Fuel is one of those operational costs that can be difficult to predict. One month, prices may appear relatively manageable, the next however is a different story. For fleet managers, these fluctuations can quickly become more than a line item on a budget. When vehicles cover significant distances and fuel makes up a substantial portion of operating costs, even relatively small changes in the price per litre can have a noticeable effect on overall expenditure.
This is particularly relevant in South Africa, where fuel pricing is influenced by international factors. The country’s Basic Fuel Price is linked to international refined petroleum product prices and the Rand/US Dollar exchange rate, while other elements of the pump price include taxes, levies, margins and transport-related costs.
So, what can a fleet manager do when fuel costs are difficult to predict?
One option available to some larger fuel consumers is fuel hedging. By using financial instruments designed to manage exposure to future fuel price movements, businesses can potentially create greater certainty around a portion of their future fuel costs. However, fuel hedging is not as simple as predicting that fuel prices will rise or fall and placing a bet accordingly. It is a financial risk management strategy that comes with potential advantages, costs and risks of its own.
Fuel Hedging Explained: How Does It Work?
At its simplest, fuel hedging is a strategy used to manage the financial impact of future fuel price movements. A business that expects to purchase a significant amount of fuel in the future may be concerned about prices increasing before that fuel is required. Through an appropriate hedging strategy, it can use financial instruments to establish a degree of price protection.
The goal is not necessarily to achieve the lowest possible fuel price, instead, the goal is to reduce exposure to unexpected price movements and create greater certainty around future costs.
There are several financial instruments that can form part of a fuel hedging strategy.
- Futures: Futures contracts are standardised agreements traded on exchanges. They can be used by businesses with exposure to commodity prices to manage the risk associated with future price movements. For example, a business expecting to need fuel in the future could use an appropriate futures position to offset some of the financial impact if fuel prices subsequently increase.
- Swaps: A swap can allow a business to exchange a floating fuel price exposure for an agreed or fixed price over an agreed period. In simple terms, the business gives up some of the benefit it might receive if prices fall in exchange for greater protection if prices rise. Swaps can therefore be useful for businesses looking for greater certainty around future fuel costs, although the precise structure and terms can vary.
- Options: Options work differently because they provide a right rather than the same type of obligation associated with a futures position. A business can purchase an option that provides protection against an unfavourable price movement while retaining the ability to benefit if the market moves in a more favourable direction. The trade-off is that purchasing an option generally involves paying a premium. That premium is a cost of obtaining the protection.
- Forward contracts: Forward contracts can also be used to establish an agreed price for a future transaction. Unlike standardised exchange-traded futures, forwards are generally privately negotiated contracts and can be structured around the specific requirements of the parties involved. This flexibility can be useful, but it also means that businesses need to understand the contractual terms, counterparty exposure and risks involved.
Weighing Up the Benefits and Risks of Fuel Hedging
Fuel hedging can look attractive when fuel prices are rising, and a fleet is under pressure to control its operating costs. However, no financial risk management strategy is without trade-offs. Before considering fuel hedging, fleet managers and business leaders should understand both sides of the equation.
Benefits of fuel hedging
- Greater cost certainty: One of the most significant potential benefits is greater certainty around future fuel expenditure. If a business can reduce its exposure to sudden increases in fuel prices, it may be easier to plan budgets and forecast operating costs.
- Protection against rising prices: Fuel hedging can help protect a business from some of the financial impact associated with rising fuel prices. If the physical price of fuel increases after an appropriate hedge has been established, gains on the hedge may offset some of the additional cost of purchasing fuel.
- Improved budgeting and planning: Greater certainty around fuel costs can make longer-term financial planning easier. Instead of having the entire fuel budget exposed to unpredictable market movements, a business may be able to establish a more predictable cost base for at least part of its anticipated fuel requirements.
- Reduced exposure to market volatility: Fuel prices can be affected by factors well outside a fleet manager’s control. Global supply and demand, geopolitical events, shipping costs and currency movements can all influence fuel costs.
Disadvantages and risks
- You may miss out when prices fall: Protection against rising prices comes with a trade-off. If the market subsequently moves in the opposite direction and fuel prices fall, a business that has locked in a price or entered into certain types of hedge may not enjoy the full benefit of that decline.
- There are costs involved: Financial instruments can involve premiums, transaction costs, financing considerations and other expenses. For example, options involve a premium, while other instruments can involve their own contractual and financial costs. These costs need to be weighed against the value of the protection being obtained.
- Hedging can be complex: Fuel hedging is not simply a matter of deciding that prices are going to rise and locking in a price. Businesses need to understand the instrument being used, the amount being hedged, the timing of the exposure, contractual requirements and the relationship between the hedge and the actual physical fuel purchase. This complexity is one reason fuel hedging programmes are generally associated with organisations that have appropriate financial, treasury or risk management capabilities. IATA, for example, highlights the need to understand fuel exposure, financial instruments, risk management strategies and hedge counterparties when developing a fuel hedging programme.
