NEW ORLEANS, La. – Fuel prices, in similar fashion to the flood waters that devastated the U.S. Gulf Coast and sent fuel pricing to record heights last month, are receding. But the potential for long term pain at the pump as the markets remain jittery about the future of the Gulf Coast’s damaged oil infrastructure poses a dire threat for carriers north of the border.

The region pummeled by Hurricane Katrina is key to America’s oil production and it suffered significant damage and disruption. Eight Gulf Coast refineries were closed or flooded and offshore drilling platforms were shaken off their moorings by the storm which packed 135 mph winds and a 30-foot storm surge.

The Colonial pipeline, the largest petroleum pipeline operator, was disrupted for days.

The Plantation Pipe Line Co., which has a pipeline that runs from Baton Rouge, La., through six states into Washington D.C. was mostly idle.

In all about 92 per cent of the Gulf Region’s oil output was shut down, with more than three million barrels of production lost since Sept. 2, according to the U.S. Interior Department’s Minerals Management Service. Refineries in other parts of the U.S. are unlikely to pick up the slack because they already are operating at near full capacity.

Shortly after news reports placed the impact of Hurricane Katrina in perspective as one of the worst natural disasters the U.S. has faced, the price of crude rose to almost $71 a barrel. By week’s end it had dipped back down to $68 in intraday trading on the New York Mercantile Exchange as the Bush administration opened the nation’s Strategic Petroleum Reserve to ensure adequate crude oil supplies. But American Trucking Associations chief economist Bob Costello, among others, expects retail diesel and gasoline prices to remain at high levels over the short term. The trucking industry in the U.S. consumes 50 billion gallons of fuel each year, and was on pace to spend an unprecedented $80 billion on diesel fuel this year, $18 billion more than a year earlier. That follows a $10 billion increase in fuel costs over 2003.

In Canada diesel pump prices soared over the $1 mark in certain locations. And fuel prices sustained over a period of months at or close to those levels may prove disastrous for some carriers north of the border. While most carriers have fuel surcharges in place – our own Transportation Media Research indicates 99 per cent of shippers using truck transport are paying a fuel surcharge – and are trying to pass rising fuel costs on to the shippers, not all surcharges may be adequate.

“Most shippers are paying (a fuel surcharge), the question is are they paying enough?” says Doug Switzer, manager of government relations with the Ontario Trucking Association. “There’s carriers out there who are operating very close to the margin who really don’t have much of a cushion to absorb this kind of an increase in their costs. Whatever profit they were making, the question is can they keep operating at those rates?”

The current shock in fuel pricing may also present cash flow problems for the smaller carriers.

“While it may take some time to negotiate with the shippers to get (appropriate) fuel surcharges, carriers are burning fuel at that high price and that’s eating into their ability to make money. Guys are losing money right now transporting goods unless they can get money back from the shipper and some shippers come to the table more easily than others,” Switzer says.

Whether shippers will balk at fully shouldering this latest fuel increase remains to be seen. Certainly there has been a lot of talk and concern at recent shipper gatherings about the impact of fuel surcharges on their ability to ship product at competitive pricing. Fuel surcharges are representing almost 25 per cent of truckload costs for some shippers in certain lanes.

“The fuel surcharge mechanism is there and I suspect it will continue to be used. At what point shippers will say I can’t afford to service my market any more is a hard question to answer at this point,” says Robert Ballantyne, president of the Canadian Industrial Transportation Association.

The last time the Canadian trucking industry experienced a similar sudden spike in diesel prices – albeit from considerably lower levels and in combination with a weakening economy – at the close of the last decade, one quarter of the nation’s small carrier base (companies earning less than $1 million in annual revenues) was withered away.

That spike in diesel pricing also forced about 12 per cent of the nation’s then 41,000 owner/operators out of the business. Evidence of the havoc rising diesel prices over the past year is wreaking on the financial stability of the nation’s owner/operators was clearly provided by the five-week strike staged by independent drivers of drayage operators serving the Port of Vancouver earlier this summer and similar discontent voiced by O/Os across Canada in recent months.

