High crude prices may lead to cash flow woes for retailers
WALL, N.J. -- Record-high crude-oil prices and the subsequent volatility at wholesale may lead to a particularly difficult squeeze for retailers this spring, as carrying costs, credit-card fees and aggressive competitors align to push companies to the brink, according to forecasters.
In its February issue, CSP magazine examines how sky-high crude prices—at an average of $88.71 per barrel as of the first week of this month, down from $92.93 at the beginning of January—have affected the tail-end of the supply chain, with increases in the cost of doing business coupled with stagnant [image-nocss] margins clouding the near-term business climate.
"At the end of the distribution chain, you have a margin that has not appreciably ramped up," Tom Kloza, chief oil analyst, Oil Price Information Service (OPIS), Wall, N.J., told CSP Daily News. "Operating on a 12-cents-per-gallon margin meant something different several years ago, when that profit was a much higher percentage of both the sales pie and profit ratio."
The business metrics have changed. In 2002, an 8,000-gallon delivery with tax went for $10,000-$12,000. This year that dealer cost is $25,000-$30,000, Kloza said, adding that he has heard retailers speculate that the cash-flow system as it stands would "break down" once wholesale gasoline got above $2.20 per gallon. "It didn't break down, but we are looking at the prospect of [record-high wholesale costs] for whatever short a period," he said.
Retailers and distributors, who have already become used to wide swings in wholesale prices, are victims of proportion, Kloza said. The percentage that wholesale costs can change in a single 24-hour period has remained the same over the past decade. "[When gasoline] was $1.50 a gallon, [price swings] would be 2, 3 or 4 cents," said Kloza. "Now with $2.40 gas, you get the 5- to 10-cent moves."
That volatility means that on any given business day, 40%-80% of a retailer's margin is at risk, he said, noting how the game is not about yearly averages but the wild swings. "Conservative [sources] predict crude at $85 averages, but that's like saying the average temperature in Tucson will be 85 degrees," he said. "Crude in 2008 could broadly range from $50 to $105 a barrel. What we average may seem temperate, but there's bipolar extremes."
Unfortunately, that volatility is not going away any time soon, Kloza said. "There's been an explosion of oil trading in the last two years," he said. "The spot market loves volatility. It's their Elvis—or what Britney Spears is to TMZ."
The situation is forcing retailers and wholesalers to become "day traders," he said, in that people who buy fuel for their chains today have to watch the market. "They feel compelled to buy ahead of [an] increase and load up when decreases come in," he said. "What other business is there that puts your 12-cent gross margin at risk because your wholesale fluctuation is 5 to 10 cents?"
Rich Cilento, founder CEO of FuelQuest, a Houston-based fuel-management firm, said one of the solutions is to buy fuel as far up the supply chain as possible. He spoke of a day when more end-users buy fuel right from the refiner or pipeline, and in barrels, not gallons, as airlines and Louisville, Ky.-based UPS currently do.
"If you could move up higher and buy in larger bulk or larger volume with different types of contractual products, then you're going to optimize as good as the market can give you at the rack," Cilento told CSP Daily News. "Supply portfolio management at the rack is a pretty complex thing, because there's complex tax consequences of buying at the rack and obviously there's some logistical challenges with getting the product from the rack to your own location. That's how people are dealing with volatility primarily: How do I get a better price?"
What do retailers have to look forward to this spring? Kloza of OPIS was optimistic. He said retailers can expect a "big inning," or that period where wholesale prices drop at the same time prices on the street linger at high levels. "I think we're going to get one, but getting there is going to be painful."
DTN analyst Darin Newsom said recession talk figures in as well. Are we or aren't we?
"If not, if this [crude price] rally is due in large part to speculation, are we really ready to slip into recession as these commodities move higher, or is it time for the market to realize that maybe this $99, $100 is just too high at this point and we need to back it off?" Newsom told CSP Daily News. "We need to pull back to the $89, possibly $84, take some steps down, re-evaluate the situation, take a look at the fundamentals again and see what the market will support. I think over the winter we might see more of that play out."
[For more on the issue of gasoline price volatility, look for the February issue of CSP magazine.]