Previously, fuel surcharges were simply taxes levied by carriers and passed on to their customers. Surcharges appropriately reflected the expenses of a carrier’s fuel. The surcharge indices were modified up or down based on the direction of diesel and jet fuel prices.
Those days have long passed. Carriers now routinely arbitrage fuel costs and fees to squeeze every last dollar of revenue out of their shipments. There is no attempt at subtlety in the parcel-delivery market, which is still controlled by FedEx Corp. (NYSE: FDX) and UPS Inc. (NYSE: UPS). The two titans can change their indices whenever they wish. They base their levies on their own diesel and jet fuel price bands. UPS has raised its fee rates three times since August of last year.
Users of UPS ground delivery and SurePost services in partnership with the United States Postal Service presently pay a 12.75 percent fuel surcharge based on the Department of Energy’s Energy Information Administration’s countrywide on-highway diesel price of $4.03 per gallon (EIA). Every Monday, the price is determined, and the next adjustment will account for the impact of Russia’s invasion of Ukraine on fuel prices. If fuel prices reach $4.10 per gallon or more on Monday, UPS’ ground delivery surcharge will increase to 13%. Mike Erickson, head of AFMS LCC, a parcel consultancy, predicted that once the impact of the Russian invasion is reflected in Monday’s costs, surcharge levels will “skyrocket.”
Small to medium-sized shippers have no choice but to pay the carriers’ demands. For either airline to agree to discuss fuel fee reductions, larger enterprise shippers must generate between $10 million and $20 million in shipping spend.
The silent killer for shippers is that almost every delivery surcharge — and there are dozens of them — includes a fuel surcharge component. Fuel surcharges have become a budget buster for shippers as a result of this “death by a thousand cuts” tactic, paired with rapidly rising oil costs in recent months. According to Karl Wheeler, senior consultant for professional services at Shipware and the firm’s point person on the subject, a large FedEx customer and a Shipware client spent almost one-third of its 2020 surcharge expense on fuel. According to Wheeler, by 2021, that figure will have risen to 56%.
Fuel surcharges remained mostly steady in 2020, a year in which diesel and jet fuel costs fell during the early months of the COVID-19 epidemic before rising in the fall and winter. Last year, though, fuel costs and surcharges began to rise at the end of the first quarter. Prices have risen again in 2022, fueled by fears that geopolitical unrest in Europe may constrain energy supplies.
Once fuel costs begin to fall, it will be difficult to entice carriers away from the fuel surcharge trough. During UPS’ fourth-quarter analyst call last month, the company noted that fuel surcharges accounted for roughly 40% of year-on-year revenue per package growth in its US ground-parcel operations.
That could explain why fuel surcharges have climbed far faster than fuel prices, and why higher surcharge levels may not fall as quickly even if fuel prices fall. Diesel costs were computed at $3.61 per gallon in the first week of January this year, compared to $3.08 in the same week in 2020. Despite all of the ups and downs, fuel costs grew by 17.3 percent during that time period. However, according to Wheeler’s estimations of the historical distribution of prices, UPS’ diesel surcharge levels increased 36.7 percent from mid-August to Jan. 3 based on prices resting at a two-year average of $2.93 per gallon. The increases are the result of three surcharge increases that began in August.
With demand high and energy supplies tight prior to the Russian invasion, it’s difficult to see prices falling into the high $2 a gallon level very soon. Even if that happened, the carriers would still be making out like bandits, according to Wheeler. UPS’ diesel surcharge was 7.5 percent on August 16. The surcharge had risen to 10.25 percent by early January. Even if prices fall to the two-year median, UPS will profit handsomely from surcharges, according to Wheeler.
According to Wheeler’s calculations, the lower the diesel price falls, the more surcharge revenue UPS and FedEx will get. Based on $2.37-per-gallon diesel costs, UPS’ surcharges would increase from 6.5 percent in mid-August to $9.25 percent on Jan. 3, according to Wheeler. This equates to a 42.3 percent raise.
“Even if the price of petroleum retraces, [the carriers] will still be getting much more for fuel,” Wheeler added.
The macroenvironment, as well as the headline news of growing geopolitical tensions, will provide carriers with ample economic and political cover to raise surcharge levels, according to Wheeler. FedEx and UPS, which are already sailing in the strongest-ever seller’s market for parcel delivery services, have a wide berth to extract more revenue dollars from their fuel surcharge policies.
