A hedge against Uncertainty
Owens Corning takes a stand against unpredictable fuel costs with its new risk management program.
By John D. Schulz, Contributing Editor -- Logistics Management, 3/1/2006
Not so long ago, truckload shippers didn't take fuel surcharges very seriously. They didn't have to: As recently as 2001, surcharges represented perhaps 1 percent of a shipper's freight bill. But nobody is laughing now. As the price of crude oil has spiked to $60 a barrel and beyond, these once-insignificant costs have risen to 25 percent or more on top of the typical trucking rate.
In general, motor carriers peg their fuel surcharges to the average weekly price for a gallon of diesel fuel, as calculated by the U.S. Department of Energy (DOE). These closely watched numbers are issued in Washington every Monday, and virtually every trucking company in the country adjusts its surcharges accordingly. (For an example of the DOE's price information, see the chart on Page 37.)
But the Department of Energy's numbers merely tell shippers and motor carriers what the price of diesel was last week. They say virtually nothing about what the price will be next week, next month, or next year.
That was troublesome for Owens Corning, a world leader in building materials and composites that is best known for its pink fiberglass insulation. The company, which contracts with more than 300 motor carriers for some 400,000 shipments in North America each year, wanted more precise data about its future exposure to spikes in fuel costs.
In 2004 Owens Corning created a risk management team that is charged with forecasting the shipper's energy costs and expenses. One of the team's initiatives was the Diesel Fuel Hedging Project. That project's objective was to introduce more predictability to the company's fuel expenditures while allowing its motor carriers to recover their own rising costs through accurately calculated fuel reimbursements.
Forecasting the Future
In essence, the program lets Owens Corning "hedge" (protect itself from future financial loss) against volatility in diesel fuel prices. By analyzing pricing trends in the crude oil market, the company can more accurately forecast on-highway diesel prices and therefore get a better picture of its future transportation costs.
Now, instead of basing its cost projections on the DOE's weekly average diesel price, Owens Corning bases its forecast on the trading price for No. 2 heating oil on the New York Mercantile Exchange (NYMEX) over the most recent month, plus the cost of transportation, refining, and taxes. The risk management team believes that the NYMEX price for crude oil is a more useful measure because it is a reliable indicator of the future retail price of the refined product. (No. 2 heating oil essentially is the same as diesel fuel; its selling price therefore influences the retail price of diesel.)
"There is a very clear correlation between NYMEX, the price of refining, transport, and taxes, and the retail market," says John Gentle, Owens Corning's global leader, transportation affairs and processes. "You can start to predict with some degree of accuracy what the cost will be today, tomorrow, and the next month."
Because the shipper can't do anything about the price of oil, better forecasting and planning is the most effective step it can take to control fuel costs. "All you can do is manage the risk," says Energy Leader Greg Horvath. "You manage that risk by removing the peaks [in fuel pricing]. You also provide a foundation from which to set accurate budgets."
Toward that end, Owens Corning in January launched a new fuel-reimbursement program for its truckload carriers. Instead of paying a fuel surcharge set by the carriers in accordance with the DOE's average retail price, Owens Corning now pays a reimbursement rate based on its own forecast. Knowing what that rate will be on the first of each month positions the company with data that enables it to more accurately project its monthly fuel costs, Gentle says.
An important factor in fuel price hedging, Gentle says, is knowing how many gallons of diesel fuel its carriers will consume while hauling Owens Corning's loads. That figure is calculated based on a miles-per-gallon (MPG) formula agreed on by both shipper and carrier.
Convincing the Carriers
Once the fuel-hedging concept had been approved internally, the risk management team had to convince motor carriers to accept it. The first challenge the group faced was how to explain the technical workings of the NYMEX and the hedging-related accounting rules that would apply to Owens Corning in a way that would make sense to the motor carriers.
To help the team understand the trucking companies' needs, Gentle invited industry experts to share their knowledge of how fuel programs generally work in the truckload market. Understanding how the majority of carriers manage their fuel programs made the design phase of the new program much easier, he says.
Owens Corning called upon two of its carrier groups, the Dispatch Council and the Strategic Council, to evaluate the presentation it planned to make to its truckload carriers. The Dispatch Council works on tactical issues associated with the tendering process and the daily movement of freight, and the Strategic Council identifies future transportation-related problems and possible solutions.
The risk management team made the conceptual presentation to the 33 van, flatbed, and tank-truck carriers that participate in the Strategic Council. The presentation began with a discussion about how the NYMEX operates, then went on to explain the fuel-hedging and reimbursement program. The carriers had many questions and suggestions about the project.
"We listened attentively to the questions, concerns, and desires," says North American Carrier Relations Leader Jerry Ulm. "The sessions were invaluable because they not only pushed us to look for solutions to problems that we had perceived as being too difficult—and find ways of solving the problems in a manner that was more efficient—they also helped us to restructure our communications approach, text, and presentations."
The next phase was to announce the new fuel surcharge program to the carrier base. The team created a new "fuel-reimbursement appendix." This document explained the new program and introduced a change to the MPG formula—the medium used to translate the cost per gallon of diesel into fuel compensation per mile.
Using video conferencing at plants across the company, the project leaders explained how the new system worked and the role that its new Web portal, designed specifically for Owens Corning's carriers, would play in the management of the program. The portal provides carriers with information about tenders, contracts, rates, payments, load status, trailer pools, and other pertinent information.
A key concern for the carriers was whether the shipper's method of calculating fuel surcharges would fully compensate them for rising fuel expenses.
There was no cause for worry, according to Gentle, who says that two of the "guiding principles" of the fuel- hedging project were that carriers' compensation had to be no more or less than they had bee receiving before, and that the carriers would not incur extra costs. To prove that there would be no net difference between the old and the new systems, the presentations included calculations and comparisons of both the DOE and the NYMEX data.
Owens Corning assured its carriers that they would not be shortchanged. "The only thing people can do is trust you or not trust you," says Ulm. "We crafted communications and systems in our Web portal so they would be fair and equitable to all."
"It's really not magic … the correlations prove that," Gentle adds. "We feel that, armed with the right visibility and information, our carriers will begin to make fuel purchasing decisions in the future with more insight than they have in the past."
Carriers Accept Program
So far, the new fuel-cost hedging program appears to have been well received by most of Owens Corning's carriers. John Pope, president and CEO of Cargo Transporters, a Claremont, N.C., dry-van truckload carrier, predicts that the shipper's new methodology will work well for his company. He finds the information available at Owens Corning's Web portal, including comparisons to the old fuel surcharge program, especially helpful.
"The current system works, but obviously everybody wants to operate on their own program, or hybrid," says Pope, whose company has been a supplier to Owens Corning since the 1980s.
He's not opposed to that concept as long as shippers ensure that carriers are adequately reimbursed for rising fuel costs. "I don't think we're doing business with any shipper who's not 'making us whole' on fuel," he says. "It's such a huge expense, we can't afford not to anymore."
It's too soon to tell whether other shippers will decide to implement similar fuel-hedging programs, but Pope expects adoption is likely to be limited. "You have to have a fairly sophisticated shipper to manage the program and not hurt your carrier base," he observes. "For other companies to make the program work, they're going to have to have the resources of an Owens Corning and the commitment to make the program work."
John Gentle, on the other hand, foresees more shippers taking similar approaches to managing their fuel-cost risk. "As CEOs and CFOs read more about this and discover the true costs of the uncertainty of the current system, more will get on board," he predicts. "There is tremendous value to the company in terms of financial recovery and visibility."
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