Rising Gas Prices Fuel Industry’s Resilience

Mon June 30, 2008 - National Edition
Giles Lambertson




How are construction contractors, who operate massive diesel-gulping equipment, responding to the high price of fuel? Mostly by gritting their teeth and passing along the extra costs wherever contract price indices allow it.

“As far as what we are doing, we are just ’taking it’ right now,” said Don Clarkson, engineering and marketing director of Clarkson Construction Co. in Kansas City, Mo.

“Taking it” is another way of saying contractors are beginning to feel like a punching bag. They are being socked with quick uppercuts in the cost of construction materials like cement and steel and, perhaps most dramatically, diesel fuel.

The price of highway-use diesel fuel in the fourth week of June stood at $4.64 a gallon, a full $1.81 a gallon higher than one year ago, according to the U.S. Department of Energy. Generally speaking, off-road diesel runs about 30 cents less per gallon, mostly because fewer taxes are attached.

An alternative fuel increasingly coming into play is biodiesel. However, little or no cost savings are gained from switching an equipment fleet to the usually soy-based fuel. In the middle of June, the wholesale price of a gallon of a B20 blend of biodiesel was $4.16; the wholesale price of No. 2 petrodiesel during the same period was $3.96.

Amber Thurlo Pearson, a communication specialist with the National Biodiesel Board, notes that tax incentives can alter the equation. She observes that a 20-cent-per-gallon incentive is given B20 in some states, which almost eliminates the cost differential. In Illinois, a tax break is given B11 and higher blends of biodiesel so that the soy-based fuel actually is cheaper than oil-based diesel.

“As a general rule, though, a blend of B20 costs a few cents more than diesel,” she said.

The rising cost of fuel, whatever the type, is passed along to project owners where contracts include the pass-along language or where states regulate fuel costs by indexing them to current market conditions. Thirty-nine states allow fuel price adjustment clauses in contracts, according to data supplied by the American Association of State Highway and Transportation Officials. The Federal Highway Administration began posting the data on its Web site four years ago when price escalation began to be a hot issue.

The indices are triggered in different states by different mechanisms, with the Oil Price Information Service and Platt’s Oilgram among the favorite resources tapped for pricing. Some coastal states tie their adjustments to the price at local terminals; others look to state or national departments of transportation for a base price.

Downward adjustments in price are made as well as increases, but declining fuel costs are not the bedeviling problem. And the adjustment is not always applied to every project or to every piece of equipment fired up on a job site.

“We do have fuel adjustment indexes on certain types of jobs, for instance on the most apparent fuel-costly jobs where they are moving a lot of dirt,” said Steve Parks, executive director of the Georgia Highway Contractors Association, “but it is not across the board.” The Georgia fuel index applies only to contracts for projects that run 366 days or longer and is based on the amount of projected excavation work, quantities of aggregate base to be hauled, or asphalt pavement to be laid. And calculations can be complex. For example, computed and applied where applicable is the rate that fuel is consumed to move a certain number of cubic yards of dirt.

“We are trying to make sure it is accurate,” Parks said.

Such calculations vary from state to state. In Louisiana, the adjustments are made for 30 types of construction work. In Massachusetts, contracts are adjusted only for projects that are at least two years in duration with a price tag of at least $10 million. And so on.

“The fuel price index deflects the pain a little bit,” Clarkson said at Clarkson Construction, the 1,200-employee Missouri firm whose annual contract volume is in the $150 million to $175 million range. “In the past it hasn’t been a huge, huge issue, but now it obviously is.”

A heavy highway and civil construction contractor in Roanoke, Va., Branch Highways Inc., moves tons of dirt in several states in the region. Dams, landfills, reservoirs, industrial site preparation, airports, highways — none of its work is accomplished without burning lots of fuel.

Will Karbach, president of the firm, said the impact of fuel costs on his business in 2008 is “very real.”

“Fuel is probably 25 to 30 percent of our cost. It is huge,” said Karbach, who has 21 years of experience in the industry. Building a fuel index into a contract is one part of his company’s strategy to overcome rising fuel costs.

