In 2006, the U.S. saw record retail fuel prices (non-inflation adjusted). There are those who believed the 2006 record retail fuel prices (non-inflation adjusted) were an anomaly. The principle was that the natural disasters and political instability of the Middle East, along with a variety of other factors, caused a high degree of abnormal commercial volatility that would eventually smooth out.
However, as 2007 draws to a close, that principle may be disproved. Historical gasoline prices (see Chart on page 32) as reported by the Energy Information Administration for June 2007 show an increase of 3.9 percent from a year ago and more than 100 percent from four years ago. Continuing geopolitical uncertainty, extended and unanticipated refinery outages, and increases in global consumption have kept retail prices soaring at record levels for most of the year.
Businesses in which fuel or other petroleum-based products are a significant portion of the cost structure are looking for ways to reduce the effect these high prices are having on the bottom line. Fuel costs and volatility have caused business to search for creative solutions to help ease the impact. In addition to price risk management programs, other strategies in a comprehensive fuel management program include bulk fuel purchases and overall fuel efficiency efforts.
Historically, negotiating hybrid pricing programs with strategic fuel merchants and fleet card companies has been the most pragmatic way to offset the cost of a retail fuel purchase. In the past, discounts measured in cents-per-gallon “retail-minus” or “rebates” measured as a percentage off the posted retail price have been offered by merchants to help drive fleets to their locations. However, as oil prices rise, distributor retail fuel margins tend to shrink. The rise in cost of wholesale fuel coupled with increases in short-term interest rates has considerably escalated the overall carrying cost of the product. Translation: fewer discounts passed on to the customer.
Some fleets have engaged in indexbased pricing programs commonly referred to as “cost-plus” pricing. This type of pricing program involves an agreement between a fleet and a merchant or other third party that offers the fleet the opportunity to pay a price based upon an index. Instead of paying the posted street price at a network of retail locations, the price is based upon a published index price plus taxes, freight, and a fixed margin. The theory behind this practice is the fleet pays less-than-retail price for fuel by negotiating a fixed margin in areas where the contract margin is below the historical average.
Creating a network of hybrid pricing locations can be part of an overall fuel management strategy, but it’s only one small component. It is important to note that many “retail-minus” and the “costplus” costs associated with them are not necessarily transparent. Merchant-funded discounts are time-consuming to negotiate and expensive to audit. In the case of a cost-plus program, the fleet may be required to pay for a subscription to the wholesale fuel index to insure it is charged the contracted price. Additionally, if retail margins in an area are invert, the fleet could end up paying more for fuel than the posted street price.
Both solutions can require a great deal of analysis to identify, negotiate, and re-route drivers to discount fueling sites strategically located along a route. The diversion costs alone can far exceed the fuel savings. So if you are willing to spend this amount of time, money, and effort to control margins why not directly manage the fuel price?
Price Risk Management
Price risk management does not have to be difficult. The financial markets offer a broad spectrum of products that can be tailored to suit specific needs whether basic or complex in nature.
Financial institutions have, for some time, offered risk management to support fleet pricing programs. Financial hedging should not be viewed as betting, investing, or a way to guarantee savings. Hedges should be embraced as a chance to avoid some volatility in your business costs. Margin management is a way to contain the distributor’s spread. Price management addresses the larger issue of market risk; think of it as a way to add certainty where currently there is none.
A comprehensive hedging program can be an invaluable tool to help manage the price of fuel and offset the risk of adverse price movements. In addition to price stability, a well-managed program can aid in securing corporate objectives and profit margins through improved management planning.
Include Fuel Conservation
Fuel conservation can be easily incorporated into any fuel management program, since fuel economy efforts are based more on common sense than scientific theory and complicated formulas. Following regular preventive maintenance schedules, maintaining proper tire pressure, and reducing idle times, vehicle weights, and speeds help provide increased mpg and lower overall maintenance costs.
A number of telematic companies provide hardware and software solutions that supply real-time data capture of vehicle diagnostics and driver speed to help ensure policy compliance and maintenance scheduling. Often, these solutions can be directly integrated into a fuel card or fleet management company’s online application to provide a central location for administering your program.