This story originally was published by FreightWaves in October 2017 and remains particularly relevant in the current supply chain environment.
Fuel surcharges have a long history in the transportation industry, dating back to the Arab oil embargo in 1973 by most accounts. While the early days of surcharges were straightforward to calculate – although wholly unfair to shippers in many cases – that is no longer true.
In the 1970s, the Department of Energy (DOE) set up a fuel surcharge formula to compensate carriers for wild swings in diesel fuel prices. According to Timothy D. Brady, a consultant to small trucking operations and owner-operators who runs TruckersU.com and also spent more than 20 years as a driver himself, the fuel surcharge was a flat 15% fee based on the linehaul charge.
Shippers who moved high-value goods were overpaying as result, Brady notes, explaining that a truck hauling a $10,000 load of electronics was getting $1,500 in a fuel surcharge but a truck hauling a $1,000 load on the same route to the same destination would receive $150 in fuel surcharge payments.
Eventually, the flat percentage disappeared, and what the industry has been left with is a variety of calculations to determine the fuel surcharge.
The American Trucking Associations, Truckload Carriers Association, Owner-Operators Independent Drivers Association (OOIDA) and others all provide calculators. “And then each carrier sets its own formula,” Brady says. “The best way to manage your cash flow is to have your fuel surcharge right on the money.”
Doing that, though, is easier said than done, as contracts are locked in for months or years at a time and fuel prices change by the hour.
“If you get in a situation where diesel goes up 50 cents in a week, and the hurricanes were a perfect example of this, and the fuel surcharge changes each month, then those carriers are not covering their cost of fuel,” Brady explains.
So what is a fuel surcharge and how does it work?
“A fuel surcharge is a way of adjusting the amount paid to move freight by taking into account significant variation in fuel prices, compared to historical levels. It is a method for sharing or transferring risk,” explained third-party logistics provider C.H. Robinson in a December 2016 whitepaper.
A fuel surcharge typically includes three components: a base fuel price, a base fuel mileage, and the source and interval of the current fuel price. For example, if the base fuel price is $1.25 per gallon, the base fuel mileage is 6 mph and the current price of fuel is $3 per gallon, the fuel surcharge is 28.6 cents per mile (the sum of the current fuel price minus base fuel price divided by 6).
The real confusion is that no two carriers, it seems, calculates this the same way. Some don’t use the DOE’s average but rather something called the Petroleum Administration for Defense District (PADD), which splits the nation into five districts.
Every fleet has different operating characteristics and larger fleets have fuel agreements in place with providers to purchase fuel at a discount. Some change their fuel surcharge daily, some weekly, and some monthly. To calculate the rate, some fleets use a base rate, others may use a ratio or a percentage calculator.
Whatever method used, the end result is confusion for shippers and carriers and owner-operators who are constantly defending their fuel surcharge program while simultaneously trying to ensure it covers their fuel costs.
“When companies use a percentage fuel surcharge, lanes with high rates per mile (typically over $1.50) will tend to move more than they should as the price of fuel fluctuates. Low rate per mile lanes will not move enough to cover the increase or decrease in fuel, resulting in over or under payments on a by-lane basis,” C.H. Robinson’s white paper explained.
As confusing as this sounds, it is equally confusing to many in the industry, which is the reason why there is so much disagreement over what the fuel surcharge should be and how best to use one to your advantage.
Brady explains how a fleet might typically handle a fuel surcharge: On Monday, the fleet’s fuel manager looks at the average DOE price of fuel from the previous week and sets the fuel surcharge for the coming week accordingly. However, in this scenario, the fuel surcharge is based on a historical number. If fuel goes from $3.50 a gallon to $3.55 a gallon in the current week, the fleet’s fuel surcharge is a penny per mile too low, Brady argues. The fleet is always playing catchup. The opposite is true if fuel prices go down, except it is the shipper that is now overpaying and expecting a rebate.
Whether prices go up or down, what is not happening is a real-time charge – it is always historical, and that can create cash flow problems for carriers who do not understand that aspect of a fuel surcharge.
“When fuel increases, it usually increases at a much quicker rate than it decreases,” Brady says, “which really puts the trucking company behind the fuel eight-ball.”
Brady is an advocate of setting a “fuel cost adjustment policy” (FCAP) rather than using a fuel surcharge. An FCAP is a per-day rate for the truck and driver that includes both the operational cost of the equipment and fuel cost.
“For example, for a truck getting 6 miles per gallon, for every nickel increase or decrease in the price of fuel, the FCAP is adjusted by a penny per mile,” Brady explains. “If your fuel cost per mile is 67 cents per mile at $4.01 per gallon, and the price for fuel goes to $4.06, the rate per mile for fuel would increase to 68 cents. If it went to $3.96 per gallon, it would decrease to 65 cents. Place the trucker’s pay and carrier’s profit in the per day truck use rate and have the real-time fuel and operational costs as add-ons to the per day truck use rate for actual miles driven.”
Another approach is to leverage technology to get a more accurate picture of fuel usage and cost. Breakthrough Fuel offers a solution that calculates the actual price of fuel paid by carriers on each move. The company, which focuses on transparency in the process, uses data to create what it calls “Fuel Recovery.”
“Unlike an Index-based surcharge program, Fuel Recovery accounts for the time, tax, price, and geography specific to each shipper’s individual freight movements,” the company explains. “Fuel Recovery calculates the cost of fuel accordingly so shippers can be certain they are reimbursing their carriers a fair amount.”
The solution is designed to eliminate distortions such as fuel taxes, which differ by state, and geography, and can have a significant impact on the cost of fuel.
If you eschew the technological approach and choose to maintain a fuel surcharge program, it’s important to remember that a surcharge is really a historical charge, so proper budgeting is important. The charge you are receiving for the load you are hauling today may not cover the cost of fuel for that load and carriers that fail to properly account for all their fuel costs can easily slip into financial trouble by charging rates that are too low their expenses.
Fuel surcharges, though, have a benefit for fleets running fuel-efficient equipment. Since the surcharge is generally based on a set mpg rate for a truck – say 6.5 mpg – a fleet or driver who achieves higher numbers will actually make money off of the fuel surcharge. Shippers know this, of course, and will try to increase that base number when negotiating a contract.
If you operate in an area of the country where fuel prices are typically higher than the weekly national average, you need to consider that when negotiating a fuel surcharge. If the surcharge is based on the national average, you are likely losing money on your surcharge program. In this situation, it may be best to switch to a different baseline – perhaps the PADD average for the region you operate in, or consider a program such as Breakthrough Fuel’s that uses a more data-centric approach to generate actual fuel costs.
Surcharges remain a crucial tool for carriers to protect themselves against fuel price increases over the life of a contract. Negotiated correctly, the fuel surcharge should not cost the carrier any money, but could turn a little profit. Done improperly, though, and a carrier could be burning through thousands of dollars a year.