Fuel cost increases diminish fleets’ buffer from weak shipper demand

The price of diesel is creeping up, threatening to put new pressure on trucking companies still grappling with a weak freight market.

Fuel is one of the trucking industry’s biggest expenses, with diesel making up anywhere from 30% to 40% of the average fleet’s spending, according to the American Transportation Research Institute, an industry group.

Diesel prices have soared more than 10% in the futures market since the Organization of the Petroleum Exporting Countries agreed in late November to cut oil production. Prices at the pump are climbing more slowly, but—at $2.49 a gallon this week—diesel hit a roughly 13-month high, according to the U.S. Energy Information Administration.

For truckers, this potentially marks an end to two years of cheap fuel that has helped them weather weak demand from shippers. Fleets typically pass along higher diesel costs to customers via a fuel surcharge. But that can be risky at a time when freight volumes are flat, giving retailers and manufacturers their pick of trucks to hire, particularly for small fleets that have less control over pricing. Shippers also can switch over to moving goods by rail, where fuel is a smaller piece of overall costs.

“Typically the smaller carriers can have very thin margins,” saidJason Seidl, an analyst with Cowen & Co. “Anything that cuts into that would leave them more vulnerable.”

Trucking companies say the jump in diesel prices is too small and too new to hurt their business; today’s prices are still about 50% lower than their all-time high set in 2008. Last year, fuel accounted for 25% of overall expenses, the lowest share since the ATRI began tracking truckers’ budgets.

“The one thing I’m not worried about for quite some time is the price of diesel,” said Dan Murray, the group’s vice president of research.

That could change if oil prices continue to climb. Over the weekend, non-OPEC producers, including Russia, agreed to reduce output, sending U.S. crude futures briefly above $54 a barrel for the first time since the summer of 2015.

Swift Transportation Co., the largest truckload carrier in North America, last week cited rising fuel prices as one factor contributing to its expectations that its 2016 profits would be at the lower end of what it had predicted. Other factors included the weak used-truck market and insurance expenses.

Smaller fleets could face a cash crunch if diesel prices soar. Truckers charge customers a fuel surcharge based on price of gas from previous weeks. The time lag works in their favor when diesel prices fall, but surges can lead to cash shortfalls for carriers because drivers spend more at the pump they recoup from shippers.

Diesel price spikes can trigger a wave of trucker bankruptcies, saidDonald Broughton, an analyst with Avondale Partners LLC who tracks fleet failures.

“Here’s what kills a trucker: Demand plummets and fuel skyrockets,” Mr. Broughton said. “When those two things happen, trucking companies go out of business en masse.”

For example, failures surged in late 2007 and continued into 2008, as the average price of diesel rose from just over $2.50 a gallon to more than $4.40 a gallon.

Truckers also run the risk of preparing for higher diesel prices too soon. Some large trucking companies insulate themselves from fluctuations in the fuel market by locking in the price they pay in advance, a practice called hedging. But such arrangements can work against carriers when prices fall, as they are stuck paying the higher amount while competitors who didn’t hedge see their costs fall.

Chattanooga-based Covenant Transportation Group Inc. hedges about 25% of its fuel purchases, sometimes years in advance, and recoups most of the remaining cost from shippers via surcharge. That strategy hurt the company after fuel prices plunged in 2014.

“We’ve been taking a hit for the past two years,” said Richard Cribbs,Covenant’s executive vice president and chief financial officer.

These days, he said, the company is no longer hedging as far out as it once did, though it does have some hedges out into 2018.

Write to Jennifer Smith at jennifer.smith@wsj.com

source: Wall Street Journal