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The Fuel Surcharge Head-Scratcher

By Mark Solomon | February 11, 2015 | 8:05 AM

I’ve been doing this stuff for awhile, and I must confess that I don't really get the mechanism of fuel surcharges.

 

In its fourth-quarter conference call last week, UPS Inc. executives talked about the headwinds its three units—in particular less-than-truckload operator UPS Freight—would face as a result of lower fuel surcharges that would negatively impact revenues. But all the comments did was reinforce a basic question: Wouldn’t UPS offset those revenue headwinds from the lowered costs that would come from the cheaper cost of fuel purchases?

 

I have asked this general question of many analysts, especially in the wake of a dramatic fall in oil prices and recent moves by FedEx Corp. and UPS to raise their surcharges despite the dramatic decline in the price of the commodity. I get what appear to be cogent responses, but they are just not sinking in.

 

I am guilty of looking at this in a symmetrical way. That is, fuel costs and expenses should even out, albeit with a time lag that should be appropriately priced in by the shipping and investment community. Yet I am reminded that such thinking is off base. I’m told through analysts’ comments that the decline in oil prices is a negative for some of the largest consumers of fuel in the country. I read that some LTL carriers historically over-recover fuel expenses, and that when prices decline they have to give back some of that recovered revenue.

 

Fuel surcharges were created in the early 1970s after the first Arab oil embargo. They were designed to help carriers recoup the volatile—and in those days unprecedented—moves in oil prices without resorting to the difficult practice of hedging. Surcharges disappeared for about 20 years before returning as a permanent fixture in 1996. At that time, diesel prices had risen to about $1.19 a gallon, a high price in those days. A group of retail outlets was formed to report diesel prices to the Department of Energy. DOE compiled the data into a weekly index of chart of average prices on a national and regional scale. The DOE index would allow carriers to keep fuel charges separate from the line-haul rate, thus ensuring transparency on the impact of fluctuating fuel prices.

 

Over the years, surcharges have taken on different forms. For example, one approach has been to calculate daily fuel prices along a specific route and to set surcharges based on the prevailing daily changes. Whatever the case, a mechanism originally meant to be a pass-through to help carriers cope with fuel price volatility has turned into its own revenue stream. Today, somewhat perversely, it is better for carriers when fuel prices are higher so they can impose higher fuel surcharges in the hope that the surcharges run ahead of their costs. And conversely, in an environment like today’s, where in theory lower oil and fuel prices should benefit those who consume lots of the product, it’s actually a bad thing.

 

 I think I’m getting it…

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