Wednesday, March 28, 2012

The diesel question - future price trends, and cutting costs

As the price of oil rises the pain for buyers increases. Farmers are price takers and not price setters, so they have no possibility to raise their selling price of corn, meat or milk to take account of the rise in diesel. 
Securing supplies of diesel is a major concern for farmers today. Now is not the time for supplies to be interrupted. Each farmer has to make his own buying decision, and the relevant information he has to do this is scarce, even though commodity markets are in information overload, with facts mixed up with fiction, 
politics with lobbying from pressure groups. Farmers, as ever, are retail buyer in a commercial market, though farmers in buying groups have a trading advantage.  Big businesses, on the other hand, have oil buyers who have the time and means to research the market, while the farmer generally has to take a seat-of-the-pants decision.

Short term issues, such as the threatened tankers drivers' strike action, could, if they occurred, have a devastating effect on individual farm businesses.

Farmers want an answer to some simple questions:

Should I buy as much diesel as I can now? Will the very rapid price hikes be followed by a fall in the price of oil? Should I invest in additional on-farm storage?

A senior oil trader told me last night the pressure on increasing prices continues. Oil company stocks have not been replenished over the slack winter period as they
normally are. Government strategic stocks are huge, and rising, as political concerns about Iran and other hot spots increase. Global strategic reserves are around 4.1bn barrels (more than half a barrel for every man, woman and child on the planet). Oil stocks in China are at record levels, and are continuing to grow even during this time of high prices, as their government and investors see the commodity as one of vital importance to the economy. India has begun the development of an oil reserve, as have many African countries. Japan's state controlled reserves of petroleum totals 324m b at 11 locations. Other countries are doing the same, and EU rules state that reserves must equal 90 days consumption. As oil prices go on up, so governments are investing taxpayers money in buying more.

On the production side, Saudi is pumping more than it has for the past 30 years, which makes additional production less likely, particularly at today's price levels, and the same is true for other producers. Ramping up production takes considerable time, particularly when production is already high - the taps are turned almost full on. In the longer term the investment in new fields and facilities will bear fruit, and these efforts are reflected in the future price which in a five year period shows a significant fall.

This makes little difference for farmers at the present.

Every business decision has + and - factors, and those concerned with the farm diesel supply are summarised as follows.

1. Market prices over the next six months - These are likely to increase still further, maybe as much as 12p/litre. It's the rate of oil price rises which cause economies to stagger - between Jan and April 2011 crude rose 35%. The same period in 2012 has seen a rise of 'just' 15%. However, if prices to rise to levels which trigger a release of stocks from the US Strategic Petroleum Reserve, (which is around 727m barrels) and which at the same time dampen demand, prices can fall. Brent oil prices flattened following the last release of SPR.
2. On farm storage. Diesel is too expensive to store in old tanks. It is too expensive to be stored without any security on the tanks. The cost and effort of re-siting tanks in the farm yard is a small price to pay for added security.
3. On-farm capacity. Diesel use on most farms is highly seasonal. Tanks that can be emptied in a week in the summer can last for months in the winter. On-farm strategic storage needs to take account of both. Enough capacity to allow buying at favourable rates and at favourable times. Given seasonality, a six month storage buffer for spring and summer work could be as much as 80% or so of total annual farm use.
4. Fuel condition. Long term diesel storage in static tanks allows for separation of components in the fuel. The fuel needs mixing on a regular basis. Half empty tanks take in condensation and the fuel gets contaminated by water.
5. Financial protection can be gained by forward trading - buying oil futures. If the oil price rises the value of your investment increases, theoretically covering the added cost of the actual fuel you need. If the price falls, then you fail to benefit. as your contract is at the earlier, higher price.
6. Security of supply. If the local supply is disrupted and your tank doesn't have enough for the next job, you have a costly delay.

Tips to consider to cut fuel costs

1. Get the tractor and implement maintenance right - tyre pressures, air filters, oil condition, ballasting to a minimum.
2. Don't drive like a goon
3. Use appropriately small and light tractors suited for the job. More fuel is needed to move that big tractor up the slope.
4. Control how much the contractor takes from the tank. Politely check tanks on arrival, and get the contractor to brim tanks from his own can / bowser before starting work. A padlock on the nozzle, and the key in your pocket is a good idea. Check on driving styles, and remember to praise contractors and drivers who use their tractors economically. Measure consumption and make the contractor aware of the figures, maybe on a daily basis. But don't get their backs up, ask why engines are left ticking over rather than demand they are shut down. Contractors are often the biggest users of farm diesel, so you have most to save if the drive sensibly.

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