Bidding on construction projects has become increasingly competitive. And because construction businesses often consume a lot of fuel, companies must know their fuel costs when estimating a job to stay profitable. The longer the project, the less control companies have over their fuel costs.
While fuel prices were relatively calm last year, we have seen a drastic upswing in fuel prices due to growing demand from emerging markets, supply disruptions from the Middle East turmoil and natural disasters including the Japan earthquake and tsunami. Crude oil prices have doubled in the past year alone. In late February of this year, we experienced the second largest one-week increase in gas prices since 1990.
With these drastic price fluctuations, fuel price volatility is a growing concern. The 2011 Pricelock Fuel Pricing Survey found that an overwhelming 99 percent are concerned about fuel prices this year, with the majority (65 percent) forced to directly absorb any fuel price increases. Only 16 percent are able to pass on higher fuel costs by raising prices. This online survey had 451 participants—the respondents included executives, fleet managers, directors and other industry professionals associated with small, mid-size and large fleets.
With the construction industry’s dependence on fuel, fuel price volatility is among the industry’s most threatening financial risks. Many construction firms have reduced their fuel costs by adopting good maintenance practices, incorporating route optimization technology and limiting idling, among other best practices. Savvy construction businesses have taken it one step further by adopting a more strategic and proactive approach to fuel risk management with fuel hedging.
Historically, most construction firms could not hedge their fuel costs due to small fuel budgets or no in-house expertise to participate in the fuel commodities market. However, recent technological advances and new services have leveled the playing field for construction fleets of all sizes.
How Hedging Works
Using fuel price protection is one of the simplest and safest ways to hedge fuel costs. With fuel price protection, a company selects a protection price that represents the maximum cap it wants to pay for fuel. When gas or diesel prices—typically the U.S. Energy Information Administration’s national averages—go above the set protection price, the company receives a cash payment equal to the difference based on the number of gallons it chooses to protect.
If fuel prices drop, the company can still buy fuel at the lower market price with no penalties, unlike fixed price programs. As a financial arrangement, the company does not pre-purchase fuel, and the fuel hedge is not tied to actual usage. If the protected fuel amount is not used, the company will not incur any additional cost.
With fuel price protection, construction firms can protect their most volatile expense upfront, accurately predict their maximum fuel costs, bring earnings stability and redirect their limited resources to strategic initiatives, such as growing the business.
How to Leverage the Protection
Fuel price protection is flexible and can be leveraged in different ways. Some construction companies opt to set their protection price close to market price for budget predictability. Others may set it at the highest possible price they can comfortably absorb to ensure their protection if fuel prices go any higher.
Some construction firms use fuel price protection to inject price predictability on the project level, while others leverage it to protect their entire fuel budget. Still, others price-protect fuel only during their busiest months or in the summer months when fuel prices tend to be highest.
By stabilizing fuel costs upfront, construction companies can run their businesses profitably and gain a competitive advantage—without worrying about cost overruns. With many experts predicting increasing volatility in future fuel prices, now is a good time to see if fuel price protection is right for your business.
