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Industry News

Rising Fuel Costs Challenge Trucking Industry

Industrial Fleet Management, Forest Hill, MD, July 23, 2008

Light sweet crude oil rose to an all time high of $146 dollars a barrel this July before settling back $22 to $124. Crude was floating around $135 dollar a barrel through much of June, until spiking at the unprecedented $146 on July 14th, according to the NYMEX index.

Market forces traditionally produce corrections in steep price increases. As the per-barrel cost rises, OPEC, or non-OPEC members, increases production to capitalize on windfall profits eventually creating excess oil inventory. Concurrently, demand drops as users economize. When the on-hand supply is larger than the immediate demand, prices plateau and even decrease.

Optimistic observers are predicting price rollbacks. They attribute the current spike to speculation. Oil futures are traded as much as eight years out. The 2016 futures rose May to $134 US in mid May. Traders who bought oil purchased at a lower future rates years ago are reselling it at costs near the 2016 benchmark. These speculators have the oil to sell and scarcity is allowing them to get the $140 plus price. If demand slackens, some of these speculators may be left "holding the barrel".

Alan Kohler of the Business Spectator in a recent article says "clearly there is a big element of hedge fund trading in this new spike... trading (oil) commodities these days is like putting your hand in a blender." But he goes on to say "this bubble won't burst." Kohler cites two principle causes that will keep oil prices up. In 2008 global production is down while global demand is at an all time high.

China's oil consumption is increasing at 7.2% per year. As third word nations industrialize and industrial nations move to consumer driven economies demand increases. The Saudis, the world's largest crude producer, are pumping 100,000 barrels a day less then their 2005 levels. Iraq, the world's number two producer is straining current infrastructure to produce 2.5 million barrels a day, a million barrels a day short of it's pre-war peak. The Wall Street Journal reported this month that an official of the International Energy Agency warned of a global oil production shortfall. The complete IEA report comes out this November.

No industry is more directly affected than transportation. The American Trucking Association, in their newsletter Transportation Topics, recently reported "OPEC ministers said they could do nothing to stop a rally that could put the price on a track toward $200." That makes headlines. And other industry observers agree. The energy analyst Arjun N. Murti of Goldman Sachs, now famous for predicting a per-barrel price hike to $105 US just a year ago, is forecasting the same increase, to $200 US. T. Boone Pickens said, just days ago, that he expects a cost of $150 US a barrel soon.

The government is anxious to act. President Bush completed a recent Middle-East tour, and the reason for his Saudi visit was to pressure both them and OPEC for production increases. He spoke from Sharm el-Sheikh, Egypt of an agreement with the Iraqi government to increase oil production and said the Saudi's agreed to a 300,000 barrel per day increase, but admitted it was "not enough'' to address U.S. energy needs.

Some feel that the Saudis and OPEC are holding back to artificially increase prices. Bloomberg quotes the Iraqi Oil Minister Hussain al-Shahristani on Saudi Arabia's decision to increase production in June; "It will not help lower the price of crude. Everyone is pumping as much as they can at the moment,'' he said. "Iraq has added 500,000 barrels (per day) over the last six months and it has made no difference.''

Dr. Jon Alterman, previously a specialist in American-Saudi relationships at the State Department and now a Director at the Center for Strategic and International Studies was recently interviewed concerning the Saudi response to the President's requests.

"I expect a gesture of goodwill, but not a fundamental change in the shape of the market. ...the only way to fundamentally shift the nature of the market is on the demand side, not the supply side. There's no way to spike up the supply of oil in the interim and demand is rising tremendously. Demand has flattened in other places, and demand goes down in a recession. My guess is that the real change in the oil market will be demand driven rather than supply driven. On the supply side, you may have a little bit of easing, but there's just no way to dramatically affect the market that way.

Current US oil inventory has plummeted 5.3 million barrels this spring, according to the Department of Energy in spite of an industry forecast of a 300,000-barrel increase. Gasoline inventories fell 760,000 barrels. Demand has not decreased.

Hardest hit are truck fleets requiring diesel according to Laurie Falter, of the DOE's Energy Information Administration. Diesel has topped all record prices at of $4.33 a gallon. She agreed that strong global demand and tight domestic supplies were all factors behind the record fuel costs. Ms Falter went on to explain that diesel remains so much higher than gasoline because refineries "can't make more distillate without making more gasoline." A typical refiner's yield from one barrel of crude includes about 19.4 gallons of gasoline but only about 7.8 gallons of diesel, according to the EIA. "All the infrastructure in the refineries is geared towards gasoline production," Falter said.

With At a weekly burn rate of about 730 million gallons that means the trucking industry paid about $1.1 billion more for diesel than it did in the corresponding week of 2007. Yet there seems little chance of passing those costs on to clients.

"I don't see rates picking up this quarter," said Ray Haight, chairman of the Truckload Carriers Association and executive director of MacKinnon Transport in Guelph, Ontario. "Typically, this quarter sees a bit of an upswing in volumes. I have talked with a number of carriers that are saying volumes have come up in this quarter, but the margins have deteriorated. There is a lot of competition for that little bit of extra volume."

Diesel prices present an insurmountable stumbling block to operating ratio improvement. And dedicated contract carriers may have locked into rate structures that can't keep up with double-digit fuel cost increases. Prices are rising so quickly that, short term, even surcharge collections are falling short. "While we have dynamic fuel surcharges in place, they cannot keep pace in the short-term with rapidly rising fuel prices," Alan Graf, FedEx's chief financial officer, said in a statement.

The ATA's Transport Topics reported that the industry was turning to extreme measures, including negotiated contract fuel purchases, adding aerodynamic skirts, installing governors to reduce the maximum speed, office staff reduction and even parking trucks. Cost cutting measures in other areas of operation and overhead may be the only short-term solutions for the beleaguered trucking industry.