, vice president of risk management for Challenger Motor Freight, says his company hedges between 25 and 30 percent of its fuel purchases. For him, hedging is a no-brainer in this twitchy energy environment.

"If you’re a trucking company, you have to look at hedging as insurance," he says. "You can look at it purely on a speculative basis to make money, but that’s not the game we’re in. We’re basically trying to protect our margins. At the end of the day, it’s a risk management tool."

But isn’t hedging itself risky as those folks who locked into distillate futures last fall found out after diesel prices plummeted over the next 10 months?

True enough, says Aaron Fennell of MF Global Canada, but even moreso is the decision not to hedge. "It used to be that hedging wasn’t necessary because prices didn’t move that fast. That’s not the case anymore," he says. "Basically, not hedging is just as much a speculation. Because if the price goes up, you’re stuck just the same. Saying ‘we could lose if we do this’ isn’t really a valid argument because not doing it often costs you more money."

Lower fuel prices since the latter half of 2008 have chased fuel buyers away from hedging and into the spot market sandbox. But the price of crude is shooting up again, enticing hedgers to ask themselves if it’s time to get back in the game. So, is it?

Absolutely, says Bob Tebutt, an investing and hedging specialist with Peregrine Financial Group. 

"Demand is [on the rise]; we’ve got prices to where they were in 2006-2007, and the economy’s starting to come back. So why wouldn’t [you] be a fuel buyer?" he asks rhetorically. "Once supply and demand are balanced … you start showing price increases, and that’s what we’re seeing now."

But hold on. Fennell says the time to hedge once again is fast approaching, but admits that there’s still plenty of room for diesel prices to retreat between now and the fall. 

He says that the lack of economic freight and manufacturing activity is mainly to blame for middle distillate inventories being absurdly high for this time of year. Usually, spring and summer is a seasonal low point as the market recovers from winter’s high home heating demand. Worse, that inventory is expected to rise even further throughout the summer driving season (since each barrel of oil produces both gas and diesel).

As Roger McKnight elaborates: "If the refineries keep ramping up for the gasoline season, a necessary evil in their mind is also the production of distillates. So, those inventories are going to keep growing. That means huge inventory with flattish demand at best."

That bodes bullish for truckers looking for cheaper diesel over the next couple of months. "As we come out of the recession, we’ll also come out with a lot of fuel in the marketplace that needs to get burned," says Fennell, who warns, though, that the window won’t be open long. "Once the economy shows some real signs of life, you won’t have a lot of time to lock into the most desired price. Early fall, I would say, is when we’ll be in a really good position to set up hedges."

Challenger’s Jacobson doesn’t think hedging should be particularly limited to only big fleets. One thing’s for sure, though, hedging isn’t like buying RRSPs. You need to do your homework — constantly — no matter what size your company is.

"You can be small and hedge, but you need to really understand the market, the seasonality of the market, inventory levels and even geopolitics and things like that," says Jacobson. "There is no slam dunk, of course — if there was, guess where I’d be — but staying vigilant is essential."

Who said, again, that trucking is just about hauling from point A to point B?

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