The Fuel Gamble

Some people swear by fixed rates. “It’s easier for budgeting,” says a veteran management executive. Some people swear by market rates. “You don’t have to gamble on getting it right,” says another veteran management executive. And some people are, understandably, confused.
We’re not talking about Wall Street but Fuel Street, and with gas and oil prices fluctuating dramatically in the last year – and with April, May, and June serving as the months when fuel contracts are traditionally signed – co-op and condo owners may be wondering what’s the best way to cope: should they lock in fuel prices at a fixed rate or trust the market?

Larry Collins, the director of sales at Approved Oil, is an unabashed advocate of locking in the rate. “I think that gasoline is going to be almost $3 a gallon again. All you need is a hurricane or talk of war [with Iran], and the refineries shut down. It makes sense. To give you an example: rack price, the day after [Hurricane] Katrina hit, was $2.55 a gallon. My customers that locked in [before that] for $1.89 loved me. They weren’t happy with the $1.89 when I recommended it, but then the oil market took off.”

Collins argues that, like the stock market, it is important to keep tabs on the fuel market before locking in – and, he says, the best way to do that is to keep in regular contact with your professionals, such as your fuel supplier and/or your managing agent. “We know the market,” he adds, noting: “If you lock in [every year] for five years, only one year you might get hurt and that’s how it’s been in the last five buying seasons. I’d say you’d have saved 20 percent by fixing the rate. In the year that you didn’t do well, you lost maybe 10 percent.”

Others counter that argument by saying that fuel-buying is not such a precise science and that locking in the rate means taking a risk that prices won’t go down – as they did last year after spiking up during the aftermath of Hurricane Katrina.

“We had this problem after Katrina and we had virtually every building ask us about the numbers that were being offered by fuel suppliers,” recalls Don Levy, a senior management executive at Brown Harris Stevens. “We went through a period of several weeks when we were getting rates that varied almost on an hourly basis from the oil companies. The rates that were being offered at that point were in effect 10 cents a gallon higher than the spot rates that were being charged for people that just got ordinary deliveries. Some buildings, nevertheless, decided to lock in six months or a year’s worth of deliveries. Most of the overwhelming majority of the buildings did not and what’s happened since is that the prices have come down considerably since the post-hurricane highs.”

In fact, some professionals have compared the practice of locking in the market rate to playing the stock market – or placing bets in Las Vegas. “I specifically discuss this with my boards when I meet with them,” Levy notes. “These boards are not in the commodities markets and, in effect, what you’re doing when you lock in the oil price is you’re betting on future oil rates. What happens in a lot of these buildings is that – even though the board members would be protected if the building loses a lot of money because they made what would be a protected decision under the Business Judgment Rule – a board would hear all sorts of grief if things didn’t work out. Most boards are not willing to run that risk.”

You can also put in floor and ceiling caps – but you pay extra for the security. “What ends up happening when you create a floor-to-ceiling price is you pay for that,” observes Dan Wurtzel, chief operating officer at Cooper Square Realty. “You’re usually paying a nickel or ten cents more than market, because you’re paying for some insurance. To the extent that oil prices stay relatively level or inch up a little bit, you’re better off paying market. And it’s a safer choice. If you really want to fix your fuel costs and you’re willing to pay more money, then you can go into one of these caps where your floor and ceiling are set so you’re not going to pay more and you’re not going to pay less than a certain price. But that number – whatever you’re paying – is generally higher than market, unless the market spikes dramatically.”

Adds Carla Romita, senior vice president at Castle Oil: “Those who have been lucky with locking in prices – who have picked it for a couple of years – they’re going to swear by it. But you could just as easily be unlucky in the next couple of years. Nobody wins all the time.”
Some properties have tried a mixture of the two approaches. At a co-op handled by Jim Flaherty, director of management at Century Management, the board decided to lock in fuel prices for the coldest months of the year and pay market for the rest. “We locked in 100,000 gallons with the intention that we locked it in from the heating season, which is November 1st until June 1st, with the anticipation that the fuel rates would drop during the summer months, which they have historically.”

In the end, then, the answer to the fuel dilemma is: it depends. “It really depends on what your needs are,” says Romita. “If your needs are to [get a very accurate] budget, sometimes the fixed rate – if the market is not at an all-time high – would be a proper way to go. The problem is that you are gambling that the market will either stay at the same rate or go higher than the rate that you’ve contracted to pay. If the market; bottoms out, you’re not going to benefit from the downfall of the market, you’ll still be obligated to pay that high price, and you’ll have shareholders blaming you for picking it wrong. If you just need to know that you’re not overpaying, then you should go with the market rate.

“It really depends on the risk tolerance of the co-op,” she continues. “I tell people you have to decide whether you are a ‘market person’ or a ‘fixed-rate’ person and then to just go with that and live with the consequences. If you look at it from a global perspective, either choice is just as risky.”