How Do Fuel Contracts Work?
A fuel contract is a type of futures contract that helps you to avoid the risk of fluctuating fuel prices. When you enter into a fuel contract with a wholesale provider, you agree to buy a specified amount of fuel from this provider. The wholesale provider agrees to provide you with fuel at a specified volume and price.
A typical fuel contract determines a set price per gallon for the amount of time agreed upon by both parties. Fuel prices may fluctuate during that time, but the price you pay stays the same due to the fuel contract in place.
A guaranteed price for fuel helps you better manage a budget and save on overall fuel expenses.
Components of a Fuel Contract
Whether you are purchasing diesel fuel, gasoline, crude oil, or another refined product, a fuel contract involves both a buyer and a seller.
You, as the buyer, determine the average amount of fuel you need. When you enter into a fuel contract, understanding your fuel needs is key to avoid overpromising or exceeding expected usage. It is never a good idea to contract 100% of your expected volume.
Price is also a key aspect of entering into a fuel contract. The fuel seller will provide you with a quote that should be based on the average price per gallon. The price per gallon will differ depending on the type of fuel you need and market conditions.
Types of Pricing Contracts
There are four main types of pricing contracts: Fixed-Price Contracts, Price Cap Contracts, Trigger Contracts, and Price Collar Contracts. The type of fuel contract you choose should help you lock in fuel costs at a lower price for a higher profit margin. Talk to your supplier about which type of fuel contract works best for you.
A fixed-price contract allows you to lock in a specific price for a set time period. With this type of contract, you agree to pay a specific amount per gallon whether the market price of the fuel goes up or down. If the market price for fuel goes up during the contracted period of time, then your fixed-price fuel contract will help you save money. Locking in a set price can help you avoid unpredictable swings in the commodities market.
Price Cap Contracts
A price cap contract sets a limit on how much the fuel supplier can charge you per gallon. A price cap is also known as a price ceiling, which means the seller cannot charge you higher than the limit. This can allow you to pay a lower amount per gallon when the market price falls below the cap price. A price cap contract can provide you with upside protection and price certainty in a fluctuating fuel market.
A trigger contract sets a basic level for fuel price per gallon and the contract is triggered only when the market reaches a certain level. This type of contract will have a set price or date agreed upon by both the buyer and the seller. When this price or date is met, this triggers the contract to begin.
Price Collar Contracts
A price collar contract sets a cap and a floor on how much a fuel supplier can charge you per gallon. This means your price will not exceed an agreed-upon high and will not fall below an agreed-upon low. When the market prices rise, this type of contract has a ceiling price in place. When the market price lowers, there is also floor price. This means you may risk the market price dipping below your agreed-upon floor price.
The Benefits of a Fuel Contract
A fuel contract can benefit both the buyer and the seller. A fuel seller benefits from a fuel contract by ensuring a consistent supply of product and fuel sales. This allows sellers to provide buyers with a steady supply at predetermined prices.
Decrease volatility of fuel costs
When you enter into a fuel contract with a seller, you can spend less time worrying about fluctuating fuel market prices and availability. A fuel contract can help ensure you always get fuel even when supplies are running low. When refineries or pipelines go down it can cause scarcity and sky-high prices for the smallest of quantities.
A fuel contract helps you lock in at a certain price for fuel or even a price range, particularly when fluctuations may lead to higher prices for others.
A fuel contract will help you to better forecast your fuel requirements and budget needs when you lock in fuel pricing, giving you a better bottom line and increasing your profitability.
When you commit to a futures contract with a fuel seller, you can expect reduced fuel costs and reduced variability. This helps you to avoid any unforeseen costs and can help protect your profit margins. In addition to locking in lower fuel costs, fuel contracts help avoid spikes in pricing with the marketplace.
A fuel contract might take more work and expenses on the front end, but it can help you save significantly on future fuel prices in a market that is constantly changing.