Fuel Management

Figuring Out Fuel Contracts

Fuel contracts give fleets a guaranteed price over the duration of the contract. The result: easier budgeting, potential cost savings, reduced administrative time, and guaranteed supply. With careful consideration on the front end, fleets of all sizes can make fuel contracts work in their favor.

June 2014, Government Fleet - Feature

by Shelley Mika

While cost savings isn’t guaranteed, it can be substantial savings if it happens.With a fuel contract, however, these fluctuations can become a thing of the past. Fleets using fuel contracts agree to a set price per gallon for a set amount of time — typically a year or two years. While gas prices fluctuate throughout the year, their prices stay the same. Sometimes that means a fleet wins, seeing lower-than-average prices per gallon over the course of the contract. Others may end up paying slightly more if fuel prices lower. But in either scenario, the fleet is guaranteed a price — and enjoys an easier-­to-manage fuel budget.

“Contracting a portion of your fuel is one of the most effective ways to save money on overall fuel costs. Since 2004, day-to-day price swings of 5 cents or more occur 25% of the time; given the significant market volatility, it’s increasingly difficult for fleet managers to keep fuel costs down,” said Ryan Mossman, vice president and general manager, FuelQuest. “Establishing an index-based (Argus, OPIS, or Platts) fuel contract is one way for fleets to better control their business operations.”

In addition to savings, a major benefit of fuel contracts is guaranteed supply. “If you have a contract, you can be protected during tight supply situations,” explained Denton Cinquegrana, chief oil analyst for OPIS.

“There will always be clauses for force majeure — hurricanes come to mind — but with a contract, more times than not the fleet will have a guaranteed supply.”

Based on your fleet size, fuel needs, and budgeting constraints, establishing a fuel contract could be right for you. Here are steps you can take to leverage a new fuel-buying strategy.

Fuel Contract Considerations

Whether your fleet is required to issue a request for proposal (RFP) or follow another formal bidding process — or even if you’re in the early stages of considering establishing a fuel contract — keep in mind the following considerations.

Know Your Need

Understanding your fuel needs is the best place to start. Take into account the size of your fleet, the number of fuel tanks you have on site, how much fuel you currently use, and how consistent your fuel usage is.

“Though there is no set standard or average amount of fuel to contract, it’s important for fleet owners not to overpromise to the supplier,” Mossman said. “Therefore, the amount of fuel specified should not exceed expected usage. This would result in costly fees for underlifting product, ultimately diminishing the cost savings of the contract.”

Cinquegrana suggested asking first if your fleet is big enough to warrant a fuel contract. Then, focus on specific fuel needs. “Fleets should ask themselves if they are buying enough fuel. Is your fleet growing or contracting?” he said.

Negotiate a Below-Market Price

Clearly, price is an important consideration when establishing a fuel contract. While there are no guarantees a fleet will save money per gallon over the course of the contract, you’ll want to negotiate a below-­market price.

Start with market indices like Platts, OPIS, or Argus. “Published market indices are great resources to leverage when attempting to ensure fleets are regularly getting a better-than-market price,” Mossman said. “Fleets should utilize an index for price discovery to gain transparency into the market and an understanding of the industry’s pricing assessment.”

Cinquegrana recommended reviewing several sources to gain a fuller understanding of the market. “No two markets are alike, and looking at the NYMEX futures screen is not enough,” he said. “Looking at oil prices does not tell the whole picture. Know where your fleet is operating and the physical bulk market it is attached to.”

Mossman warned not to rely on a supplier’s quote without doing your homework, or it could cost you. “It’s common in the industry to receive partial commentary on price type, so fleet managers should monitor carefully,” he said. “A supplier may say they will give you a quote based on a ‘rack average,’ but a statement like that is meaningless. Make sure the offer points back to a published pricing index. Not understanding the price ‘average’ could cost you up to two cents per gallon or more.”

Ronald Pruitt, equipment management coordinator for the Alabama Department of Transportation, helped establish the department’s fuel contract. Its 3,200 vehicles and equipment are fueled at state DOT pumps. “We have saved a lot of money. We average a savings of $0.26 per gallon for unleaded and $0.55 per gallon for diesel,” he said.

The City of Bowling Green, Ky., has a collective fuel contract. It partners with other agencies to purchase fuel in order to reduce costs. Photo Courtesy of City of Bowling Green.
The City of Bowling Green, Ky., has a collective fuel contract. It partners with other agencies to purchase fuel in order to reduce costs. Photo Courtesy of City of Bowling Green.
Consider Fuel Type

Your contract may vary based on the fuel type(s) your fleet requires, so Mossman said it’s important to pay attention to the product code specified. “Additionally, certain types of fuel have supplementary factors that should be accounted for within the contract. For instance, a contract for diesel fuel will require different specifications due to the fuel blend in winter weather,” he said. “Also, as every [diesel] engine built after 2010 now requires the addition of diesel exhaust fluid (DEF), some contracts could include a DEF price as well.”

Cinquegrana said it’s also important to ensure you’ll get the right product at the right time of year. “As it pertains to gasoline, I think the most important thing is having the correct Reid Vapor Pressure (RVP) delivered — higher in the winter, lower in the summer,” he said. “It’s also important to make sure the fleet is getting the correct gasoline if they are in a reformulated zone, like big cities and the surrounding areas.”

