NAFA Webinar on Fuel Hedging provides some effective options amid volatile energy market conditions.
Over the last 24 months, the world has found itself dealing with a level of unpredictability not seen for a very long time. The onset of the COVID-19 pandemic has disrupted virtually every sector of the global economy, resulting in government instigated lockdowns, supply chain disruptions, and product and resource shortages.
One area that’s been particularly volatile, is the petroleum sector. The price and demand for oil and related products have fluctuated wildly over the last two years, leaving many businesses vulnerable to price shocks, impacting their operating costs and bottom line.
For many vehicle fleets, fuel costs represent some of the biggest expenses in their operating budgets. In some cases, should fuel prices rise, there is often pressure for increased costs to be passed on up the supply chain, leading to higher prices for items that are shipped by air, sea, rail, and road transport including food, clothing, and other consumer items.
On the flip side, many municipal and government fleets with vehicles aren’t often able to pass on higher fuel costs to passengers or customers at least not until fares or budgets are recalculated or taxes increased to pay for these services.
As a result, fuel hedging can present an attractive option for fleets during times of extreme price volatility. To provide an understanding of the benefits and potential drawbacks, NAFA Western Canada Chapter hosted a webinar entitled Fuel Hedging: Fixed Price Fuel. Hosted by Conchur Brennan, General Manager at Portland Fuel (Canada), the webinar outlined some of the global activity in the oil market since the onset of COVID-19 as well as taking a look at some of the strategies fleets can consider when it comes to hedging and fixing the price of their fuel costs.
Decline and rise
Starting off, the onset of the COVID-19 pandemic and the resulting lockdowns instigated by Governments across the world, caused fuel prices to tumble after a relatively stable period in 2019 and early 2020. Yet by the beginning of summer 2020, oil markets were rising again and since then, as Brennan noted, have, despite volatile swings, continued to rise, leading to almost record high prices for fuel today.
A big influence on global oil prices is the Organization of Petroleum Exporting Countries (OPEC) and their decisions on production targets, based on global supply and demand. When demand drops, OPEC tends to cut supply, causing prices to rise.
Additionally, other factors, such as geopolitical tensions in areas such as the Middle East can also impact fuel demand, supply, and pricing, especially given that some of the world’s largest oil-producing nations, such as Saudi Arabia and Iraq are located in the region.
Other external (and predictable) factors such as damage to oil installations and tankers via accidents, fire hazards, and extreme weather can also have a major impact on oil supply and pricing.
Due to this unpredictability, the concept of fuel hedging can seem very attractive for road transport and vehicle fleets, yet as Brennan noted during the webinar, there are some important factors to consider.
“Fuel hedging is the number one tool an organization can use to protect itself against rising markets,” explained Brennan. He noted that businesses such as government municipalities, trucking companies, and airlines often use hedging to fix their fuel costs.
Brennan did say however that when you choose to fix the price you pay for fuel, it isn’t necessarily the cheapest price and often comes with a premium attached, though he says one way of looking at it is like having a fixed-interest rate mortgage on a property. Even though the rate maybe be a bit higher than what is available on the market, the borrower is protected from rate fluctuations during the term of the loan and knows exactly how much they are paying each month.
Fuel hedging providers, while not supplying the fuel themselves, do offer a protection against rising fuel prices in the market, no matter which supplier their clients source their fuel from.
Depending on where your fleet is based in Canada, Brennan explained that your fuel will be protected against the local rack price, for example, the rack price in Edmonton, Vancouver, or Toronto. With fuel hedging, you are fixed against that rack price and the price you pay for fuel is an average, based on data from Natural Resources Canada and the average if the markets go up, so it tends to be at mid-point pricing level, relative to the market.
With most hedging providers, Brennan noted that there aren’t any upfront payments required and in most cases; organizations will tend to hedge fuel prices from approximately 3-24 months for the strategy to actually prove effective.
Budgets and hedging
Additionally, organizations such as fleets should be looking at the budgets for the next six months to a year and then plan a fuel hedging strategy based around that.
Some companies, explained Brennan, might also choose to hedge only 60-70% of their volume so they aren’t exposed to the whole market. Additionally, a tactic known as layer hedging, where an organization might still hedge 60% of its volume but do it piecemeal, such as applying 20% to one month and 20% to the next can also be an effective approach, “the idea being,” stated Brennan, “that you’re not exposed to one price or one point in the market.”
The ultimate goal with fuel hedging and price-fixing, said Brennan is to give organizations a bit of certainty during uncertain times. This is especially important if they want to protect against major oil and fuel price pressures during periods of extreme volatility, or, like many government agencies and municipalities cannot always pass on the cost of fuel directly to their customers.