Fuel cost spike hits carrier margins

J.B. Hunt, a major carrier, warned of a 5% to 10% earnings decline in the third quarter due to escalating fuel and driver expenses. Retail diesel prices surged around 31% between July 5 and September 17, while wholesale prices increased more than twice as fast, reducing the retail-wholesale spread by nearly 48% over the same period.

When the spread narrows, larger carriers that purchase fuel wholesale face the consequences, although they often recover when fuel prices drop. The market penalized J.B. Hunt for potential margin erosion in Q3, likely due to a possible overvaluation in Q2. Large carriers can negotiate fuel purchases at a discount to the retail price, commonly referred to as a rack price, typically around 2% higher than the rack price.

These discounts are usually passed onto customers through fuel surcharges, providing carriers with a buffer against fuel cost fluctuations. However, J.B. Hunt's dedicated and intermodal businesses have longer-term contracts that were set before the recent market shift, leaving them more vulnerable to fuel cost fluctuations. The fuel spread between retail and wholesale diesel prices highlights this vulnerability.

Wholesale diesel prices are more volatile than retail prices, as they are negotiated daily in a free market, while retailers can stabilize their retail prices over time. As a result, carriers are buying fuel at higher costs than their fuel surcharges based on retail prices can cover, leading to lower fuel spreads and margin erosion.

While the current market may have seemed promising for J.B. Hunt in Q2, this quarter's earnings decline is a more realistic reflection of the company's exposure to fuel cost volatility. Smaller fleets, which do not purchase fuel wholesale, face a different issue. They are unable to pass rising retail prices on immediately, especially in a competitive market.

The retail diesel price has increased roughly 24% over the past three months, while spot rates have decreased by around 6%. Although this does not necessarily indicate financial loss, it suggests margin erosion. The challenge for small carriers is the uncertainty of recouping this margin loss later, as it depends on market conditions.