Consider Contracts to Save on Fuel
January 17, 2016
Written By Tim Danze
By the time you read this column, you may have heard the news about OPEC’s recent decision to cut crude oil production. I have to give OPEC credit; I did not think it would be able to pull off this historic agreement to limit its members’ crude output. The details of this agreement are still being questioned and analyzed, but the bottom line is if OPEC and non-OPEC members can work to scale back production as they have agreed, supply and demand will begin to rebalance at a faster pace.
Oil prices rallied approximately 15 percent in the days followings OPEC’s announcement. Historically, winter and early spring present the best opportunities to lock in cheaper fuel prices through contracting, and that may be especially true this year in light of the OPEC agreement.
Ivan Glasenbeg, CEO of Glencore, one of the largest global natural resource commodity companies in the world, said the oil market will be at the mercy of a “cat and mouse game” between OPEC and its shale-producing rivals in the United States during 2017. The market rally in crude delivered an opportunity for U.S. frackers to hedge or sell forward production for 2017 and beyond, to increase their coffers against possible future price declines.
OPEC will have to prove its members are capable of following through on their pledge to reduce crude production for any of this to matter.
In its Short Term Energy Outlook Report, the U.S. Energy Information Administration said, “The extent to which (OPEC’s) announced plans will be carried out and actually reduce supply below levels that would have occurred in their absence remains uncertain.”
According to the consensus opinion of 260 energy professionals who were informally surveyed, OPEC will achieve some, but not all, of the agreed-upon production cuts. The respondents expect OPEC will lower its output to about 33 million barrels per day in January 2017, down marginally from 33.6 million barrels per day in October, but well above the target of 32.5 million barrels per day.
If OPEC is able to make the cuts it pledged, the market will respond. I do not want to create a panic, but fuel contracting may be even more prudent now than in past years given the circumstances. There are still plenty of questions to be answered, but the season is at hand and if the market price is in your budget range, it’s probably a good idea to lock in pricing on a percentage of your future fuel needs.
MFA Oil Company offers customers the opportunity to lock in a fixed or maximum price on future diesel or gasoline purchases. These options are helpful for budgeting fuel expenses and managing risk.
Here’s a quick overview of the two contract options:
A fixed price contract can be purchased for a single month, a few separate months or a block of consecutive months to lock in a price for a given timeframe. The best way to think about these contracts is to look at them with respect to your budget or at what price you need to run a profitable business, farm, etc. We all want to buy the low in the market, but it’s extremely difficult to time the market perfectly. Instead, I recommend determining the fuel pricing level that enables you to operate profitably and then locking in a price as close to that level as possible.
Maximum price contracts can be purchased in similar increments as fixed price contracts. You will still be locking in a fixed price, however, for a fee, you can participate in lower prices should the market move lower. Think of the fee like an insurance premium. It gives you protection should fuel prices drop considerably, allowing you to buy at the lower price at the time of your delivery.
The MFA Oil fuel contract program offers pricing for 12 months into the future. The contract program is flexible and relatively simple. All you need to do is determine which months make sense for price protection, the number of gallons you think you will need and a good sense of what price you need to be profitable.
Your goal should be to lock in a price on a percentage of your projected needs. You are likely to never buy the low, so work to lock in a price that best fits your budget.
Because fuel prices tend to trend lower near the end of the year and early into the new calendar year, that’s when you typically find the best opportunities to put price protection in place.
Another thing to consider when deciding on futures contracts is that you will likely pay more than today’s prices. It is rare that you can lock in forward contract prices at lower values than current ones. Futures pricing factors the current spot price, time until delivery, risk-free interest rates and storage costs. In other words, futures have the volatility and risk of the market priced into them.
The decision to buy a fixed price or a maximum price contract is a personal decision that should be weighed with regard to your business’s fuel needs. Signing a contract can make budgeting easier, provide potential cost savings, reduce time spent shopping around and guarantee supply in case of a fuel shortage.