Diesel Fuel price risk is one of the main challenges that trucking fleets have been battling this fall. Since mid-August, when news stories started circulating about hurricane Harvey, diesel fuel futures had gained more than 25-cents over the next month. GasBuddy reported that the national average price of on road diesel fuel increased about 20-cents. That was the national average so depending on your location the price increase varied, but regardless of the location majority of all markets in the U.S. increased their diesel fuel price.
Most small to mid-sized carriers have taken steps to help increase their fuel savings. Fuel card programs can provide discounts on diesel and many other services for trucking companies, and fleets continue prioritizing increasing fuel efficiency to save on fuel. These are two good steps to help reduce your risk exposure to fuel prices.
However, these solutions do not provide the same level of price protection that a properly ran hedge program could potentially provide. An increase of 20 to 25 cents per gallon on diesel fuel can really cut into a carrier’s budget. Let’s break down how this price increase could have potentially effected a trucking fleet.
- Assume that one semi-truck on average drives about 2,500 miles a week and that the truck averages about 6.5 gallons/mile.
- Based on those average the truck will burn through about 385 gallons (2,500/6.5) of diesel fuel a week and 1,540 gallons over four weeks.
- A 20-cent increase on that 1,540 gallons used is equal to $308/truck. This would be the increase in fuel cost for one truck.
Now that we have a rough estimate of what the potential cost over the last four weeks was for 1 truck, let’s see an example of how a fleet of 200 trucks would be effected based off of the same parameters above.
- A fleet of 200 trucks would burn roughly 77,000 gallons of diesel a week or about 308,000 gallons for four weeks.
- A 20-cent increase to fuel cost would be equal to $61,000 cost.
That increase in fuel cost is precisely why fleets and other end users of diesel fuel use the futures and options markets to help protect themselves against a portion of the inverse price moves. Diesel fuel futures and options are traded as an Ultra-Low Sulfur Diesel (ULSD) contract that is traded on the New York Mercantile Exchange in 42,000 gallon increments. There is risk involved with trading futures and options, and you should consult a professional broker before making any trading decisions.
One hedging solution that some trucking fleets utilized earlier this summer was a cap price program using the options market. To help cap a portion a fleets fuel cost they would buy call options on a portion of the gallons that they expect to burn during peak hurricane season August through October. The example below is hypothetical and prices may have varied depending on entry and exit points of the hedge.
- A call option is the option to buy the underlying commodity (ULSD) at a predetermined price (the strike price) by a predetermined date (the expiry). Essentially one buys call options to give themselves upside price protection, a call option gains in value as the market rises.
- The trucking fleet would want get price insurance before peak hurricane season sets in. When mid-July rolled around they purchased October ULSD Call options for a premium.
- In mid-July the October futures were trading around $1.55. An October $1.55 call option at the time would have cost approximately 6-cents a gallon depending on market timing. The October options expire at the end of September.
- A fleet with 200 trucks could estimate that they will have to purchase about 714,000 gallons of diesel fuel from August until the end of September.
- Depending on a company’s risk parameters, most commodity brokers would recommend hedging between 20% – 35%. 30% of 710,000 is 214,200 gallons.
- So the fleet buys 5 call option contracts for October ULSD futures at a $1.55 strike price, those 5 contracts are hedging 210,000 gallons. It cost the fleet $12,600 in premium cost for the hedge structure ($0.06 option premium x 210,000 gallons).
Now that the trucking fleet has a hedge structure in place they can hold onto those position until almost the end of September. That should give them plenty of time to get through a good portion of the hurricane season, and they have the ability to liquidate the options at any time if they would like.
Let’s say that the trucking fleet decided to liquidate the position on September 15 after the threat of Irma had moved through Florida. On September 15th the October Diesel fuel futures closed at $1.7988/gallons. If they would have liquidated the hedge positions at $1.78/gallon, then they potentially could have picked up 23-cents a gallon for the hedge position.
After you reduce the cost 6-cent premium paid for the options, the net payout for the hedge on 210,000 gallons would have been $35,700. Any profits the fleet made on the hedge are used to offset a portion of the higher fuel prices they were paying on the street.
As mentioned above a fleet of 200 trucks fuel cost might have increased by $61,000 during the 4-week time frame between both hurricanes. That hedge profit of $35,700 does not cover all of the cost, but it would have been able to help ease some of the pain from higher fuel cost and potentially improve a fleet’s P&L.
The hedge example used in this article is hypothetical and is meant for educational purposes. Trucking fleets and other end-users of diesel fuel should seek out a professional brokerage firm, such as Powerline Group.
Darren Dohme has been in the petroleum hedging business for 30 years. He was one of the first to utilize the newly listed gasoline and heating oil options for commercial hedgers and end users to build price cap contracts, which became a great success through the first Gulf War in 1989. Customers that he personally instructed on the hedging strategy include the U.S. Department of Energy (DOE), Bank of America’s large Asian and Australian petroleum customers, UPS, Cargill, John Deere and many other major over-the-road trucking fleets, railroads and barge companies. Darren was also one of the first to fulfill a need to hedge a fluctuating retail gasoline street margin for the retail marketing industry. Darren is also a managing partner of Powerline Petroleum and understands that every cent counts. Powerline works with both transportation companies and other end users of diesel fuel to help cap their fuel prices, and also works with petroleum jobbers and wholesalers to offer Maximum Price Contract Programs to their customers. To learn more about how you could utilize this hedge structure or similar hedge structures to potentially help protect yourselves against inverse price moves in the fuel markets please contact Powerline Group at 217-351-9030 or visit our website at www.powerlinegroup.net.
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