Combined, the demise of many small for-hire fleets and owner/operators five years ago were a major contributor to the current capacity crunch. (A situation which admittedly helped carriers push through the first significant rate increases in recent memory with more than 50 per cent of shippers agreeing to freight rate increases upwards of four per cent, according to our Transportation Media Research.) Should the industry expect a similar thinning of the ranks over the coming months?

“It’s hard to say in the long term what will happen because who knows at this point how long prices will stay at this level? If they stay up there for only a week or so the impact will be minimal but it they stay high for a sustained period of time obviously that will have an impact on smaller carriers not capable of absorbing the higher costs. Trucking companies can operate a long time on cash flow but this is a huge hit,” Switzer says.

There are also questions as to whether the current fuel surcharge mechanism is the best way to handle the latest spike in fuel pricing. Up to now the fuel surcharge mechanism set up by many fleets has worked fairly well in creating a stable financial atmosphere during a time of rising and frequently fluctuating oil pricing. But one has to question if the mechanism can handle such dramatic fuel price increases as evidenced following Katrina and expected for at least the short term.

“The mechanism we have put in place to handle minor fluctuations perhaps is inadequate to handle a dramatic increase over such a short period of time,” Switzer acknowledges.

Energy firm Global Insight recently issued a worst-case scenario that forecast oil jumping to $100 a barrel and causing a possible recession by year’s end. Such dire warnings also raise concern that carriers will be blindsided by the faltering viability of their customers, those serving both domestic and U.S. markets.

“The overall impact,” says Jayson Meyers, chief economist with Canadian Manufacturers and Exporters, “is higher energy costs which translate into higher costs for transportation, raw materials, components, going all the way down the supply chain.”

There was already concern in trucking circles that the high Canadian dollar combined with rising energy costs and difficulties in crossing the border following 9/11 would make American companies re-think their strategies in sourcing from Canadian manufacturers. Will Katrina’s impact further exacerbate the situation? It’s a guessing game because there are competing dynamics.

“Obviously the dollar is going to hurt our exports but with higher fuel prices, the ability to move goods long distances cheaply will diminish. I think people will start looking for supply sources closer to home,” Switzer argued.

The impact on Canadian manufacturers, and the carriers who serve them, will depend on the scenarios considered.

“For example, if an Ontario plant was in competition with a plant in Ohio to service Detroit, the American plant could win out. But if the competition was between Ontario and Georgia where the distan
ce is much greater, suddenly it’s going to cost a lot more,” Switzer said. “It all depends on whether this is just a blip or the new normal. If it is the new normal, shippers are going to start looking for sources closer to home.”

The second factor impacting Canadian manufacturers will be lower consumer confidence in the United States and Canada. There will be less money to spend and this slowdown in spending will affect North American demand.

Manufacturers were wary about their short-term prospects prior to Katrina. Twenty two per cent of manufacturers had indicated they would decrease production in the third quarter according to a Business Conditions Survey conducted by Statistics Canada in July. Manufacturing shipments appeared to have plateaued since October 2004 and inventories were continuing to accumulate. June marked the 18th consecutive rise in inventories, which now stand at the highest level since September 2001. The inventory to shipment ratio – a key measure of the time, in months, that would be required to exhaust inventories at current shipment levels – has been climbing for a year. The survey noted that about a quarter of manufacturers considered their inventory levels as being too high.

All the dire warnings raise the question about what role Ottawa should play to relieve the situation.

“There’s no reason on earth that our governments – provincial and federal – should be cashing in the way they are by way of taxing us on the increased cost of oil,” said Rob Penner, Bison Transport vice-president of operations. “The fuel tax revenue has grown exponentially, as have the profits of the oil companies, at the expense of us all. It may cost more to produce oil, but there is no basis to tax the general public at the same percentage per litre.”

Switzer said it’s too early to say how hard to push governments on this but some tax relief would be helpful.

“Even if it was only a symbolic cut people would like to see the government step in and help. But the government is also probably waiting to see if this is a long term or short term situation. If fuel prices stay high the government will come under sustained pressure to cut taxes. But it’s going to be a problem for Ottawa because if prices stay high, consumption is going to go down and the economy will take a hit. So government revenues will go down,” Switzer says.