Holcim (US) launches new strategy to control trucking costs
Jan 1, 2008 12:00 PM
Fuel Hedges are being touted by one US cement processor as a way to gain greater control over fuel surcharges and improve transportation costing. It's a strategy that the cement company believes will benefit all of the parties in the transportation process.
The program was proposed by the logistics team at Holcim (US) Inc, a subsidiary of Swiss-based Holcim Ltd. Rollout of the program began in late 2007. Working with the Holcim logistics team on the fuel-hedging project was FCStone Trading LLC, an 84-year-old commodities brokerage.
“We see a huge amount of variability in fuel costs due to seasonal dips and spikes in price,” says Joel Adams, Holcim (US) logistics manager for road transportation. “Surcharges further complicate the fuel cost issue, especially for shippers and their customers.
“We're still at the beginning of this fuel hedging strategy, but we see it as a way to manage the variability in fuel pricing. If we can make this program work, it should provide a competitive advantage for both Holcim and its trucking partners. It's a value-added service that we can offer to our customers.”
Adams and his logistics team have worked hard to sell cement haulers on the benefits of the fuel-hedging strategy. “Some of them were concerned that if Holcim was the winner in the fuel-hedging process, the carriers would be on the losing side,” Adams says. “We've tried to make it clear that we view this as a win-win arrangement. It offers mutual advantages.”
He adds that Holcim has implemented the program internally and is using costless collar hedges to control the fuel costs related to intra-corporate movements. This type of hedge combines a put (floor) and a call (ceiling). This arrangement seems to do the best job of putting a cap on fuel costs. While there is some risk, it is clearly identified.
On the carrier side, one of the Holcim cement haulers has begun building the fuel hedging process into some transportation quotes for large public works projects. “Public works customers want a fixed transportation rate, and the fuel hedge is ideal for that,” Adams says.
The process of educating cement haulers on how they could use fuel hedges included a seminar in Kansas City, Missouri, in August 2007. Conducted by FCStone, the seminar was attended by most of Holcim's core US cement haulers.
L E “Tripp” Dunman III, FCStone managing director, began the seminar with an explanation of the factors affecting oil prices. Factors include soaring worldwide demand for petroleum that pushed crude oil prices to a record $100 a barrel at the start of 2008. The number of refineries in the United States has dropped steadily even as fuel demand has grown.
Fuel price spikes have resulted from worries about terrorist attacks in key oil production areas overseas. Prices also are affected by hurricanes and other weather events in the United States.
All together, these factors have brought steady increases in fuel prices. Trucking companies have dealt with that by using surcharges to pass along the increased fuel costs to shippers.
The surcharge is a variable based on the price of diesel fuel. Calculations are based on a floor price and include the Department of Energy's national average reported diesel price. Surcharges may be a percentage of the underlying freight rate or based on cents per mile.
While surcharges enable carriers to recover fuel cost increases without constantly renegotiating freight rates, they complicate the budgeting process for shippers. The surcharges change with the price of fuel, and those changes can be very frequent.
“Government entities that are responsible for public works construction projects hate the cost variability that comes from the fuel surcharges,” Dunman said. “We can address that with fuel hedges. We believe it offers a significant market edge, and it is the wave of the future.
“The purpose of hedging is risk mitigation and stabilization. Shippers are most interested in the stabilization factor. Hedging removes volatility and helps achieve budget certainty. However, it doesn't offer any guarantee of saving money.”
A fuel hedge management program can be independent from the carrier's surcharge program. Another choice is to integrate the surcharge protection into the freight rate as a service offered to the customer. Carriers also can use hedges to help manage their own fuel costs.
Dunman stressed that fuel hedges can be structured in a way to ensure that the carrier takes on no additional risk. He listed several surcharge strategies that the carrier can develop with fuel hedges.
In one approach, the carrier can lock in a maximum surcharge rate for the next 12 months using fuel hedges as surcharge protection. Effectively, the shipper pays the same surcharge regardless of fuel price changes. The hedge ensures that the shipper is protected against market price increases.
Another strategy is to cap the freight rate with a fuel hedge. In return for the payment of what is essentially an insurance premium, the shipper is protected against rising diesel prices and surcharges. At the same time, the shipper benefits from market drop in both price and surcharge.
The final option is a no- or low-cost collar hedge. This provides protection if fuel costs go above the ceiling, and there is no loss if fuel costs drop below the floor. As Adams states at the beginning of this article, this is his preferred option.
While FCStone and other firms have simplified the fuel hedging process, shippers and carriers must be disciplined in the way they approach these programs. They need a good basis history for fuel prices, credit access, and good communications and accounting procedures. Top management must be on board.
Realistic goals are a must. Shippers and carriers must ensure that they don't lose track of their objectives with a fuel-hedging program. They need to focus on their operations and let qualified brokers handle the hedging process.
“Don't try to become a commodities trader,” Dunman said. “Make sure you are using the right metrics for your operation. Don't let payouts become the sole criteria for the program. Finally, don't get caught up in Monday morning quarterbacking.”
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