Fixed-Diffs: Making program gallons more predictable…

Written on: May 8, 2013 by Phillip J. Baratz

As a general rule, the most profitable and most loyal customers that a heating oil dealer has are those who participate in price-protection programs. Whether it is the programs that the dealer offers that makes for loyalty, or simply the nature of customers who select programs in the first place, is a matter of conjecture. However, knowing that your most loyal customers are ones who also allow for steady and predictable margins is a very good thing.
While bearing in mind the value of the price program customer, and at times bemoaning the challenges of those customers who are not on pricing plans (the “variable” or “rack-plus” customers), there are some challenges which can be faced by dealers in adhering to the program agreements, while still achieving desired profitability. When dealers offer programs, there are a number of assumptions that are built into those offers. The most important of which, depending upon whether the offer is for a fixed-price sale or a capped-price sale, is how to actually buy the product that will eventually—IN THE FUTURE—be delivered to customers at a price that will allow for the desired profit margin.
There are several methods of buying, and each has its own potential benefits and drawbacks:

•  You can buy oil and put it into storage. The benefit is that you absolutely know the fixed-cost of that product. The downside is the expense of purchasing product (and possibly the hedging) potentially many months before delivering the oil.
• You can fix your price with a supplier, and lift the product at that fixed price, during the winter months. This is a preferred method by many, but does come with it the risk that the diff that had been locked in many months before will simply be well higher than the diffs available at that time.
•  You can buy oil at the best rack every day. That has the definite benefit of comparative shopping (at least being able to compare the prices of the suppliers with whom you have credit), but also has the risk of everyone’s diffs being well higher than where you “thought” they would be.
• You can fix your diff, and pull rack gallons, at your discretion, each day—indexed to THAT DAY’S Merc (of Platt’s) price. This is a more common choice for larger dealers, and it does come with the same risks of “maybe there is a lower diff out there” that other methods have.

Graphic Copyright 2013 Bloomberg L.P.

Each choice then needs to be considered when planning for both your program and your non-program gallons. Then, it needs to be further refined when considering the possibilities— greater in certain areas than others—of supplier outages, and variances in the weather/demand part of the equation.
This past year, whether from the ULSD change in New York State, or the result of Superstorm Sandy, diffs varied more than any time in recent memory (variance of particular rack to Merc, from Nov.-Feb. See attached chart). As the industry all-too-often (over)reacts to the most recent occurrences, there will, no doubt, be a rush to fix prices and diffs on many more gallons than were done for this past winter.* What we are finding is that the notion of fixing the diff, however you decide to get it done, should definitely be a part of any purchasing plan, and you need to shop around and seek suppliers who can help you get what you are after.
The “need” for the fixed diff supply is most prominent in order to supply program gallon customers, but not nearly as important for variable customers (let’s face it, when in a bind, the variable customer is the one who ends up taking it on the chin, price-wise, anyway). However, protecting the costs of variable sales via fixed diffs can have some clear benefits as well—though, perhaps, not enough to protect 100% of the variable sales. Though you certainly can push the envelope on margins with variable customers, all too often, dealers end up playing catch-up after changes in diffs take a bite out of their profits. Scrambling to “make up” lost margins on those variable accounts is also part of the reason that “variables” are the most likely to shop for other dealers. So, while your fixed-diff needs are not the same for variable customers as for program customers, serious consideration needs to be made there, as well.
Hedges generally tie-in best with fixed diffs, and that would be another reason to consider shying away from them (i.e., no hedge needed) for variable sales, but in certain areas, if the variances in the diffs is so pronounced, then you might want to consider fixing a bit more than simply for your program gallons.
The retail heating world has changed. There is no longer that same allowance for variances to planned margins or other budget items. Though perhaps a broken record (CD? MP3? Vine? Harlem Shake?), working to set up a budget, and finding a way to best adhere to that budget, may be the single biggest planning task that you can undertake in the “off season”.

*Contrast that with dealers who, coming into this winter, thought that a cold winter was something that could never happen again, in the aftermath of the winter of ’11-’12, and shied away from committing to too many gallons.