- Over-hedging can create problems: A business needs to have a realistic understanding of how much fuel it expects to consume. If a fleet hedges substantially more fuel than it ultimately requires, it can create an exposure that does not match the underlying physical requirement. This is why effective hedging requires careful planning and ongoing management rather than simply attempting to secure as much future fuel as possible.
Building a Stronger Fuel Strategy Without Hedging
Not every fleet needs to, or should, participate in fuel hedging. Smaller fleets may not have sufficient fuel exposure to justify the costs and complexity involved, and other businesses may simply prefer not to take on the financial and contractual risks associated with derivatives.
That does not mean these fleets are powerless against rising fuel costs. In fact, before considering a financial strategy such as fuel hedging, fleet managers should have a clear understanding of where their fuel is going in the first place. Effective fuel management and fleet optimisation provide a practical starting point.
Start by understanding fuel consumption
You cannot effectively manage what you cannot see. Fleet managers should have reliable information about how much fuel vehicles are using and how that consumption relates to operational output. If fuel usage is increasing without a corresponding change in vehicle activity, it may be worth investigating what is happening.
Poor vehicle efficiency, inefficient routes, excessive fuel consumption, fuel theft, siphoning or fraudulent activity can all contribute to unnecessary fuel expenditure.
Monitor vehicles and fuel activity
Regular monitoring can give fleet managers a clearer picture of what is happening between fuel purchases. Rather than relying entirely on manual records or assumptions, real-time fuel monitoring can provide data that helps businesses identify unusual activity and better understand consumption patterns.
For a fleet already under pressure from rising fuel costs, this visibility can be valuable because it shifts the conversation from asking, “Why is our fuel bill so high?” to asking, “Where is our fuel going, and what can we do about it?”
Look for unnecessary fuel loss
Fuel optimisation is not only about negotiating a better fuel price, it is also about making sure the fuel a business has already paid for is being used as efficiently as possible.
Fleet managers can review areas such as:
- Unusual fuel consumption patterns
- Potential fuel theft or siphoning
- Vehicle or tank inefficiencies
- Fuel usage per trip
- Route efficiency
- Differences between expected and actual consumption
- Vehicle performance and maintenance requirements
These checks can help businesses identify opportunities to reduce unnecessary fuel expenditure before looking at more complex financial strategies.
Use data to make better operational decisions
Good fuel management should ultimately support better decision-making. When fleet managers have access to reliable information, they can identify patterns rather than reacting to isolated incidents.
For example, understanding estimated fuel usage per trip can help businesses assess routes and operational efficiency. This is where fuel monitoring technology can become an important part of a wider fleet optimisation strategy.
Creating More Control Over Your Fleet’s Fuel Costs
Fuel price volatility is not something fleet managers can control. International oil markets, geopolitical developments, supply and demand and currency movements can all influence the cost of keeping vehicles on the road. In South Africa, these influences feed into the country’s fuel pricing structure, making fuel expenditure particularly important for businesses operating fuel-intensive fleets.
Fuel hedging can provide a way for suitably positioned businesses to manage some of this price risk. When properly structured, it can offer greater certainty around future fuel costs and help reduce the impact of unfavourable price movements.
However, it is not a universal solution. Hedging involves financial costs, complexity and risks, and it does not guarantee that a business will achieve the lowest possible fuel price. It also does not itself guarantee the physical availability of fuel. Rather, it is a financial strategy designed to manage exposure to price movements.
For fleet managers who do not want to enter the world of fuel hedging, there is another practical route to better cost control: optimise the fuel you are already using. By monitoring consumption, identifying potential fuel theft and inefficiencies, understanding fuel usage per trip and improving operational visibility, businesses can work towards making every litre count.
That is where Landmark FuelSecure can help.
With over 15 years of experience and a focus on fuel management and monitoring, Landmark FuelSecure provides solutions designed to give businesses greater visibility over their fleet’s fuel usage. From real-time reporting to fuel monitoring and anti-theft solutions, the focus is on helping businesses understand their fuel activity and identify opportunities to manage it more effectively.
If you want to gain greater control over your fleet’s fuel usage, connect with Landmark FuelSecure today and discover how smarter fuel monitoring can support your fleet optimisation strategy.
Make every drop count.
Disclaimer
Landmark FuelSecure is not a financial services provider and does not provide financial, investment, trading or hedging advice. The information contained in this article is provided for general educational and informational purposes only and should not be regarded as financial advice or a recommendation to enter into any financial product, derivative, hedge or other transaction. Businesses considering fuel hedging should obtain independent advice from an appropriately qualified financial professional and assess the suitability, costs and risks of any strategy for their individual circumstances.
