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Comprehensive Fuel Management: More than Controlling Margins

Companies are seeking creative ways to blunt the impact of volatile fuel costs on fleet budgets. A hedging program can be an invaluable tool to help manage the price of fuel and offset the risk of adverse price movements.

January 2010, Work Truck - Feature

by David Maxsimic

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 fuel 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 index-based 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 on 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 many "retail-minus" and the "cost-plus" 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 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 reroute 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?

Custom Programs Offered

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 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. A comprehensive hedging program can be an invaluable tool to help manage the price of fuel and offset the risk of adverse price movements.

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 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.

Develop Strategies & Plan

Before becoming involved in hedging, a trading strategy and plan must be developed. Strategies vary based on a company's characteristics, but the fundamental principles of a fuel price management plan are universal.

Establish goals. The crucial part of any program is determining short-, medium-, and long-term objectives. Reduced vulnerability to price fluctuations, improved planning, and insured profit margins are all achievable results with a hedging program.

Enlist a professional. When beginning a hedging program, seek the help of the professional trading managers and registered brokers to administer a hedging program and help design an overall strategy. Many fleet card companies also provide this service and can settle transactions on a fleet's monthly billing statement, centralizing all fuel purchasing activity. Wright Express, for example, offers a number of convenient price risk management solutions through a relationship with Pricelock.

Determine the volume. A standard fuel contract volume is 42,000 gallons of fuel or diesel, though some programs such as Wright Express' can offer prices for smaller volume commitments. Initially insuring 50-65 percent of fueling volume is a good benchmark.

Determine the time. Contract prices can be purchased for one month or, in some cases, up to three years depending on the product. To provide ample insurance, experts recommend purchasing contracts with expiration dates six to 12 months in the future.

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