The price of fuel is constantly fluctuating. It can spend weeks in a steady decline, followed by an overnight upswing. So, say you own a fleet of trucks, construction equipment, or other vehicles that rely on large, regular amounts of diesel fuel in order to do business. A sudden, unexpected surge in diesel prices can cut into your bottom line and harm your business. So how can you keep your fuel costs steady and manageable over time? Use a method called diesel hedging.
Hedging is a form of risk management in investment that protects you against rising prices. It’s the principle behind futures. The buyer of a particular commodity (in this case, diesel fuel) makes a deal with the person or organization that sells it, to lock that commodity in at a certain price for a given period of time. The average price of that commodity may rise or fall in that time, but either way, the buyer pays the price that’s been agreed upon.
In the fuel industry, this is called a diesel swap. Let’s give an example. Say you have a construction company, with a variety of cranes, bulldozers, and other heavy equipment, all with diesel engines. Diesel fuel is currently an average of $1.50 per gallon. In order to complete your June construction projects on time and on budget, you can’t afford to pay any more than that for fuel that month, for all of your equipment.
You go to an oil company and propose a diesel swap. For the month of June, you’ll lock in that price of $1.50 per gallon for diesel fuel. Then, you continue to buy fuel as needed, at whatever price it’s currently being sold.
By the end of the month, the price of fuel has spiked again, and is currently $1.85 per gallon. And your company bought a total of 10,000 gallons of fuel at that price. The oil company now owes you the $0.35 per gallon difference for those 10,000 gallons, or $3,500, meaning that your cost for diesel for the month remains locked at $1.50.
Benefits of a Diesel Swap
What if the price of diesel goes down, though, and that $1.50 per gallon price becomes $1.15 by the end of the month? Then you’d owe the oil company that same $3,500, to maintain your locked in price of $1.50 per gallon.
With that in mind, what’s the benefit of diesel hedging? Sure it might save you money, but it might just as easily cost you, and cause you to miss out on rock bottom fuel prices. It’s a risk, to be sure. But to continue buying fuel without a diesel swap can be even more of a risk.
Remember, in our scenario, that your company can’t afford to pay more than the current $1.50 per gallon for diesel fuel. Without that $3,500 reimbursement, you would have gone over budget, and your company and shareholders would have suffered the consequences.
When the price goes down instead of up, it’s a disappointment, to be sure. But it’s not like you’re being cheated. You’ve budgeted for $1.50 per gallon in fuel for the month, and that’s what you paid. Your costs remain within acceptable parameters, and your shareholders remain happy. For many companies, missing out on a little extra savings is a small price to pay for that guaranteed stability.
The fact is, you never know what oil prices are going to do, and they can easily turn on a dime. And a diesel swap is only in place for a limited time period, so if prices do continue to go down, you can take advantage of them once the swap ends. But if you’re afraid of what might happen to your bottom line if fuel prices go too high, then you may find diesel hedging to be well worth the risk.
For more information on how to cut your fuel costs read "8 Tips for Fleet Managers to Save on Fuel Costs."