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Rising Fuel Prices Increase the Necessity of Fuel Surcharge Programs
With diesel fuel likely to rise to historic highs this summer, having a fuel surcharge program in place is an important step to mitigate sudden cost pressures. Various experts explain the details of calculating fair and accurate fuel surcharges.

By Chaille Brindley
Date Posted: 4/1/2012

          With the prospect of record fuel prices looming on the horizon, pallet and lumber companies need to brace for higher fuel prices and continue to find ways to pass along these costs to customers. At the recent National Wooden Pallet & Container Association (NWPCA) annual meeting, a majority of pallet companies reported having fuel surcharge programs in place. Whether or not these companies can pass along all costs or make the surcharges stick – that is another matter.

          The use of fuel surcharges by major trucking companies became common in the late 1990s as fuel began to skyrocket. Some trucking companies were caught off guard and began to impose fuel surcharges as a way to hedge against spiraling costs for long-term business arrangements.

          Bob Costello, the chief economist for the American Trucking Association, said that fuel surcharges can range widely depending on the truck company and its customer base. He explained that some common carriers may have as many as 100 different fee structures.

          Some of the largest pallet companies do add on fuel surcharges while others add the cost of fuel into the initial price quote. For example, the two largest wooden pallet rental companies in the country – CHEP and PECO Pallet – take different approaches. CHEP charges a fuel surcharge that is tied to government fuel price numbers. PECO offers a set price that includes all costs, including pallet rental, fuel, transport, etc. PECO regularly changes its all-inclusive price per customer to reflect market and customer use trends.

Real World Challenges of Fuel Surcharges

          Even if you have a fuel surcharge in place, you may not be able to absorb all your costs. “It is very difficult to pass along fuel increases for pallet shipments,” said JoAnne Scott Webb of Scott Pallet in Amelia, Va. She added that it is easier to raise prices for transporting large industrial items compared to pallets.

           Some pallet companies separate out the cost of fuel as a separate line item on the invoice. This may make it easier for some customers to accept fuel price increases when they would balk over a general price increase even if it was blamed primarily on rising diesel costs.

          Fuel prices have reached the point that they can no longer be ignored. Costello said, “Four dollars per gallon is the price when fuel passes labor as the number one cost for trucking companies.”

          Costello said that many common carriers are doing whatever they can to reduce fuel costs. This includes adding skirts to trucks to reduce drag, upgrading to newer trucks that have small engines that kick in when the truck idles, adding monitors to keep track of driving traits that can impact MPG and offering incentives to drivers to reduce fuel consumption. Cutting down on idle times and out of route miles can also help improve fuel economy.

          Calculating fuel surcharges is far from an exact science. A lot depends on your cost and what you can get away with charging. If you work with a third party carrier that charges you a fuel surcharge, you may simply just pass along that cost. If you have long-term contracts, making sure to institute a fuel surcharge is even more important.

         

Basics of Calculating Fuel Surcharges

          Most companies base fuel surcharges on the diesel prices collected by the U.S. Energy Information Agency (EIA). This index is updated every Monday and can be found at http://www.eia.gov/petroleum/gasdiesel/.

          According to C.H. Robinson Worldwide, a major logistics and transportation company, fuel surcharges are either computed on a cost per mile basis or a percentage of the total linehaul price. Both methods have their pluses and minuses.

          The cost per mile approach is the most common method and is considered the most accurate because it is based on the actual costs for that load. See “Formulas for Calculating Fuel Surcharges” to read more on the actual method to figure out your fuel surcharge.

          There are numerous ways that you can tweak the formula to turn the fuel surcharge into a profit center. Thomas Moore, managing partner of Moore Associates (http://www.mooreassoc.com), said that many carriers use fuel surcharges as a profit center even though it was originally designed to recover rising fuel costs not covered under long-term contracts.

          Moore, who serves as logistics consultant for major corporations, such as P&G, Nestle and British Petroleum, said that trucking companies have ways of making the fuel surcharge pay. He explained, “Fuel surcharges are based off the retail price for diesel, but nobody pays retail price for diesel.” This is especially true for larger carriers that buy fuel in bulk and develop specialized pricing structures with the major truck center operators.

          Moore said that another trick some companies use is to base the diesel price on the national average when the route covers an area of the country where diesel prices are well below that index. Areas father away from refineries in the Gulf Coast or Northeast may have higher prices. California with its more stringent environmental standards tends to have the highest prices in the country. The fairest way to calculate a fuel surcharge is to base it on the regional prices if you are going to use the EIA index.

