Fuel Solutions: Shelter from the Financial Storm

Vessel operators seek protection by hedging fuel needs. It’s easier than you might think. 

Some workboat operators defend themselves against higher diesel prices by buying futures contracts, while others purchase fuel at prices fixed in advance from their suppliers. Others, perhaps less-savvy and/or smaller companies, however, take their chances by buying in the spot market. While some operators are uncertain about their future fuel requirements and consumption, domestic ferry operators for the most part know exactly what they’ll need in the year ahead. For these passenger vessel and commuter ferry outfits, the need to protect themselves against fuel spikes can lead to creative solutions – like, for example, ‘hedging’ when purchasing bunkers. It’s easier than you might think.

Options
When it comes to defending your operating budgets and, at the same time, sparing paying passengers the pain of sudden fare increases, you do have options. In February, we asked Richard Larkin, president of Hedge Solutions, Inc. about workboat operators and hedging. His Manchester, NH-based firm provides risk management to fuel users, distributors and retailers. One client is The Steamship Authority in Massachusetts, the largest ferry service operating between Maratha’s Vineyard, Nantucket and Cape Cod.
“Our vessel operator clients use ultra-low sulfur diesel fuel,” Larkin explains, adding, “All vessels need to adhere to federal diesel-program regulations. But right now we have a patchwork quilt of federal and state regulations.” Low sulfur and ultra-low sulfur diesel, or ULSD, is being phased in for non-road, locomotive and marine or NRLM engines from 2007 to 2014, according to the U.S. Environmental Protection Agency. Those changes, along with new pollution-control technologies, will cut emissions from engines by over 90 percent, the agency says. The changes will also cost operators money, as it is more expensive to produce ULSD and the new hardware solutions also come at a premium.

Hedging, Fixed Price Contracts & Surcharges … Oh My!
ULSD prices rose to $3.15 a gallon last August and have since eased a bit. Fuel prices remain volatile, but even now, only a small percent of U.S. workboat operators hedge their costs. “My finger in the wind guess is it’s less than 10 percent,” Larkin said. “A lot of operators view hedging in futures as mysterious, and it makes them nervous. We’re trying to demystify it, to get them to use hedging as a way to control their budgets.”
Larkin discussed the ways vessel operators can protect themselves against higher fuel. “The ones that hedge use the Chicago Mercantile Exchange’s (CME) Nymex ULSD futures contract for paper hedging, or else they’re facilitating their hedging through fuel suppliers with fixed-price contracts,” he said. “They tend to buy further out on the calendar in the Nymex market and well into the future.” CME New York Harbor ULSD futures are traded in all calendar months, going out four years.
“Vessel operators, like The Steamship Authority, are planning a year in advance,” Larkin said. “A user might be long a futures contract, or buying call options, with the expectation of buying physical diesel down the road.” One CME Nymex contract is 42,000 U.S. gallons or 1,000 U.S. barrels.
A user’s hedge plans might be made when the company decides its next annual budget. “We often meet with companies then,” Larkin explained. “A company might draw up its annual budget in the winter and will make its hedge plans a year in advance. They’re looking at a price point, asking where risk exists for them. They look at futures prices and try to plan around them.” But given the market’s volatility, “timing-wise, one never knows when prices will be advantageous,” he added. For The Steamship Authority, he says, “we plan during their lowest volume months in the winter, before the high-volume summer months, which have the biggest impact on them,” Larkin said.

Hedging 101
Hedging in futures can be done a number of ways. “One approach is to use perpetual hedging twelve months forward, doing it on a rolling-forward basis,” Larkin said. When a futures contract is about to expire, the position is moved into a more distant month. Being unprotected against fuel price surges can hammer a firm. “A tugboat company that isn’t hedged, or doesn’t have a fuel surcharge, quotes someone a future job, then fuel prices go up,” Larkin said. “An unhedged OSV operator quotes a job and fuel prices rise. A ferry service that isn’t hedged may have to raise ticket prices at the last minute because of higher fuel.”
And surcharges don’t necessarily work in the marine industry. “In some cases, when a user tries to offset an increase in fuel prices with some kind of surcharge, the surcharge isn’t enough,” he said. Then too, operators employing a customer surcharge must decide whether to remove it if diesel prices retreat. For any vessel operator who relies on a surcharge, however, “there are ways to hedge it, and things you can do to augment it,” Larkin said.

Fuel: Big Expense for Ferry Operators
Wayne Lamson, general manager of The Steamship Authority, said the service’s biggest annual costs are wages and employee benefits, fuel and insurance. “Fuel, including the cost of hedging, has accounted for 9 to 10 percent of our annual expenses in recent years,” he said. “We started using Hedge Solutions in 2009 after trying to do our hedging in house. We were concerned when crude oil reached $150 a barrel in 2008.”
The Authority knows about how much fuel it will need in the year ahead. “After working on our annual budget each fall, we set our ticket prices in the winter for the next summer,” Lamson said. “We don’t use customer surcharges. Customers start buying their ferry tickets for the summer early in the year.” As for the fuel it uses, The Steamship Authority switched to ULSD five or six years ago. “We’re long two Nymex contracts, so we’re about 90 percent hedged,” Steamship Authority treasurer and comptroller Robert Davis said. “Although hedging has been a net cost to us in recent years, we’re protected if something happens to fuel prices on the upside. It’s like having fire or health insurance; you’re covered during adversity.”
Meanwhile, at Washington State Ferries, the largest such service in the United States, fuel is the fastest-growing, operating expense. Fuel accounted for over 29 percent of its fiscal 2011 to 2013 costs, versus 12 percent when the decade began. “In FY12 and FY13, we locked in prices in advance on 10.8 million gallons of fuel or about 50 percent of fuel consumed,” WSF deputy chief Jean Baker said. “We did this with our fuel supplier through fixed-price physical contracts. The prices we paid were less than what we’d budgeted for those gallons.” Savings, in this case, were considerable.
Fuel used by WSF isn’t hedged in the futures market now. “We’re working to get financial hedging contracts in place,” WSF spokeswoman Joy Goldenberg said. Lamson said The Steamship Authority will have another ULSD-fueled ferry built soon. When asked about LNG, he said it’s the vessel fuel of the future. “LNG is popular in Europe, and we’ll be considering it down the road,” he said. LNG is used to fuel ferries in Norway, Japan and Argentina.

Peace of Mind
Hedging strategies aren’t free, but buyers can choose from a wide range of brokers and/or consultants to get the job done. Larger operators with a bit more wherewithal might even get the job done in-house, if their operating budgets allow for that kind of staff expertise. For those who choose an outside service, Richard Larkin says, “Fees are all over the map and depend on the size of the hedge program, and on how many hours a broker or consultant assists on it,” Larkin said. “Fees usually come in anywhere from a quarter of a cent to a penny a gallon, depending on the work involved.”
A vessel operator who negotiates a reasonable fee with a hedge manager and has a price-protection program in place has peace of mind if diesel prices suddenly spike. A ferry service that’s hedged doesn’t have to ask customers standing at the ticket counter to cough up higher fares. And, a professional boat delivery service can safely quote a fixed price contract without worrying about a fuel increase eating the entire profit margin. ECA’s, increasingly low sulfur bunkers and a dozen other variables can negatively impact your fuel purchasing power. Today, and for those employing hedge strategies, price doesn’t have to be one of them.

(As published in the March 2014 edition of Marine News - www.marinelink.com)