For Dealers, A Year Really Only Lasts 100 Days
This just in, a year is not 365 days long for oil and propane marketers. Seasoned dealers know this by instinct and probably will tell you it is 120 days in terms of compressed seasonal demand. In truth, a year has now been shortened to a mere 100 days or so by the degree day gods and the impacts of global warming. For those of you who spend any time staring at your heat curve, it doesn’t take long to realize that you essentially have less than four months to drive 90% of your annual fuel profits. And thanks to warmer temperatures and shorter winters, this window of opportunity appears to be shrinking before our eyes.
Before you go running off to call a broker to sell your business, remember that this miniature year has been a part of our industry for generations. It’s probably why we have more in common with ski resorts than we do with grocery stores.
First, let’s give this some perspective. Imagine that you are the president of a large regional bank. You are sitting at Thanksgiving dinner in the warm embrace of kith and kin, the smell of turkey in the air, smiles all around. Life is good. That is until a courier comes to the door and delivers a message from your board of directors. The note says that you only have until St Patrick’s Day to deliver the entire year. What? How on earth can I do that? If you’re smart, you will call your heating oil dealer because this is the world he lives in and one that he has managed to conquer.
One thing all seasonal businesses have to understand and embrace is that “every day counts”. Write that down on a sticky note and put it on your computer right now, or on your car dashboard, anywhere you can see it over and over. It sounds silly and obvious but trust that many fuel dealers lose sight of this concept and put themselves at risk. With only 100 days to ring the register, you literally cannot afford to spend one day below your target gross margin.
Oh yes, a quick reminder, this is a margin business. We seemed to collectively forget that during the program era when nearly 80% of sales were made to cap or fix customers. With a good hedging advisor and some discipline, margins were essentially in the bank before the first frost. Now that trend has reversed and 80% or more of sales are rack to retail. Due to volatility, margins expand and contract daily like some defective accordion. “Margins, margins, margins”…write that on the sticky note too.
The solution is simple. Make sure you adjust your price every day to reflect the price changes in the cash market to safeguard your margin. OK, that was sarcasm. In the real world, that rarely if ever happens. Dealers are programmed to lag on the way up and then lag on the way down. Basic arithmetic promises that we willingly erode margin on the way up because we can make up for it on the way down. Caution: that is extremely dated thinking rooted in a long ago time when prices were largely stable, we were not afraid to buy wet barrels months ahead of the season, and we changed our retail price 5 times in a year.
If you look at daily margins in today’s world you will see them dip below target on up market days and then go above target on down days. It would be easy to assume that it all comes out in the wash and balance is achieved but that is absolutely untrue. Volatility is not about up and down price, it is about the magnitude and speed of those price moves, both of which are entirely unpredictable. The net impact is that no dealer can accurately measure the effects of their lag to the market; hence the industry has seen organic margin erosion that has nothing to do with competition, consumers, or natural gas (it seems to get blamed for everything).
Here is the game plan. Establish a target margin, one that is realistic and achievable. Manage to that target every day. Use buying and retail pricing techniques to ensure you are above target daily. There are great business intelligence applications that help you do this efficiently. Learn to make volatility a friend by capitalizing on dips in the market to expand margin. Buy wet prompts or bulks using the “425 Rule”; if you can sell the product in 4 to 5 days, there probably isn’t a reason to hedge it with downside protection because you can hold your price. But if you cannot move it in that time period or you buy into a nice big price dip for 10 days, then by all means protect it with options.
Above all, stop assuming you can make up for lost margin “later”. As we saw in 2011, that price drop may never come. It is also sobering to recognize that due to the pesky degree day gods, one day below your margin target in January equates to 4 days above target in April. The moral of the story is that if you trend below target during the 100 day year, there literally isn’t enough time to make up for it.
Did I mention that every day counts?
The information provided in this article is general market commentary provided solely for educational and informational purposes. The information was obtained from sources believed to be reliable, but we do not guarantee its accuracy. No statement within this article should be construed as a recommendation, solicitation or offer to buy or sell any futures or options on futures or to otherwise provide investment advice. Any use of the information provided in this article is at your own risk.