          Newer trucks get well over seven miles per gallon in fuel economy. Some companies will use a lower rate, such as five or six miles per gallon, just because that used to be the average for older trucks.

          The second major method for calculating fuel surcharges is the percentage of the total linehaul rate. This method increases the rate by X% for every Y cents per gallon increase in fuel. LTL carriers tend to use this method more than full truckload carriers. The reason is that a carrier’s MPG doesn’t change with the price a carrier charges in a lane but the fuel surcharge does.

         

Strategies for Starting a Program

          The basic idea is to have a way to pass along skyrocketing fuel prices without having to regularly change the price of your product. You typically start by analyzing your current fuel costs. Is this something you are already tracking in your accounting system? If you use third party trucking firms or owner/operators, you may already be paying fuel surcharges to those suppliers. If you have fuel cards that you provide drivers, it can be very easy to setup a basic spreadsheet to track your costs. This may be figures that you never share with your customers. But it will give you an idea of how rising fuel costs are affecting your bottom line.

          You have to develop a strategy for dealing with rising fuel costs now if you don’t already have one in place. If you wait for even higher price spikes, it may be too late. Once you formulate a plan, you need to communicate it to customers. Separating out the cost of fuel as its own line item will help customers see that you are not trying to pull a fast one on them. As with any negotiation, this resembles a game of chicken. You may not get all customers to accept some or all of the surcharges. But if you don’t try it at all, you risk what little margins you may have left. Having this discussion now, even if you don’t institute actual price increases, at least allows customers to know that you are not immune from the fuel situation facing everyone else in the market.

          Your communication with customers should stress the necessity, fairness and transparency of your approach. Be ready to have to deal with some clients. But there does come a point where customers either have to pay the price or the business may not be worth the effort.

How Much Will Fuel Prices Rise?

          As the summer driving season sets to begin, fuel prices are already at historic highs for this time period. Prices could jump to as high as $7 per gallon according to Robbie Watlington, a trucking consultant with HLC Government Services (www.hlcgovservices.com). Watlington said at the NWPCA meeting that price spikes could go much higher than EIA estimates depending on the situation with Iran, oil speculation or refinery shutdowns causing supply disruptions.

          Others suggest that prices will go up this summer but not to the extremely painful levels some forecast. Thomas Moore of Moore Associates suggested that speculators were causing prices to spike beyond what the real supply/demand situation dictates. He pointed to the price of oil company stock, which has remained fairly constant, as a sign that overall world supply is not a real problem in the short term.

          The EIA expects that on-highway diesel fuel retail prices, which averaged $3.84 per gallon in 2011, will average $4.15 per gallon in 2012 and $4.11 per gallon in 2013. There are some areas of the country where prices could trend higher due to supply disruptions and refinery shutdowns. The EIA reported, “If Sunoco’s Philadelphia refinery closes in July 2012, as Sunoco has announced may occur if no buyer is found, the Northeast could be significantly affected, as replacing the additional lost volumes will be complicated by reduced access to distribution systems. Adequate refining capacity is available outside of the East Coast to replace product supplies, but logistical constraints to delivering product to the Northeast in the short term may present significant challenges.”

          Even if diesel doesn’t shoot up in price this summer, having an effective understanding of fuel costs and developing a system to deal with price spikes is good business. Yeah, the competitor down the street may not be doing it right now. But he may wish he had if prices spike in the coming year.

         


Formulas for Calculating Fuel Surcharges

Cost Per Mile Basis

Here are the basic formulas:

Per Mile Fuel Surcharge = (Current Fuel Price – Base Fuel Cost)/Miles Per Gallon

Total Fuel Surcharge = Per Mile Fuel Surcharge x Estimated Mileage

Fuel Efficiency:

6-7+ miles per gallon depending on the route and efficiency of your trucks

Current Fuel Price:

Use either the national average or the regional price (the most accurate)

Base Fuel Cost: This is the big variable depending on when you quote the order and what you consider your base fuel cost.

Total Miles: Calculate based on the route to and from the location unless you can backhaul to cut this amount in half.

 

Trucking and Logistics Consultants

 

Thomas Moore

Moore Associates

615/791-8000

http://www.mooreassoc.com

 

Robbie Watlington

HLC Government Services

919/286-7887

www.hlcgovservices.com

 

 








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