It’s not quite 2008 again, but heads up: After two years of relative stability, transportation fuel prices are creeping back up, raising costs across the supply chain and concerns that the heavier costs of the past will come back for good.
Rising demand driven by the global economic recovery has pushed crude oil prices to about $90 a barrel from $82 last year and just above $40 at the depths of the recession. That’s still well below the pre-recession peak of $147 in July 2008, but most analysts forecast a gradual rise to about $100 by the end of this year.
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And where crude oil prices lead, fuel costs follow. Ship lines’ bunker fuel costs have topped $500 a ton this year, nearly double their recession levels, and have grown steadily since last October. The Energy Information Administration said highway diesel prices, which averaged $2.99 a gallon in 2010, topped $3.40 a gallon Jan. 17 and are expected to stay about that level this year and average $3.52 a gallon in 2012.
Ocean, truck, rail and air carriers are ratcheting up surcharges to recoup their higher costs. “Shippers are definitely going to see an increase in their fuel surcharge, which adds to the cost of distribution,” said Charles Clowdis, managing director, North American transportation markets, at IHS Global Insight.
Economists say rising gasoline prices could slow economic growth and freight volume by cutting consumer demand. A 4 percent rise in gasoline prices from December to January contributed to a drop in the Reuters/Michigan consumer sentiment index to 72.7, down 1.8, in mid-January. Average U.S. gasoline prices, which peaked at $4.11 in July 2008, topped $3 a gallon in January for the first time since October 2008.
JOC Economist Mario Moreno estimates that U.S. consumer spending growth, excluding gasoline and other energy, is reduced $11 billion, or one-tenth of a percentage point, for each 17 cents that average gasoline prices for all grades rise above a base of $2.90 a gallon. He said if average gas prices reach $4 a gallon as they did in 2008, consumer spending on non-fuel purchases would fall $60 billion, or 6.5 percent.
And the energy costs are only part of an industrial equation that is seeing costs for various materials grow. World steel prices rose nearly 13 percent last year to $736 per metric ton as industrial demand grew, according to MEPS, an industry consulting firm that forecasts steel prices will exceed $1,000 this year.
The Industrial Price Index of raw commodities prices, jointly produced by The Journal of Commerce and the Economic Cycle Research Institute, reached a 53-week high the week of Jan. 21 after eight straight weeks of sequential growth and was up about 33 percent over its 52-week average.
Supply chain managers’ immediate concerns are focused less on the broad economic impact of rising fuel prices than on the immediate impact of carrier surcharges. Direct diesel fuel prices across the United States have grown on average 60 cents a gallon over the past year, pushing higher costs downsteam to shippers. Despite a general trend toward more transparency, carrier surcharges are based on formulas that vary widely among and within transportation modes.
Much of the criticism over ocean carriers’ surcharges has been defused by efforts of groups such as the Transpacific Stabilization Agreement, representing Asia-to-U.S. carriers, to switch to a simplified formula based on published prices for bunker fuel at key ports.
The TSA surcharge is adjusted every three months. For the current quarter, the surcharges are $328 per 40-foot-equivalent container from Asia to West Coast ports and $727 to the East Coast. That’s on par with the second quarter of last year but more than double the recession level in the second quarter of 2009.
After years of waiving fuel surcharges for many shippers, container lines were burned badly when fuel prices spiked three years ago. Now they’re enforcing surcharges for most customers, a stance many shippers seem to have accepted.
“Many shippers now recognize that fuel needs to float, and that carriers need to be able to cover their costs,” said Steve Horton of Horton Global Strategies, which negotiates service contracts on behalf of shippers.
Horton said, however, shippers don’t have to allow open-ended increases. “They can protect themselves with a clause saying that if fuel goes up X percent over the life of the contract, the shipper and carrier can have a mutual agreement to negotiate the contract,” he said. “Then if they can’t reach a mutual agreement, the contract can expire and the minimum volume commitment can be changed to the volume already shipped.”
Rising bunker costs have accelerated the trend toward slow-steaming, which carriers introduced on the long Asia-Europe routes in late 2008 to save on fuel and bolster freight rates by absorbing excess vessel capacity.
Slow-steaming is less prominent on trans-Pacific routes because there’s less opportunity for fuel saving than on the generally larger ships in Asia-Europe trade, and because adding a sixth ship to a five-ship trans-Pacific route requires a larger percentage increase in capital costs than going from eight ships to nine or nine to 10 in an Asia-Europe loop.
In the trucking sector, surcharges have long been a point of contention during rate negotiations between shippers, who complain surcharges are based in pump prices when most carriers buy fuel in bulk, and carriers who say they aren’t compensated for empty miles or local cost variations.
