With gas prices surpassing $2/litre in Western Canada, Ontario is projected to follow suit
The war in Ukraine triggered fuel costs to become highly volatile, and Ian Breneman, a lawyer at Alexander Holburn Beaudin + Lang LLP, says price volatility may force a transportation company to disproportionally absorb surging costs or leave customers dissatisfied with the dramatic increase in transportation costs.
The “Navigating Volatility: Contract Tips for Fluctuating Fuel Costs” article by Breneman and Johann Annisette stresses that fuel price volatility can result in financial difficulties, unhappy customers, and costly disputes.
CTV News previously reported that gas prices in Vancouver had surpassed the 2$ per litre mark and projects that Ontario will follow suit before the end of the month as most GTA stations currently sell at 191.9 cents per litre. In addition, gas prices in the region are expected to set a new record of 195.9 cents per litre by Friday.
Although it may be difficult to predict fuel prices, Breneman says the impact of volatility can be managed and mitigated by determining whether and how to account for fuel price volatility and reflect those decisions clearly in a written contract.
Breneman says it is common in the transportation industry to enter fixed-price contracts for a freight rate, including a percentage or weight-based fuel surcharge that does not consider fuel price volatility.
He says fixed-price contracts provide parties with predictability, and, subject to third-party costs and inspection fees, all parties involved know the amount paid for the carriage of goods.
While fixed-price contracts create certainty for the shipper, Breneman says it poses a risk to the carrier or broker because when fuel prices spike, they suffer the financial impact, and if prices plunge, the customer may perceive that they overpaid.
"If you are a company that gives a quote and takes a deposit from a customer for moving household goods from one place to another, your client might not be too happy if the gas price has dropped a lot before the actual delivery takes place and they could have gotten a much better deal somewhere else."
One way to mitigate these circumstances is to ensure that quotes or estimates remain open for a limited time or that they are subject to change until the carriage is confirmed, Breneman says.
Another contract that addresses fuel volatility is the floating price reimbursement model, which Breneman says involves passing the carrier's fuel cost to the broker and through to the shipper, who reimburses the carrier for the actual fuel cost.
While the reimbursement model reduces uncertainty for the fuel carrier, it places a disproportionate risk on the broker or shipper, and he says the contractual structure places an administrative burden on the parties required to process such repayments.
In longer-term contracts, Breneman says fuel carriers may establish a fixed percentage or price increase assuming that fuel costs will rise steadily over time.
He says a fixed increase structure may permit parties to build predictable cost increases into their contracts. However, parties may become dissatisfied or unprofitable if price increases initially agreed on do not reflect actual fluctuations in the market price of fuel.
A hybrid approach that shares the risk of fuel price volatility is attainable through a fuel surcharge arrangement or price adjustment clause, which Breneman says typically includes a benchmark source to determine the market cost of fuel—for example, the Freight Carriers Association of Canada Fuel Index.
A hybrid approach also includes a base fuel price to be paid until a change in the market cost of fuel occurs and a price adjustment mechanism if costs fluctuate, Breneman says.
He says a price adjustment clause should address the timing and frequency of adjustments and set out a clear formula that indicates whether upward and downward price modifications are permissible.
A contractual price adjustment approach provides flexibility and shares the risk of fluctuating fuel costs, but the cost of transportation may remain unpredictable, Breneman says. "Given their complexity, these contractual clauses could result in more time negotiating terms such as the base fuel price or the price adjustment mechanism."