Sunday, March 9, 2008

Rising Diesel Fuel Price’s Negative Effect On The U.S. Economy

In the continuing look at the increasing oil price in the U.S., this article will focus on the impact that increasing diesel fuel price will have on the U.S. economy.

Trucks Are Vital To The U.S. Economy
According to the Research and Innovative Technology Administration (RITA), trucks transports approximately 70 percent of the total value of all goods in the U.S.[i]:

“…trucking as a single mode was the most frequently used mode, accounting for an estimated 70 percent of the total value, 60 percent of the weight, and 34 percent of the ton-miles. In 2002, the trucking industry, both for-hire and private own-use, transported over $9 trillion worth of shipments…”

Additionally, trucks carried over $491 billion, or 62 percent, of the total value of U.S.-NAFTA merchandise trade in 2005[ii]. Given these facts, the importance of trucks’ role in the U.S. economy can be firmly established.

No True Alternatives To Trucks
The alternatives to trucks as a mode of intra-U.S. transportation of goods are limited to trains, planes, and boats. Since the river and canal systems in the U.S. are not extensive or provide direct point-to-point connections, boats would be poor alternative to replace trucks.

Airplanes have the ability to quickly deliver goods and are able to modify delivery points while in transit. However, the cost per ton of goods is the most expensive of the four alternatives. Moreover, the airplanes are not a true point-to-point mode for transporting goods as the initial and final legs of goods transportation must be made by other modes, mostly by trucks. While airplanes serve a vital role in transporting goods that are highly perishable or require fast delivery, the airplanes will not replace trucks for transportation of goods within the U.S. due to its high cost.

Trains come the closest to meeting trucks in transporting bulk goods within the U.S. While trains transport more ton-miles of freight than trucks – 1,733,777 million ton-miles for trains versus 1,293,326 million ton-miles for trucks, out of a total of 4,537,921 million ton-miles in 2005[iii] – they do not have extensive rail network to effectively compete with trucks[iv]. Moreover, as in the case of airplanes, the initial and final legs of goods transportation must be made by trucks.

What Does This Mean?
With no true replacement for trucks in providing a true point-to-point transportation of goods, any increase in the cost of diesel fuel will have a direct effect on the cost of goods and productivity of U.S. companies as trucks are an integral part of transportation of raw materials and finished goods within the U.S. and between NATFA countries.

A Penny Here And Penny There…Soon It Becomes Material
In 2005, trucks, as defined as single-unit 2-axle 6-tire or more and truck combination, traveled over 222.8 billion miles, according to RITA[v]. At an average 6.7 miles per gallon, the trucks are not very fuel-efficient[vi].

Therefore, cost of fuel is critical for the trucking industry and for the U.S. businesses that rely on trucks to transport their raw materials and finished goods.

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Data Source: and; 2006 and 2007 miles traveled and fuel consumed, extrapolated using the % increase from 2004 to 2005.

Overall, truck vehicle-miles have increased from 209 billion in 2001 to 222.8 billion in 2005 (and extrapolated to 226.9 billion in 2007, using 0.92% annual increase from 2005 figures), an 8.6% increase. During the same period, the #2 diesel price per gallon rose from an average of $1.40 per gallon in 2001 to $2.88 per gallon in 2007, a 105% increase. The most recent price for a gallon of #2 diesel fuel was $3.66 nationwide, as of March 8, 2008[vii] (or an additional 27% increase from 2007 average price). The increased cost of diesel fuel was partially mitigated by increased MPG efficiency, which went from an average of 5.8 miles per gallon (MPG) in 2000 to 6.8 MPG in 2002.

Rising Fuel Cost Poses Risk To Financial Health Of U.S. Businesses
According to RITA, truck’s average freight revenue per ton-mile (moving one ton of good one mile) from 1990 to 2001, the years of the available data, was $0.255 – the highest freight revenue per ton-mile was in 2000 at $0.27[viii]. Figures for 2002 to 2007 were extrapolated using the average year-over-year growth rate of both Ton-Miles and Revenue Per Ton-Miles from 1990 to 2001 of 3.88% and 1.10%, respectively. Based on the estimated growth rate, it reasons that the revenue growth lags the rapid increase in fuel cost.
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Data Source: and; 2002 to 2007 Ton-Mile and Revenue per Ton-Mile were extrapolated using the respective average % increase from 1990 to 2001.

With diesel fuel price increasing much more rapidly than revenue, it becomes very clear that the cost of transporting goods has to go up. However, the increased fuel cost has not fully manifested itself in the cost of goods, so far.
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When will the rising fuel cost finally manifest itself in the PPI numbers? It is only a matter of time but that time is rapidly approaching. Based on the PPI for freight trucking, the preliminary numbers for 4Q 2007 indicates that the increased fuel cost is being passed on. If the fuel cost stays or increases over its current levels, expect the final 4Q 2007 PPI numbers to be revised upwards.

Potential Risk Events From Rising Diesel Fuel Price

§ Rate of independent truckers going out of business will increase as the rise in their fuel cost overwhelms the growth in revenue per ton-mile.
§ As number of independent truckers decrease, the total number of available trucks to transport goods will decrease, keeping a floor on the cost of transportation of goods.
§ Businesses, seeing their profit margin shrink as transportation cost increases, will begin to pass on the additional cost by increasing their prices.
§ As more independent truckers go out of business, shortages of trucks to transport goods will result in certain goods being unavailable in certain sections of the country, artificially driving up the prices of those goods in those affected regions much higher than expected.
§ As a reaction to the overall rising prices, more consumers will begin switching to lower cost alternative or even cut back on their rate of consumption to save money and/or make their dollar last.
§ Business defaults will increase, particularly those businesses that are unable to monetize their receivable (AR) quickly or have to pay much higher factor to monetize AR.

The above scenarios may be all doom and gloom but it is a path that the U.S. economy is currently on, unless dramatic government intervention occurs. As a risk manager, it is my position to assess the risks and potential losses arising from the expected risks without sugarcoating the truth.

Now, being informed, do your own due diligence and draw your own conclusion. Be free to agree or disagree with my assertions. However, whatever you decide, use that decision wisely in your investment choices.

May your trading be profitable.

Ed Kim

DISCLOSURE: The author holds long positions in Oil Refining Companies at this time
[v] and[vi] Calculated using the Vehicle-miles traveled (millions) and Fuel consumed (million gallons) of RITA tables 4-13 and 4-14

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