Leslie Cernak: How to Reduce Risk in Fuel Contracts

My last two articles covered “contract basics.”  The concepts were broad, but important to the validity of a contract. Now that spring is here, many retailers will be offering fuel pricing contracts to their customers. In this article, I am shifting focus from broad concepts to a specific topic – risk management. I’ve attended many financial seminars that offered great information about fuel purchasing options that are available to back future sales of fuel.  However, these presentations rarely discussed how customer contracts should align with their financial counterpart to reduce company risk. 

In my marketing area, it was common practice for retailers to purchase 80% of the futures contracts over time to cover anticipated sales. The retailers would then average their purchase costs, add their margin, and launch one big marketing blitz to sell the fuel and secure customers for the upcoming season. The terms of purchase were misaligned with the terms of sale. For example, most purchases were made months before an offer, and customers often had months to decide if they wanted to accept. 

Business changed as a result of the 2008 market crash. In July of that year, oil prices peaked at almost $150 per barrel and then fell sharply to a low of approximately $40 per barrel in the second half of 2008, as the global financial crisis hit. Many oil retailers were left holding unsold futures gallons, which resulted in financial trouble. Some filed for bankruptcy. Others got an education.

After 2008, my company’s fixed price prepaid offer changed significantly to better align with the market and the terms of futures purchase contracts.  Instead of offering one customer contract for the season, we purchased and sold smaller batches at different prices throughout the year, and the customer was given a shorter window to secure a contract. Another shift that took place after 2008 is that fewer companies offered fixed price budget contracts, which, in my opinion, had always been a bit risky and challenging to administer. While fixed price budget contracts dwindled, cap price contracts became more popular and remain so today.

The 2008 market crash gives us a good example of a historical event that affected customer fuel pricing contracts. Some of those changes were mandated by individual states, while others were implemented by retailers based upon need. Regardless, our industry responded in a manner for which we are well known – we adapted.

As changes continue, I am reminded of the importance of updating our customer contracts to reduce risk. In addition to the usual yearly updates, these are a few items to consider:

What effect will the various states’ Clean Heat Standards have on customer contracts? Will fees or carbon taxes be imposed retroactively?

Does the customer contract language align with the supplier contract language? And are there any gaps between the two force majeure clauses?

In the event of customer default, a formula for liquidated damages may be easier to enforce than a flat fee. The latter is more likely to be viewed by the courts as a penalty.

Does the cap contract state that cap fees are deducted from customer payments before the cost of fuel? This would be useful if the customer cancels early in the contract season.

There was a recent class action lawsuit filed against a fuel retailer, based upon the retailer’s market price as it applied to a cap contract in a market downturn. Consider adding a definition to the contract, such as: “’retailer’s market price’ means the price per gallon that the company charges for fuel, to similar non-contract customers, in good faith and observance of reasonable commercial standards of fair dealing, regardless of competitor’s pricing.”  I hope these suggestions are helpful as you prepare your fuel pricing contracts for the upcoming season. As always, consult an attorney on legal matters.