Most motor carriers use a formula pegged to a past price of fuel, typically $1.20 a gallon, with a surcharge that kicks in every time the government’s average price rises by a certain amount above that level.
When diesel prices soared in 2008, some truckload carriers absorbed more fuel costs into line-haul rates by raising the peg closer to current fuel costs. Others moved toward a zero peg that separates fuel surcharges for base rates. A few shippers and carriers negotiated tiered surcharges that reward carriers for increased fuel efficiency.
Herb Schmidt, president of Con-way Truckload, expects motor carriers to shore up their fuel surcharges in contract negotiations this year.
“We’re working diligently on our contractual fuel surcharges,” he said. “Any time fuel goes up rapidly, we’re behind the curve.” But higher fuel costs are a “short-term headwind,” he said. “As the price comes down, you heal. Over time, it’s neutral.”
Truckers feel the bite of higher fuel prices when they rack up empty miles — no freight, no surcharge payment. “Carriers have to get trucks loaded wherever they land (after completing a delivery), and bake something into the rates to compensate for empty miles,” Schmidt said. “We’re doing that in anticipation of higher fuel prices.”
Truck owner-operators have traditionally gotten the worst of fuel price-volatility. They’ve complained bitterly that truckload carriers and freight brokers have been slow to pass on surcharges, which leaves owner-operators exposed to spikes in pump prices.
Clowdis said the situation has improved somewhat. “As the owner-operators’ ranks have dwindled, some of the brokers and truckload carriers have learned they’d best pass on a portion of the surcharge pretty quickly,” he said. “It’s gotten a little better for the owner-operators, but it’s still a tough way to make a living.”
Rail shippers can also brace themselves for higher fuel surcharges. Union Pacific Railroad reported its fuel prices rose 20 percent in the fourth quarter of 2010 over the same period a year earlier. Its fuel consumption also grew 5 percent because of higher demand, pushing overall fuel costs up 27 percent over the same quarter the year before.
Major railroads use a mix of fuel surcharges. Some use both a traditional fee assessed as a simple percentage of revenue and a more complex mileage-based surcharge that can change monthly. Some are keyed to a weekly per-gallon highway pump price for diesel, while others track changes in crude oil prices.
BNSF Railway, for instance, uses both mileage and percentage fees. The surcharge formula follows the government’s average highway diesel fuel price. Although railroads buy their fuel in large volumes at lower costs, the widely watched federal diesel price report provides a standard for measuring weekly and monthly changes in fuel costs.
Other major railroads use different approaches. Norfolk Southern pegs its fuel surcharge to the per-barrel price of crude oil. CSX Transportation uses a highway price-linked surcharge on many shipments, but some customer contracts reference the per-barrel price. CSX’s intermodal fuel fee can change with as little as five days’ notice, based on highway diesel prices. UP bases some fees on mileage and some on highway diesel or crude prices.
When fuel costs spiked a few years ago, companies and consultants rushed to re-examine supply chain networks with an eye toward locating distribution centers where they could maximize intermodal and truckload service and minimize the use of more expensive less-than-truckload carriers.
“They looked at network redesign: Do we have too many distribution centers? Do we have too few? Are they in the right place? Those questions came up fast and furious in ’08,” Clowdis said.
In the end, he said, “There was more chatter than actual redesign of networks. The price didn’t stay up long enough for somebody to decide, ‘We need to open four more DCs at X million dollars each.’ But if the price goes up and stays up, that whole network-rationalization phenomenon will reoccur.”
Douglas Sowatsky, director of corporate logistics, transportation and compliance at Briggs & Stratton in Milwaukee, said his company regularly examines its models for total landed cost “to understand the impact of an increase in freight cost on our business, and whether we should change our sourcing.”
So far, he said, those studies haven’t led to changes. “We’d have to see some fairly high pressures before we made that kind of a move,” he said. “Typically, we’re going to look for at least 15 to 20 percent savings on total landed cost.”
Sowatsky said fuel surcharges usually don’t represent a huge percentage of his company’s finished costs, “but layer that onto your commodity costs such as copper and aluminum and steel, and it adds up.”
Larry Lapide, research affiliate at Massachusetts Institute of Technology, said as energy prices rise, logistics managers will have to adapt by finding ways to reduce fuel usage and expense. He said this means working with carriers on energy-efficient transportation and possibly absorbing longer lead times and higher inventory costs in exchange for fuel savings and environmental benefits.
“Energy prices go up and down, and the volatility hides the fact that the long-term trend is up,” he said. “We got spoiled by 18 years of cheap oil, and during the last couple of years people haven’t focused on this because they’ve had other things to worry about — like keeping their jobs.”
Contact Joseph Bonney at email@example.com.