Proximity to Supply

As in real estate, location matters when it comes to fuel — and can have an impact on price. “It’s crucial for fleet managers to know their location relative to the fuel supply infrastructure. Understanding where your suppliers are getting their fuel from is important because if you understand that, you can negotiate the optimal deal for you and the suppliers,” Mossman said. “Additionally, consider how far up the supply chain you want to contract. The higher up you go, the more savings you’ll be able to achieve.”

Additional Supplier Requirements

Jeff Lashlee, PE, public works director for the City of Bowling Green, Ky., worked on a collective fuel contact with other agencies. He said he and his partners learned to clearly define acceptable performance in their agreement with the selected vendor. “In our case, the vendor must have the ability to provide a bulk delivery system as well as a local and out-of-town card system,” he said. “Other requirements were individual cards for each unit of equipment, 24/7 fuel availability, and a detailed reporting system. The availability of purchase data is very important in our fleet maintenance program and also provides a means of tracking user purchases. The ability to audit ensures proper usage of the system.”

Consider Collective Bidding

The State of Minnesota also heads up a collective fuel bid. In 2008, the state’s ­Materials Management Division (MMD) collaborated with several local governments to develop a state-managed fuel contract based on a fixed-price program in addition to the spot-price program the division had in place. The participants were all members of the Minnesota Cooperative Purchasing Venture (CPV) program.

In total, 56 metro area city and local governments and school districts participate in the current program. In all, they have 4,423,412 gallons of summer and winter blends of diesel and premium products guaranteed, as well as 4,475,485 gallons of 87 octane gasoline and 210,500 gallons of E-85.

Brenda Willard, assistant director, Department of Administration, Materials Management Division, said budgeting drove their desire to establish cooperative purchasing.

“The underlying goal was to create a ‘budget tool’ with which participants could better manage their available fuel funds,” she said. “Given the unpredictability of the fuel market, the program was not
intended to be a cost savings mechanism.”

To work out the details of the program, the State of Minnesota assembled a core team of representatives from the cities of St. Paul and Minneapolis and Dakota County to create a plan for how to best provide fuels at a fixed rate based on the program participants, offering specific quantities of the products it would commit to purchase monthly over a 12-month term.

From there, the team developed an RFP, which included the following:

  • Minnesota product specifications
  • Delivery requirements
  • Reporting, including a mechanism to track usage as well as provide market and industry reports and trends
  • Customer service programs
  • Total gallons by product type required for each participant by the month
  • Delivery locations and tank sizes for each participant.

Companies responding to the bid had to demonstrate they had experience with a contract of this size and the capability to transport large volumes of fuel within 24 hours of receipt of order.

In the RFP, Minnesota also established guidelines to which the potential supplier would need to adhere. “The pricing methodology that was utilized required the responders to provide the NYMEX settlement value on a specific day and time, and then provide what their sell price would be in different quantity categories, such as 500 gallon loads up to transport quantities, by product type,” Willard explained.

The program is now in its sixth year.

“While this was initiated as a budget tool, the program has been very successful and the participants have realized cost savings,” Willard said.

Worth the Effort

While establishing a fuel contract takes time on the front end, Mossman said the hard work pays off.

“Indexed-based fuel contracts can result in significant financial savings, regardless of whether prices are rising or falling. By establishing a fuel contract, fleets can expect to save approximately two to four cents per gallon. For the average 7,500-gallon load, this amounts to $300 in savings on just one load with this individual purchasing strategy,” he said.

“Additionally, if fleet managers pair an indexed-based price contract with other fuel strategies, such as automation, inventory management, or just-in-time delivery, they can potentially see savings of up to six cents per gallon, or over $450 per load.”

A Fluctuating-Price Contract

In addition to fixed-price contracts, fuel contracts can also have fluctuating prices. While this doesn’t solve the budgeting problem, there are other benefits, as the City of Bowling Green, Ky., has seen with its collective fuel contract.

The city participated in a collective bid, partnering with other agencies to increase volume and reduce cost. With a higher volume, the agencies also earned “preferred” status so their supplier provided fuel to them in the event of an emergency.

Jeff Lashlee, PE, public works director for the City of Bowling Green, Ky., said the bid started by clearly defining the collective needs of the partners. Representatives from each agency met to determine their needs, determining future purchases through past purchase history and forecasting future changes within fleet. They also met with known suppliers to better understand the market and available products and services. With input from potential suppliers and documented needs for the group, a request for proposal (RFP) was issued by Western Kentucky University, a partner agency.

“Our prices were based on an index with a fixed markup. Prices will change based on the index,” Lashlee said. “Price, accessibility, purchasing tracking, and auditing were all benefits to users and the agencies as a whole.”

Bowling Green’s contract includes an initial two-year agreement, with four, two-year options for renewal — 10 years in all. “We wanted to have a length that made vendors aware of our commitment. Yet, we want to have the option to end the contract if needed,” Lashlee said.

At a glance

Fleet managers considering a fuel contract should determine:

  •  How much fuel they can guarantee they’ll use
  • What pricing will result in equal or potentially reduced fuel costs
  • What types of fuel they need to purchase
  • How close they are to the fuel supply.


Sources: 

  • Denton Cinquegrana, chief oil analyst, OPIS 
  • Jeff Lashlee, PE, public works director, City of Bowling Green, Ky.
  • Ryan Mossman, vice president and general manager, FuelQuest 
  • Ronald Pruitt, equipment management coordinator, Alabama
  • Brenda Willard, assistant director, Department of, AdministrationMaterials Management Division, State of Minnesota

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