Fuel Price Protection: Friend or Foe?Dispelling the Misconceptions of Fuel Price Protection

automotive fleet & leasing association white paper series ∙ volume 23

In 2009, gas prices moved 67%.1 And experts believe that 2010 fuel prices will continue to be volatile based on growing emerging market demand, inflationary concerns and wildcard factors such as natural disasters and geopolitical events.

When asked recently to name the greatest risk in 2010, South-west Airlines Chairman and Chief Executive, Gary Kelly replied, “That’s easy. It’s energy prices.”2 We found similar sentiments in the 2010 Pricelock Fuel Pricing Survey3 with 91% of respon-dents—executives, fleet managers, directors and other industry professionals associated with small, mid-size and large fleets across a broad range of industries—anticipating that fuel prices will rise. Of these, an overwhelming 96% expressed their concern about fuel price’s impact on their business.

If you operate a fleet, fuel is your largest variable cost and large fuel price swings can hurt your business. Better upfront risk plan-ning using a fuel price protection plan can help you protect your business from fuel price increases, eliminate fuel budget variabil-ity and create a competitive advantage.

Fuel 31%

Depreciation 48%

13%

8%

Maintenance & Repair

License, Interest, Rental, Other

FUEL IS THE #1 VARIABLE COST FOR FLEETSMercury Associates 2009

Given the strategic importance of managing your fuel costs, it’s surprising that more companies have not implemented a fuel price protection plan. The 2010 Pricelock Fuel Pricing Survey discovered that only 38% of respondents who considered fuel price protection have actually implemented a plan, despite the fact that nearly 90 percent of those with price protection plans in place are happy with them.

The Survey found that respondents have chosen not to price pro-tect their fuel for the following reasons:

While these assumptions may have been true, the fuel price pro-tection market has evolved in recent years. We will explore each of these assumptions and outline the facts so that you can make a fully informed decision on whether fuel price protection is right for your business.

Misconception #1: We think it’s too riskyThe Facts: Fuel price protection can be risky if not planned and executed appropriately. We hear of companies in the news who hedged and “lost.” These were companies who locked in long-term fuel prices in the futures market or pre-purchased large quantities of fuel at a fixed price and lost money when fuel prices fell.

Fortunately, there are fuel price protection programs that are not risky. These programs do not require you to pre-purchase large volumes of fuel and enable you to “cap” not “lock in” your pro-tection price. These programs typically pay you when fuel prices rise higher than your set protection price. And when fuel prices fall below your protection price, you still get to benefit from lower fuel prices at the pump with no additional fees on your part.

Remember, doing nothing is even riskier when fuel comprises a major component of your expenses. By not properly manag-ing your fuel budget upfront, you are exposing your business to

Fuel Price Protection: Friend or Foe? by Pricelock

overview

Why has your company not implemented a hedging/fuel price protection program?

We think it’s risky 22.8%We think our fuel consumption is too small 21.4%We lack the expertise 16.7%We think it’s expensive and not worth the price of protection 13.3%We think it’s complicated 7.0%

Source: 2010 Pricelock Fuel Pricing Survey

significant risk—particularly in light of dramatic price swings in recent years.

80%

70%

60%

50%

40%

30%

20%

10%

0%

Per

cent

age

Incr

ease

Regular Gas

2001 2002 2003 2004 2005 2006 2007 2008 2009

Increase from January 1 to Year’s High Point

32%

71%

35%36% 37%

67%

30%

20%21%

REGULAR GAS

Misconception #2: We think our fuel consumption is too smallThe Facts: Traditional fuel price protection vendors typically worked with large companies who could purchase fuel contracts of 1,000 barrels (with each barrel comprising 42 gallons). Fuel price protection can now be bought online by aggregat-ing demand from the masses to provide fuel price protection to businesses of all sizes. This means that small and mid-sized businesses can now protect themselves from rising fuel prices, similar to how large companies like Southwest Airlines have been benefitting from fuel price protection for years.

Misconception #3: We lack the expertise and think it’s complicatedThe Facts: Fuel price protection is confusing and complicated and requires substantial knowledge of the commodities market, prod-ucts and trading practices. Traditional vendors do not provide consultative services and expect clients to design their own fuel price protection strategy. They focus solely on placing trades.

There are companies who have simplified fuel price protection by pre-packaging protection solutions into easy-to-understand programs online. Many of these companies provide online tools, pricing calculators and access to experts to help you choose the protection plan that best meets your needs. Think of it simply as buying an insurance plan where you pay an upfront premium to protect your business from fuel price increases for a defined period of time.

If a simple turnkey solution is too basic to meet your unique needs or if you require extra handholding, some of these same companies will help you design and execute a custom, end-to-end program that meets your business needs and budget objectives. Some will even provide ongoing performance management to track your program’s effectiveness and support special require-ments such as FAS 133 hedge accounting treatment.

How fuel price protection brings fuel price predictability and peace of mind to businesses

A small, family-owned laundry facilities management company price protects its gas and diesel costs and ensures earnings stabilization with fuel price protec-tion. “I wanted security and a little stability in this crazy world. [Fuel price protection] has given me complete peace of mind.”- Scott Scarpato President, Automatic Laundry

Large landscaping business with annual fuel usage of nearly 5 million gallons struggled with impact of fuel prices on its budget for years. With fuel price protection, the company’s protection program suc-cessfully shielded them from fuel price increases and resulted in significant fuel savings of $0.47/gallon.

Misconception #4: We think it’s expensiveThe Facts: Fuel price protection can be purchased for as low as 5% of your fuel spend. Considering that fuel prices have moved 67% in the past year alone, fuel price protection provides a cost-effective way to protect your bottom line.

Further, there are multiple ways to modify your protection plan to meet your budget requirements. You can reduce your protec-tion plan fee by increasing your protection price, shortening your protection period or reducing the volume of fuel protected.

Let’s assume that you want to keep your fuel price protection costs as low as possible. Instead of selecting a protection price close to market price, set it at the highest fuel price that your company could withstand without harming your business so that you are protected when you need it most. Or, let’s assume you have a landscaping company and do most of your business in the summer when fuel prices tend to be higher. Instead of implementing a protection plan for the entire year, you can significantly reduce your protection plan fee by protecting just the summer months.

conclusionFuel prices matter. To remain competitive in today’s market, you need to protect your business against fuel price volatility and unplanned financial exposure.

Historically, a vast majority of companies were shut out of the fuel price protection market because they did not have large fuel budgets or the necessary in-house expertise to decipher and navigate the fuel commodities market. There are new fuel price

protection programs to meet the needs of this underserved market so don’t let mis-conceptions on fuel price protection prevent you from exploring your options.

As more and more companies strive to protect their fuel budget upfront, fuel price protection will become a strategic fleet management best practice. It is imperative that companies with fleets seriously con-

sider implementing a fuel price protection plan and view it as a permanent fixed expense—similar to an insurance policy—that protects them from their biggest variable expense.

“But by making a relatively small investment in hedging up front as an insurance policy, companies can protect themselves from potential disaster.” -BCG4

Sources

1) US Dept of Energy national average retail gas prices.

2) “Southwest Airlines Hedges Its Bets,” Wall Street Journal, January 22, 2010.

3) 2010 Pricelock Fuel Pricing Survey. Approximately 525 individuals completed the survey, reflecting a ±4.2% margin of error at a 95% confidence level. To view the survey results, visit www.pricelock.com.

4) “A Key to Smart Outsourcing: Hedging Against Risk,” The Boston Consulting Group, 2007.