A Volatile Problem

A blend of price, taxation and contracting make the fuel supply chain a risky business


Fuel touches all of us. So does its volatility—and not just its physical properties. It’s volatility in price, in tax rates and in contracting.

“We’ve seen businesses stop or cut back on offerings because they can’t manage fuel costs,” says Matt Tormollen, President and CEO of FuelQuest, a Houston-based provider of on-demand fuel management systems and outsourcing services. “Ultimately, when fuel prices go beyond a certain point, even state and local governments cut back on critical services such as police patrols or school busing.”

In 2008, for example, Garden City, Mich., schools eliminated Saturday transportation for extracurricular activities. In Nash-Rocky Mount public schools in Nashville, N.C., fund-raising was required if buses were used to transport students to any non-competitive events. And a Maryland school board authorized the superintendent to expand how far students will walk to school or a bus stop if gas prices rose too much.

What else? Americans will spend about $700 more this year on gas than they did in 2010, according to a an Energy Department report earlier this year. In March, airline fares were up 15 percent over the previous years and Carnival Cruises announced lower earnings because of rising fuel prices, so vacations become more expensive.

Fleet operating companies typically see fuel prices as their second-largest expense. “Without long-term fuel contracts, fuel management automation, or hedging, what they haul…will become more expensive for consumers with rising and volatile prices,” says David Zahn, VP of Marketing for FuelQuest.

A Supply Chain Like No Other

Here’s a quick sketch of how the fuel supply chain works: The refiner receives oil and produces gasoline, diesel and other petroleum products. Traders then buy and sell the fuel in bulk. The bulk fuel then moves over the pipeline, on barges or via other transportation modes to where suppliers store it in large, above-ground tanks. From there, distributors transport the fuel to retailers or consumers (such as fleet companies).

Now, let’s take a look at what has happened to fuel prices and volatility. In the last five years, fuel prices have increased 10-fold. In that rise, prices have fluctuated greatly. And it’s not just the price of crude changing daily.

“There are more intra-day price changes than ever,” Tormollen says. “Fifteen years ago change was once a day, or every other day. There was stability. Now, you may see prices change five or 10 times a day. And that could be as high as 10 or 20 cents, depending on the market.

“This is a supply chain unlike any other,” he adds. “You have buyers, sellers and intermediaries between the pipelines. What often happens is that there are many suppliers at different terminals in geographic locations where the pipeline terminates into bulk storage. Suppliers advertise prices at those terminals. Like any other buyer or seller, if they see changes they can move prices to their advantage.”

The next element of complexity that adds to the explosiveness of fuel costs is contracting. There are multiple price indices that are followed: issued by Gaithersburg, Md.-based Oil Price Information Service (OPIS), New York-based Platts and London-based Argus to name three major players.

“In these contracts, buyers will procure fuel based on things like close [prices] midday, and have more options in the way they can estimate contracts. The complexity is exponential,” said Tormollen.

From each provider there are multiple price feeds, which take into account a number of variables to calculate price. These variables include times of the day, contracting terms (prompt-payment discounts), types of feeds (branded or unbranded fuel prices), and calculation methodologies (averaging a whole day’s worth of trading activity or just the last part of the day).

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