Planning my Profits—the new Realities

Written on: June 19, 2013 by Phillip J. Baratz

Coming off a season that—unfortunately—had consistently high prices and Super Storm Sandy, but also —fortunately—had “normal” weather, it’s time to take a quick breath before planning for next year.
Okay, that was long enough!
This summer will likely be filled with the standard summer issues:
There will be the never-ending customer retention challenges, while battling natural gas utilities, and the much nastier purveyors of low-ball offers (I have spent enough time on that soap box recently, so I will just let it go—for now…) from your heating oil compadres.  Suffice to say that avoiding the economic realities of “gross attrition versus net attrition” is not the secret sauce to repeatable profitability. You must always be marketing yourself, especially to existing customers.  If you counted on the earned margins only from new customers, well…you would not be reading this article, since you would be out of business.
Pricing programs
You are going to have to make decisions about when, how and at what price to offer your pricing programs.  One thing that we have seen changing a bit over the last few years is that too many capped programs (historically, the absolute best program for customer retention) have morphed into fixed-price programs as prices have stayed steadily high.  While the logic may well be that prices COULDN’T be lowered, we can’t help but wonder whether some caps are not being hedged properly, and therefore, are truly FIXED from Day One, or—more likely—the value of the cap is not being properly conveyed.  If you are not communicating with your customers to tell them that they were protected against rising costs (which they were), but were also in a position to take advantage of lower prices, in the event of a fall in prices, then why should they choose the cap again?  Bear in mind that most do “re-up” for the cap, but simply assuming that customers understand the benefits of what you do—be it a cap, or a budget plan, or a service contract—is another recipe for having customers shop around.  That is something that most marketers (aside from the aforementioned “nasty purveyors”) do not want.
How many parts per million?
Last summer, oil dealers in New York had to face a new challenge.  The state-mandated change to the 15 ppm ULSD that went into effect in New York on July 1st, 2012  was anticipated, and (mostly) prepared for. Although the NYMEX/CME contract that was intended to be used to hedge oil purchases and sales was for a different specification of heating oil (2000 ppm), the consensus was that there would be a new futures contract to replace the “old” contract, and the basis risk*.  That “new” contract turned out to be a revision of the “old” contract, and the exchange changed the specifications to match those of the supply that is mandated in New York State, effective with the May 2013 futures contract.  So, during this past winter, heating oil dealers had to deal with the extra (and expensive) nuance of the uncertainty of the price spread between their supply (ULSD) and the pricing on the NYMEX.  Aside from a period of a number of weeks in November and December, when New York lifted the ULSD requirement, the price spread between the two products was just something that New York dealers had to deal with.  The good news was/is that starting in May, the physical and the exchange/futures products for New York dealers are again one in the same.
Nice as that may be, and as shocking as it might be to some New Yorkers (or ex-New Yorkers—and I include myself in that category), New York is NOT the only place in the world that uses heating oil, and not the only place that has concerns over “basis diffs.”  Since the new contract came into effect in May, those OUTSIDE of New York (thousands of dealers) have been scratching their heads, wondering what kind of “diffs” their suppliers would be offering them for this coming winter.  The suppliers, unfortunately, through very early May, have been scratching their heads, as well.  The uncertainty as to what the “relative cost” will be has been frustrating.  While it is clear to most that the “basis”—as previously understood—will be lower in New England than in years before (of course, until New England states**, one by one, adopt the ULSD specification of cleaner fuel to try to inhibit even more natural gas conversions!), the question is by how much.  In essence, you are buying the same product as you have for a number of years, but the universal reference point of the NYMEX (Merc, CME, however you wish to refer to it) has changed their definition of the product to a more expensive one.  Almost like a magic trick, it APPEARS as if costs have dropped.  They have not!
Budgeting for profit.
This all leads us to the budgeting process, and the “What the heck am I supposed to do?” process.  You need to start pushing suppliers to offer fixed-diffs for supply—not only for long-term contracting, but for day to day rack liftings.  Some will, and some won’t.  Some will prefer to link your costs to a non-Merc index, such as Platt’s or Argus (no, they didn’t steal our name, and change just one letter!).  While not as easily matched up to hedges, you may find that the “tethering” to something that does not appear as random as your supplier’s rack postings is actually a comforting thing.  When you consider that in addition to the actual price fluctuations of oil, itself, the discount of “old spec” versus “new spec” ranged by more than 25 cents per gallon since the start of the year, bringing a little more logic to the table might be a good idea.
For “actionable” (love that word!) steps, the “whisper on the street” is that the diff between the two products (NOT counting the cost of transporting it to your local rack, or the normal supplier mark-up/profit) should be in the 5 to 8 cent per gallon range.  We saw that range a lot during the winter—but then, again, we saw the spread burst all the way to over 20 cents as the first contracts of “new spec” were delivered in early May.  Assuming that you will keep a 20 or even a 10-cent discount may drive you to make an offer to your customers (and to assume profit margins) that will never bear a resemblance to reality.  On the other hand, simply ignoring the spread and pricing your non-NY oil as if all prices were still set versus the NYMEX might lead you to being more expensive than you should be (or that the market will bear).  Given a choice between the two, I would prefer the latter, as it should give you some needed elbow room;  but don’t push it too far would be our suggestion.
Seek advice
Many dealers are looking at marketing regulated energy products—natural gas and electricity—either as a commissioned agent, or as a full-fledged marketer (ESCO).  Others are wondering why they aren’t selling propane that costs only one-third of heating oil’s price (hint:  you need to spend a lot of money on steel).  Some are still wondering how they can even figure out where they stand financially, as they await their quarterly or annual “surprise” from their accountants.  These items are no longer the mysteries they used to be.  Ask the experts for help.  We, and others, are available to help.  We have a good idea of what might be keeping you awake at night.  Better than that, we might be able to help you find some answers.
*Basis may have a number of components in it.  It can be as simple as the cost difference between two locations (i.e. NY Harbor and a rack posting in Hartford).  That basis, or “diff”, comprises the transportation costs, credit risk, and supplier profit.  In addition, there can be a basis differential between two products, such as two different grades of gasoline, or—case in point—two different grades of distillate heating fuels.
**At this point, there is more talk than action, as to the timetable of the inevitable move by all states to ULSD for home heat.  There may be refinery issues.  There may be pipeline issues.  There may be moves to slowly transition (perhaps a stop-off at 500 ppm) to ULSD, but the future of the industry—perhaps politically, more than practically—is premised upon this “clean fuel.”  Until there is more clarity in the states’ mandate plans, there will be state-by-state confusion.

‘One thing that we have seen changing a bit over the last few years is that too many capped programs (historically, the absolute best program for customer retention) have morphed into fixed-price programs as prices have stayed steadily high.’