Fuel holds the key

Not only will the recent spike in oil prices increase the operating costs of a carrier, analysts worry, but how will it impact freight volumes in the U.S.? The biggest risk remains freight demand degradation, said Benjamin Hartford, a transportation analyst with investment bank Robert W. Baird & Co., in the firm's monthly Freight Flow brief. Yet if that does not occur, the industry could conversely

Not only will the recent spike in oil prices increase the operating costs of a carrier, analysts worry, but how will it impact freight volumes in the U.S.?

“The biggest risk remains freight demand degradation,” said Benjamin Hartford, a transportation analyst with investment bank Robert W. Baird & Co., in the firm's monthly “Freight Flow” brief.

Yet if that “degradation” does not occur, the industry could conversely find itself sitting in an even better position to increase freight rates.

Baird's analysis indicates trucking's supply and demand dynamics reached near-equilibrium from October last year through January, then sharply tightened in February due to harsh winter weather and higher demand.

Thus, unseasonably tight capacity conditions could set the stage for healthy spot markets through the second quarter of this year. And that would support strong truckload rate improvement, per Baird's research.

But if freight begins to disappear as consumer demand retrenches in the face of higher fuel prices, it presents a much bigger problem for trucking as a whole, said Eric Starks, president of research firm FTR Associates.

“If [oil prices] start to slow the overall economy down, that's different. It won't even be an inflationary issue — it'll act like a massive tax increase,” he told Fleet Owner. “That would create a major ripple effect on trucking, putting a squeeze on freight activity and fuel costs [risings] simultaneously.”

It's a concern that even Federal Reserve Chairman Ben Bernanke addressed in testimony before Congress.

“The main risk from a price stability point of view would be if higher gas prices, for example, would start feeding into the broader [economic] basket,” Bernanke testified. “That would be the point at which we would become very concerned and make sure that we would take monetary policy actions to avoid any significant increase in overall inflation.”

Currently, oil prices remain high due to the political instability in the Middle East and growing demand around the world. Average gas prices passed $3.40/gal. last month, according to AAA. Ultimately, the upswing in oil prices translates into higher diesel fuel costs for carriers, said Baird's Hartford. And such a hike tends to create a near-term earnings headwind for truckload carriers, railroads, and “integrators” such as FedEx and UPS given the lag in fuel surcharge recovery. Yet it can provide an opportunity for LTL providers.

“Rails and integrators recover most of their fuel costs once a lagging fuel surcharge is applied,” Hartford noted. “Truckload carriers also face a lagging surcharge; however, these surcharges do not fully cover their costs. Ultimately, the higher fuel costs for truckload carriers disproportionately impact the smaller carriers, which could further accelerate the truckload pricing environment.”

The fuel price run-up puts more pressure on some smaller as well as less disciplined carriers given the rising expense/cash flow demands. And that can ultimately drive some carriers out of the market, Hartford said.

“For the remaining/surviving carriers, they experience near-term pressure to profitability given the lag in fuel surcharge recovery,” he added. “But over the intermediate term, the shrinking capacity pool due to rising fuel prices will enable carriers to increase rates — ultimately a positive for the industry.”

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