Paraphrasing a song from Springsteen’s latest album, we do live in a land of hopes and dreams, but sometimes, reality must be considered as well.
We have just completed a winter with the highest (wintertime) prices ever, and had it not been for the extremely mild weather, it is hard to say how many (more) customers would have converted to another heating fuel. The futures market swings back and forth between reports of weak global economies and strengthening economies. It vacillates from increasing terror and nuclear caution all the way to prospects for peace. The underpinning reality for oil prices, as a global market, is simply that we just don’t know where prices are headed.
Though we all wish for world peace and thriving economies, we shouldn’t get carried away with those hopes. However, while there are causes for concern, the supply of oil is quite ample, the worst of the housing market catastrophe is behind us, and we may well be moving towards a time of global stability. With prices (NYMEX heating oil) having spent the last six months above $3.00/gallon, maybe we are poised to have the true economic realities (lots of oil and weak demand) bear their unintended fruit, in a sharp lowering of prices. Prices were “all the way down to” just above $2.00 per gallon just last winter, and that level should be viewed as an optimistic target for those who market, distribute and consume heating oil. I don’t know that we will get there, but if we rallied over a dollar during a time of economic uncertainty and warm weather, why would falling the same amount be out of the question?
Well, too much attention is placed on the fears that make our markets seem to be unpredictable, unsustainable and illogical (to say the least). Why do protests in Greece drive oil prices higher one day, only to seeing the same protestors “to blame” for dropping prices? Most of the support in oil prices is premised upon two things, and really only two things. Signs (and potential for) indicating improving economic situations is the first one. That, while a moving target, is a lot less volatile than the second. Weekly, monthly and quarterly reports of financial health rarely come as shocks, and more regularly reinforce bullish or bearish opinions. Rarely does an economic report stop prices on a dime and cause them to reverse.
On the other hand, the second “thing”—the terror/nuclear/ war triumvirate—causes unpredictability to be the norm. What will happen in Iran, Iraq or Korea has outsized implications on oil prices. What if the world’s economies had been strong over the last few months? What if we had a bitterly cold winter? Where would heating oil prices be? $4.00? $5.00? Higher? The fear in the marketplace is, unfortunately, the greatest fear of all—the fear of the unknown.
Though we might be just stating the obvious, and repeating what we have been saying for years…if your customers (or you) are hopeful—with good reason—that prices might fall, but scared—with good reason—that prices might rise dramatically, what can you do? If you allow prices to just float with the market, and charge a variable price to your customers, the “fear” scenario might cause even more attrition when customers leave for a better deal—a discounter, another dealer offering “a program”, or converting (never to be heard from again) to natural gas. If you push customers to fix their price of oil, in anticipation of a rally, but instead we have a winter that sees prices plummet (which, if you think about it, would be great—if accompanied by a good number of HDDs), how many customers will leave? How many will try to break their contracts? How many will be unhappy with you?
Caps DO—at a cost—offer the best of all worlds. You need to be honest and upfront with customers, as to the cost to offer a cap—it can be 25 cents per gallon, it can be 35 cents per gallon; however, if neither $2.00 per gallon nor $5.00 per gallon is unrealistic, is the “insurance protection” afforded by a cap not worth it? We have done many case studies that prove irrefutably that cap customers are both the most profitable AND the most loyal of all customers. Aren’t those the ones that you want?
The dead horse has been beaten about how awful this season was, when it comes to (missing) heating degree days. Coupled with the highest winter prices ever, this season was NOT the one that would be focused on in an effort to attract people to the residential heating oil industry. Given the financial results achieved by most dealers, it is hard to clearly pinpoint what should have been done differently, and what might just be “the way that things go.”
We can’t return to last summer to make some of the decisions that, arguably and with the benefit of hindsight, should have been made then, or at some point during the past six months. However, we can start to look at some things that should have been done differently, and—while we hope that we don’t have a winter like this for the NEXT 30 years—be prepared for whatever is thrown our way.
HDD protection. Regardless of prices, and in some ways regardless of the operational moves that you make, if the HDDs don’t show up, it will be hard to hit your numbers. There are and have been healthy discussions as to whether it is the HDDs per month, or if all that matters is the cumulative number for the year, but either way, when temps are well above normal over the winter, volumes consumed (and delivered) will fall. To combat lost HDDs, there are a number of hedges that are used by dealers. As with any type of hedge, there are those that are more appropriate than others, there are those that cut down on risk, and there are those that pretty much eliminate HDD risk. There is a clear need to assess whether an HDD in October carries the same weight as an HDD in January, but a review of your monthly financials, compared with your budgeted financials, should paint that picture fairly easily.
Pricing. Despite customer proclivity to conserve energy when prices increase, this past winter resulted in heating oil bills that were not really that high—even if ONLY because the consumption drop helped to offset the high prices. On the dealer level, you cannot simply look at the margin per gallon as a determinant of how you are doing. By delving into the numbers, you can actually have a much better idea of how to “tweak” the prices—short term, or spread over a longer term—to get back to the margins “Hedging, managing risk, insurance for your business— however you want to refer to it—cannot be done only when you KNOW it will be warm. You NEVER know.” that you need. Everyone is nervous over setting prices too high, but you really need to be even more nervous about not setting them high enough and ending up with losses during the few months a year that you actually are profitable. In addition, the likelihood of a customer switching to another dealer in the middle of the winter seems to be far lower than the likelihood of a “switch” in the summer or fall (when everyone else is lowering their prices just to bring on—unprofitable?—new customers).
Staffing. When does it pay to lay off seasonal employees? When does it pay to lay off full-time employees (or offer either group a flex-schedule)? The answer cannot be that you will wait until the season is over, and then realize what you SHOULD HAVE done! We have covered the value of data in prior columns, but simply stated, if your drivers are making as many stops as usual, but the average delivery size is 40 gallons less than it should be, something is wrong. AND something must change. Waiting for “the weather to turn” is usually not the right way to address this problem. Along with smaller deliveries and less usage, generally, are fewer service calls, fewer billing issues, etc.
The notion that there are some good years and there are some bad years, and that “everything comes out in the wash” is only good if that approach is the best that you have available. If you have the ability to monitor daily performance/production, and you can actually control the prices that you are charging customers, a lot of what happened to companies this winter doesn’t have to happen to you. If you adopt the attitude that, just the same as any other form of insurance and protection, you are very exposed to warm weather, you should seriously consider protecting against that inevitability.
Inevitability? Absolutely. Next winter might be extremely cold—how nice that would be!—but the winter after, or the one after that may again be very warm. Hedging, managing risk, insurance for your business—however you want to refer to it— cannot be done only when you KNOW it will be warm. You NEVER know. It has to simply become part of what you do. As with everything else, there is risk and reward in protecting against warm weather. However, before dismissing it as just too expensive, think of the expense this past winter by NOT hedging.