“If we are working for a private customer and there is a lot of fuel involved,” he said, “we know we are taking a very large work risk. We are not going to underprice that risk. We’ll offer a customer an index similar to what the DOT has, or arrange to give him an actual invoice of gallons used and just be compensated for the difference in price. The risk is not something we are trying to make money off of. We just need to cover our cost.”

Karbach said another piece in the company’s strategy to offset volatile fuel pricing is to anticipate the unexpected. “We have a fuel hedge in place for a very large project, a hedge account with Bank of America.”

The company executive adds that Branch really has three fuel-cost strategies. “Our third strategy is to grin and bear it.”

Fuel conservation is an obvious recourse when fuel cost begins to squeeze a company. One of the often cited examples of a company’s response to a rising fuel component in a budget was the decision some years ago by UPS to route its trucks so that drivers made few if any left turns, thereby eliminating the problem of idling trucks sitting at left-turn signals.

However, construction contractors use equipment much differently and more randomly than an on-highway trucking company, and most successful contractors long ago addressed the issue of wasted fuel, eliminating what bad practices they could.

“Obviously, with diesel fuel having a high price, contractors want to use what they have wisely, but I am not aware of any new formal conservation efforts,” said Brian Holmes, executive director of the Maryland Contractors Association.

Clarkson Construction’s experience is similar. “You know, really I can’t tell you of things that we have changed lately,” Don Clarkson said. “We try to be as efficient as possible.”

Parks of the Georgia Highway Contractors Association said he hears that companies are evaluating their equipment with an eye for getting rid of less fuel-efficient pieces in favor of new equipment, a major capital decision.

“And we do have some contractors who are looking at four-day work weeks,” he said. “I’ve had some discussions with them but we really don’t have the results in yet. The belief is that it will save in fuel costs and in other ways, in setting up daily traffic controls, for instance.”

Other company executives reject the four-day week concept because completion dates and tight work schedules don’t give them the luxury of spreading out the work over a longer period.

As for conservation, Branch Highways is looking at “some common sense stuff,” mostly relating to vehicles rather than heavier pieces of equipment. “Don’t leave the truck running, that kind of stuff,” said Karbach. “We are just starting the process to see who we have in vehicles and why we have them in trucks and if we should switch them to (more fuel-efficient) cars. We are just beginning to look at hybrids and we’re not even sure if hybrids are cost effective.”

As for replacing older pieces of heavy equipment with more fuel-efficient machines on the market now, Karbach said his company, like many others, has an ongoing replacement program.

“We are constantly recycling the equipment. We have a few specialty pieces that we will run forever, but they are the exception.”

The other side of the cost equation is whether rising prices of fuel and other commodities are raising project costs to a point where the letting of contracts is jeopardized. Contractors speculate that some jobs are being lost here and there because the price tag has been pushed too high.

Yet the relative bids of contractors are not affected by the volatility of fuel prices, with each competing company saddled with the same fuel cost.

“We are still bidding,” Clarkson said in Kansas City. “Every other company has the same issues that we do, everyone understands what is going on.”

Long-term and annual business plans aren’t being altered, in other words, just day-to-day operations.

“It really is the customer’s decision,” said Karbach, whose customers generate some $65 million a year in contracts, keeping his 200 employees working. “It is a question of whether a customer wants his project done. All the contractors are in the same boat.”

And in fact, Karbach said he has noticed that some project costs are going down. He has noticed that dump truck companies, for example, are bidding lower for jobs just to be competitive, squeezing their profit margins even thinner.

“We are seeing extremely high competition for jobs. The bottom is being knocked out on some bids,” he said. “We just withdrew from a bid in northern Virginia where 20 people showed up for the pre-bid conference.”

Karbach attributes the swell of competition to the downturn in the housing market.

“There is an excess capacity right now in the market we are in, with housing contractors crossing over into the commercial and infrastructure market. Things are getting very nasty.” CEG