Oil surcharges are killing my business

John W. Schoen Senior Producer • Profile • E-mail

The record run in crude oil prices is really beginning to pinch businesses with heavy shipping costs. Brian in Minnesota can't understand why shippers are passing along fuel surcharges so quickly these days.

We are a manufacturer of products for many industries and ship all over the world. We are starting to see a lot of fuel surcharges from UPS, FedEx, Roadway, ABF and many others, 20 to 30 percent! Examples: April 2007 — 17.7 percent; July 7, 2007 — 18.8 percent; October 2007 — 21.2 percent; March 2008 — 30.7 percent. I would think the big boys like the above would have fuel contracts. So why are we being charged fuel surcharges and they keep going up?
— Brian A., Zimmerman, Minn.

Heavy users of oil, like shippers and airlines, do try to offset the risk of rising energy prices by negotiating contracts to buy at fixed prices for a period into the future. Some of those contracts are bought and sold on the futures markets, and the value of these pieces of paper go up and down as oil prices rise and fall. If you've got a contract that locks in your price of oil at $100 a barrel in December, and the market price goes to $120 by then, that contract is worth the $20 savings you'll get if you actually buy the oil — or if you sell the contract to someone else who needs it.

These buyers and sellers of oil and other refined products are the “speculators” many readers blame for the recent surge in oil prices. If we got rid of these folks, the thinking goes, oil prices would fall back down and we would have to spend so much money at the pumps.

This is a myth, but like all myths it contains an element of truth. Speculators have indeed added what’s known in the trade as a “risk premium” — the extra money they charge to compensate themselves for the risk that oil supplies six months from now will be pinched and prices will spike. If I’m going to commit today to sell you oil in December for $100 a barrel, I’ve got to add at least another $10 to your cost to cover the risk that prices will have shot up to $130. Think of it as an insurance policy. Maybe you’re paying a little more for the oil, but you can sleep better at night knowing you’re locked in at that $110 price. And if oil does hit $130, you still come out ahead.

If we banned the futures markets, you could no longer lock in that future price. Shippers would be at the mercy of sudden market shifts in fuel costs. They’d have only two choices: eat those costs and lose money, or pass along the risk of price spikes to customers with volatile surcharges.

This smoothing of futures prices works when the markets go up and down. The problem is that for the past several years, the trend for oil and fuel prices has been pretty much one way — straight up. When your futures contract expires and you need another one, the hope is that you can buy the next one for less and lock in a lower price. With oil, that hasn’t been possible for awhile now. If each new contract costs the shipper more money, they can only eat those increases for so long before they’re out of business.

Since it doesn’t look like oil prices are coming down any time soon, and shippers have managed to pass long these higher costs to customers like you, the question now becomes: how long before you pass those cost along to your customers? Global competition has shaved profits for manufacturers to razor thin margins; until recently those who tried to raise prices simply lost market share as customers found cheaper suppliers. But at some point something has to give.

There are early signs that’s happening. Last week’s data on producer and consumer prices included pretty clear evidence that the higher cost of fuel is beginning tot “flow through” to the prices of other goods and services. As that continues — unless oil prices ease off — we could be looking at another round of energy-fueled inflation that becomes difficult to control.

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