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The Appeal of Price Cap Plans

Well-managed price cap plans can put fuel oil marketers, as well as their customers, at ease

By Stephen Bennett

 

Charlie Uglietto, owner and president of Cubby Oil & Energy in Somerville, Mass., swears by price-cap programs.

“We have been doing price cap plans for close to twenty years,” Uglietto said. “I feel if we don’t offer our customers tools that are available to potentially help them then we’re doing them a disservice.” When Cubby Oil first started offering price cap plans, Uglietto said, “we bought in the summer and prices usually went up in the winter and it was a great tool, and fairly easy to manage.”

Today, with price volatility and much higher pricing, the practice isn’t that simple any more, Uglietto observes, “but we’ve still continued to see the value in offering our customers the ability to cap their oil price.”

Uglietto said he has always chosen to offer cap pricing rather than fixed pricing because “we’ve always been cognizant of the fact that prices can move in either direction, defying any type of logic that one might want to apply to the market. I’m not a trader, I’m not a guy who thinks he knows the market better than anybody else. I’m in the business of providing services to our customers. We’ve always felt that cap pricing offers our customers the best value, so [they’ve] got upside protection, and [they’ve] got downside protection. We market it to them as a way for them to have some price certainty in a very volatile market,” he said.

“The market has become a lot more complicated, and for the owners–for us–there are a lot more tools out there for us to put money in our pockets,” Uglietto adds. “There are more economical ways to provide cap plans.” Cubby Oil works with Danny Silverman of Angus Energy, who “brings those tools to the table,” Uglietto said.

Back in the day, Uglietto recalls, he might buy one million gallons worth of wet barrels, and one million gallons worth of put options.

Today, in contrast, Silverman of Angus might advise him that there is a better way. “He will show me what is the best way to protect our program, add money to the bottom line through increased margins, and still provide me with the ability to go to bed at night and not worry that I’m going to wake up in the morning and the Middle East is on fire and my plan has blown up,” Uglietto said. “I’m very comfortable with what they come up with. It’s very cost-effective for me to use them.”

Uglietto added, “As far as pricing plans go we’ve only offered cap plans. I know in various parts of the country there are fixed plans and pre-paid fixed plans and things like that, but I’ve always felt that capped price plans were the best way to go–the best plan for our customers and the best plan for continued customer satisfaction.”

Phil Baratz, president of Angus Energy, with offices in Connecticut, Florida, New York and Pennsylvania, said that price cap plans started to come into being in the late 1980s when exchanges started trading futures contracts and options contracts. “Dealers were in a position where they could go to customers and say, ‘Prices are very volatile. Instead of just giving you my cost plus a little bit of markup I can cap your price. If you buy all your oil from me over this next year your oil will be X dollars per gallon or less.’ It’s truly a cap.”

Baratz said part of the appeal is that “if prices are going to be jumping all over the place it’s very hard for customers to budget for their household expenses.”

If the cap is $1.99 per gallon, Baratz said, customers “pay that–never any more. But if prices go down, you could even pay less.”

The fee that typically accompanies a price cap plan can be a sticking point for some customers, but the experts note that there are effective ways to address that issue. The support for a price cap program is provided by a futures and options contracts, and a fee is typically charged (in one form or another) to support the service costs. Uglietto said he deals with it candidly and from the get-go, while sparing customers the details of just how it is done.

“We have been up front with our customers right from the very beginning, explaining to them that in order for us to provide upside and downside protection–to offer a true cap–we have to buy insurance. I don’t like to get into whether we’re buying put options on our wet barrels or we’re buying call options–the customers don’t want to hear that. The way we explain it to them is we have to pay for the insurance plan so that if the price of oil goes down, your price goes down, and there’s an upfront fee to it. We charge our customers upfront the day they decide to sign up for the plan.”

There are some customers, typically a minority, who voice skepticism about the fee, Uglietto said. “Initially you’ll have people who say, ‘Sure, you’re putting that money in your pocket,’” he said. “But the reality is when the price drops precipitously we can drop [our price] and our customers see it. So now, twenty years later, they all understand that when we say cap we mean cap. If we’re retailing oil for a dollar they’re paying a dollar. If we’re retailing it for four dollars tomorrow, they’re paying the cap, and they understand it.”

Because price caps have worked well for Cubby Oil and its customers, loyalty has accrued over the past two decades or so, Uglietto said. “We’ve got customers that sign up for it every year,” he said. The customers comment that the price cap provides them with “peace of mind–knowing that if anything crazy happens in the world and the price goes through the roof, they’ve got protection.”

Alternatively, “If things are nice and quiet and it’s a mild winter and we’re producing more oil than we know what to do with and the price crashes, we’ve got the downside” covered, Uglietto said. “The fee is a very, very small price to pay for that protection,” Uglietto said.

Typically, customers end up paying 10 cents or 15 cents a gallon, however it is worked into the invoicing, Baratz said. It might be in the form of a monthly amount of a few dollars, or an annual fee, such as $99 or $175.

“It doesn’t have to match up exactly to the cost of the protection,” Baratz said.

Marketing price cap plans effectively can ease the reception that fees get from customers. Angus offers consulting services that, among other things, includes the writing of price cap solicitation letters. “You want to let the customers know you’re offering something that is of true benefit to them,” Baratz said. One of the common mistakes in marketing, Baratz said, is to tell customers they can have something, like a cap price plan, and follow that with, “Wouldn’t that be great?”

Baratz said a lot of people receiving such a letter are likely to “sit back and say, ‘Yes, but is it so bad not having it?’” The benefit needs to be specified in concrete terms that customers can relate to, Baratz said.

Incorporating the fee into a budget program works well, said Rich Larkin, president of Hedge Solutions, Manchester, N.H. “That, to me, is where the cap is sold most successfully,” Larkin said. “The average option premium”–or fee–“right now for an 800-gallon account is about $160,” Larkin said. “It’s very, very difficult to get the consumer to come in and write a check for that premium. They won’t do it. They can’t bring themselves to write the check.

“Bundle it into the budget payment–that’s how [to] get the option premium paid for by the consumers,” Larkin said.

“One my marketers a few years ago said to me, ‘I like a cap price program because once I get my customer on that I can never send them bad news,’” said Gary Sippin, marketing director of Destwin Energy Systems, Monroe, Conn., a provider of an online system that supports hedging. “So from that day forward the customer can only get good news from the company. That was a nice way of putting it.”

Sippin also said that a cap price program tends to draw a better customer “because they tend to be more insurance- or protection-oriented than specifically price-sensitive. They want to be protected almost like an insurance policy from any eventuality that might happen in the marketplace.”

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