Can shippers make truckload (TL) rates fuel surcharges less expensive by altering the way fuel surcharge programs are structured?
Fuel surcharges reflect fluctuations in prices at the pump. When prices rise above an agreed threshold, carriers receive a credit; when below the threshold, shippers are compensated. The fairness of this mechanism is the subject of much debate in the industry.
There are three main components of surcharge programs:
- The index
- The peg or base price
- The escalator.
Some shippers maintain that by judiciously selecting values for these components, they can cut the cost of surcharges and their total truckload rates (fuel surcharge plus line haul).
The reality is not so clear cut. Here’s why. In this post, we will look at the three components of surcharge programs and how manipulating them affects overall truckload rates.
The Index: Factors that Estimate Average Fuel Cost
There are a number of industry indexes that estimate what the average cost of diesel is at the pump. Choosing which index to use (and which fuel estimate to plug into the surcharge formula) influences the costs of these programs, argue some shippers.
The logic runs as follows. Every surcharge has a fuel cost level at which the program is neutral; there is neither a charge nor a rebate. This is called the peg, which I’ll explain in more detail later. When prices rise above this peg value, the shipper pays a fuel surcharge; when below, they receive a rebate. It follows that using a fuel price index with lower numbers on average makes it more likely that there will be a zero charge or a rebate (assuming the same peg is used). The lower estimate is nearer to the peg, so the effective increase in fuel price is less.
Does the theory work out in practice? In broad terms the answer is no, because it overlooks the bigger truckload picture. Basically, the gains shippers make in selecting a different estimate for fuel costs are negated by carriers’ tendency to compensate for these reductions by hiking line haul rates. This opinion is supported by research done at MIT.
Another argument used by the low-estimate camp is that the DOE (U.S. Department of Energy) National Average index—the industry’s standard measure for prices at the pump—is not an accurate yardstick of diesel costs. So, it is reasonable to use other indices. Truck drivers buy fuel in specific geographic areas or lanes, which may differ in price from the national average, they point out.
In reality, however, oil is a global commodity and its price fluctuates in response to various industry and geopolitical factors. While there is some local variation in fuel prices, in the long run, this variance remains stable.
The Peg: Selected Base Rate for Fuel
The peg is a floor rate for fuel. Credit and debit payments kick in when index prices fall below or rise above this number.
Some players maintain that raising the peg will result in lower surcharge costs for the shipper, because diesel prices are less likely to exceed the number that triggers a payment to carriers. Again, however, carriers will increase line haul rates if surcharge payments are reduced as a result of this tactic.
Historically, pegs have been set close to $1.20. But today, some shippers are moving either to a zero peg so that they can capture the total cost of fuel in a fuel surcharge, or to much higher pegs that significantly limit the amount of fuel surcharge. Either approach can work and should not change your total cost of transportation.
Escalators: The Implied Value for Fuel Efficiency
The escalator is an implied value for fuel efficiency. Will a shipper pay less in total costs (i.e. fuel surcharge plus line haul costs) by including a higher number for fuel efficiency in the surcharge formula?
The answer is: perhaps. While some research indicates that this is not the case, more recent work, also conducted at MIT and sponsored by C. H. Robinson, indicates that there are savings. The reason for this ambiguity is that the difference between, say, a fuel efficiency of 5 mpg versus 6 mpg might be negligible depending on how fuel prices are trending. In such situations, carriers may not deem it worthwhile to change line haul rates.
What do these observations mean for fuel surcharge programs? Well, these charges will continue to be a hot topic in the industry, but trying to save money by rearranging the components of surcharge programs is not the best use of your time. I believe that there are much more effective ways to trim truckload rate costs.
To learn more about fuel surcharges and how they work, download our truckload acceptance and pricing white paper.