Fuel costs are on the rise – what’s the impact for your supply chain?
According to an article by Jack Farchy in the Financial Times, oil prices have reached an eight-month high at $121 dollars per barrel and this trend does not seem to be about to change with current tensions in the Middle East. Did you ever wonder how much of that translates into a direct supply chain cost impact? Let’s take a closer look.
Freight providers are naturally the first to feel any fluctuations in fuels prices and they need to protect themselves through their pricing models. To do this, many impose fuel surcharges or escalators which are adjusted on a regular basis (usually monthly) to pass on higher (or lower!) costs related to the purchase price of fuel.
Most major companies take the published price of fuel in the local country or region and then use it on a scale to apply a percentage escalator (or more commonly known as a surcharge) to the base freight charges. The escalator is based on the percentage of fuel that will likely be used to provide the service. For example, fuel represents a much higher percentage of total cost for air freight services than it does for trucking. As a result the escalator for air freight services will be much higher than for trucking services.
However, fuel surcharges and service prices are not calculated in a universal manner. For example, all major freight providers have their own fuel escalators. An understanding of total service price requires knowledge of both the basic service price and the fuel escalator rules. Each fuels surcharge system must be investigated carefully to understand the ultimate impact on the costs of freight.
Let’s take a look at the escalator of UPS Express Critical Service, an air freight service. As demonstrated below, UPS Express Critical Service’s escalator is based on U.S. Gulf Coast Kerosene-type jet fuel prices.
(USGC) kerosene-type jet fuel historical prices
Source US Energy Information Administration
Clearly there has been a steady increase in these jet fuel prices – which have essentially doubled over the last year. But what does this mean in terms of the fuel escalator on the basic price of freight?
The below graph illustrates that as the fuel prices increase, the percentage fuel surcharge that applies will increase on a defined scale. Many providers will also provide bands for price stability within which fuel prices can fluctuate without driving a change to the escalator percentage.
UPS Surcharge Example
So what things should we look for in the surcharge system?
- What fuel and pricing mechanism is the surcharge based on?
- How often are the prices reviewed? (monthly, quarterly)
- Are they based on the costs of the previous month or an average of three months?
- What is the method of application of the surcharge?
- Are the bands small or large?
- How does the surcharge system change at different price points for fuel?
The cost of fuel can have significant effects on your supply chain. Understanding that impact is important as there are business levers that you can deploy to as the impact gets larger – network optimization, packaging redesign, postponement, changes to mode, etc.
Do you know what a further 20 percent increase in fuel costs would mean for your supply chain?