What Fuels You?

Posted on July 1, 2008 by Howard A. Morin

Page 1 of 2

During the last few months, we have learned about issues such as cash management and company benefits. Now we drill, no pun intended, into another topic that we deal with every day: fuel.

The cost of gas always seems as if it’s rising and recently hit a record high. Owners cannot afford to ignore this cost since it is a major expense in your transportation business as significant as insurance, rent, and vehicle payments. This issue causes operators of all sizes to question their ability to survive, especially with a looming nationwide economic slowdown.

So what really is the problem? Why don’t we just keep raising our prices or add escalating fuel surcharges? The rising cost of fuel is probably not something that can infinitely be passed on to clients. When times are good, people don’t seem to mind increasing costs. Now it’s hard to raise rates and surcharges, especially in a slowing economy. Variable and flat-fee surcharges are not only showing up on black car services and limousine rides, but also on airline tickets, shipping orders, and short-haul deliveries as well. And unlike surcharges based on an index which goes down when prices fall, flat fees tend to remain. Some clients don’t understand the connection between fuel charges and actual fuel costs and question it regularly.

Fuel management has major consequences. Many limousine business owners are asking whether they can afford to sustain these rising costs. Some people are looking at fleet management programs to leverage the economies of buying large quantities of fuel while others are looking at hybrid vehicles and fuel-cost hedging. The addition of hybrid vehicles to many fleets can serve more than one purpose. It allows a lower cost transportation option to the client who may be willing to surrender some legroom, comfort, and luxury. In addition, it presents a green, “eco-friendly” face on your business, and the wider industry overall.

What is Hedging?

For the purpose of this article, we will look at the business of fuel cost hedging. The term “hedging” is derived from the phrase “hedging your bets,” used in gambling games such as roulette. When you buy insurance for your vehicles, you are hedging. Doing so is one of the oldest means of hedging against risk. Insurance is bought to protect against financial loss due to accidental property damage or loss, personal injury, or loss of life. Fuel cost hedging is the practice often used by airline companies to protect against the shock of anticipated rises in price.

In the financial world, a hedge is an investment taken out specifically to reduce or cancel out the risk in another investment. By definition, hedging is a strategy designed to minimize exposure to an unwanted business risk such as the skyrocketing cost of gasoline, while still allowing the business to profit from an investment activity.

Some form of risk taking is inherent to any business activity. Some risks are considered to be “natural” to specific businesses; the risk of fluctuating oil prices, for example, is natural to firms that drill for and refine oil. Other forms of risk are unwanted but cannot be avoided without hedging. Someone who has a luxury transportation business, for example, expects to face natural risks such as the risk of competition, poor service, and so on. The risk of the fleet being destroyed by fire or getting into accidents is unwanted, and can be hedged via insurance policies.

Why Do Transportation Firms Hedge?

Fuel costs have substantially risen over the past several years, pressuring businesses such as airlines, shippers, and ground transportation services to maintain positive cash flows. The airlines have been hedging their fuel costs since the 1980s. From day to day, we don’t know if gas is headed to $5 per gallon in Los Angeles or down to $3 per gallon in your city, so what are the implications of both?

Major weather events such as hurricanes and political instability in the Middle East could cause energy prices to rise dramatically without much warning. How would this affect your business in the upcoming month, quarter, or year? In the words of an ancient Chinese proverb:

         “Predicting is very difficult, especially as it concerns the future.”

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