Report to/Rapport au :

 

Corporate Services and Economic Development Committee

Comité des services organisationels et du développement économique

 

and Council/et au Conseil

 

23 June 2004/le 23 juin 2004

 

Submitted by/Soumis par : Greg Geddes, Chief Corporate Services Officer /

Chef des Services généraux

Corporate Services Department/Services généraux

 

Contact/Personne ressource : Lloyd Russell, Director, Financial Services and City Treasurer/directeur des Services financiers et trésorier municipal

580-2424, Ext./poste 21312, Lloyd.Russell@ottawa.ca

  

 

 

Ref N°:  ACS2004-CRS-FIN-0034

 

SUBJECT:     Fuel Pricing

 

OBJET :         Prix de l'essence

 

 

REPORT RECOMMENDATIONS

 

That the Corporate Services and Economic Development Committee recommend to Council that:

 

1.         Staff continue to purchase fuel on the floating rates unless prices start to escalate again, at which time staff be delegated the authority to contract for fixed prices in order to minimize the budgetary shortfall.

 

2.         A portion of the Provincial gas tax to be received commencing in October be earmarked to offset the impacts of the increase in fuel prices.

 

3.         The Ottawa Police Services be asked to use City owned sites instead of retail fuel cards whenever possible.

 

 

RECOMMANDATIONS DU RAPPORT

 

Que le Comité des services organisationnels et du développement économique recommande au Conseil :

 

1.         d’enjoindre le personnel de continuer à acheter l’essence aux taux variables, à moins que les prix ne recommencent à grimper, auquel cas il pourrait passer des contrats, par voie de délégation de pouvoirs, pour s’assurer de prix fixes, et ce, afin de minimiser le déficit budgétaire;

 

2.         de réserver une partie de la taxe provinciale sur l’essence qui doit être versée à compter d’octobre afin d’atténuer l’effet des hausses du prix du carburant.

 

3.         de demander au Service de police d’Ottawa d’utiliser, dans la mesure du possible, les postes d’essence des installations municipales plutôt que ceux des détaillants participants.

 

 

PURPOSE

 

The purpose of this report is to provide background on the impact of escalating fuel prices on the City’s budget and a strategy to minimize the budget impact for 2004.

 

BACKGROUND

 

Over the last several months the price of fuel has risen significantly in price and fluctuated dramatically over the last few weeks. Fuel is a very significant expenditure for the City, particularly in public transit. The City consumes in excess of 44 million litres of fuel annually of which over 36 million litres is used by public transit. As such, even a one-cent price change represents a variance of over $400,000.

 

The pricing of fuel to the end of May is running at an average of 5.6% over the budgeted rates. This equates to an overall increase in fuel costs to the end of May of approximately $740,000. Since the majority of the variance is related to the consumption of diesel fuel, this report will focus on that element.

 

Crude oil prices are determined in much the same way as other stock or commodity prices around the world – when inventories are low or demand increases, prices rise. Canada, like most other oil producing countries, does not regulate the price of crude oil, allowing Canadian-produced crude oil to sell at the prevailing world price. Non-OPEC countries like Canada and the US do not have the short-term production capacity to make up for any decline, natural or otherwise, in inventory, making OPEC influential in crude trading markets – and over the longer term, affecting the price of gasoline.

 

The average price paid between November 2002 and February 2004 was $.5664 per litre. The average price for Crude Oil in June 2003 was $31.00 /barrel US while one year later it is $38.00/barrel US, an increase of 23%. The Ottawa Wholesale Rack pricing for diesel (the cost prior to taxes and delivery) increased from $.32 per litre to $.42 per litre in the same period, an increase of approximately 31%.

 

The City has a number of contracts for the supply of fuel, the largest being with Suncor Energy Products Inc. (Sunoco) for the supply and delivery of diesel fuel. The diesel contract was awarded in 2003 for a three-year period based on best value. The pricing structure is based on the average market prices in place in the previous month and is adjusted monthly. The contract also allows for the fixing of prices for a longer period by entering into forward contracts at a fixed price for a fixed period based on a contracted price formula. This process provides some security over prices increases; however, if the price decreases at any time during the locked-in period the lower prices are not received.

 

The City does not currently have staff expertise in the area of projecting the pricing of fuel. This is an expertise that is very specific unlike expertise in financial investment markets. The price of fuel is driven by many external factors most of which are driven by world events. A review of readily available materials indicates that there are varying opinions and speculation on the direction of fuel prices

Runzheimers International, one of the United State’s renowned vehicle costing experts, issued a press release on June 9, 2004, which contained the following paragraph on the state of gas prices.

Consumers and businesses alike are anxious to know when prices will return to normal levels. Per Lee Czarapata, director of client relations within Runzheimer International's Business Vehicle Services Unit,” No one can predict gasoline prices with certainty, however, many factors point to a tight gasoline market for this driving season. First, gasoline inventories are below the normal range for this time of year. Second, total gasoline imports are below last year's level during the same time period. Additionally, since crude oil prices are also critical, refiners are dependent on an uninterrupted flow of crude oil. We do not expect gasoline prices to drop to lower levels quickly. These factors - combined with worldwide fear of supply disruption, summer driving demands, environmental requirements, and increased demands from business - in general will continue to keep gasoline prices high. Although prices may dip slightly in July, we anticipate continued volatile pricing across the country with August and September prices potentially reaching an all time high," states Czarapata.

Conversely the Sterling’s World Report, published by CI Mutual Funds Inc., in its April 2004 newsletter stated “Based on these observations, we think the next major move in oil prices this year is more likely to be down, toward $30 a barrel, rather than up into the danger zone of $48 or more.”  Then in its June newsletter it stated; “ we continue to believe that the next major move in oil prices is more likely to be down than up.”

 

The following chart shows the impact of 2004 weekly posted diesel prices compared to the actual prices paid by the City under our contract. It indicates the impact of buying based on an averaging of prices under our contract.

 

At the time of writing this report, the pricing structure for diesel fuel was a current floating price of $.6373 per litre, a fixed price 12-month locked-in price of $.6323 per litre, and a 6-month locked in price of  $.6426 per litre. The budget base is $.5564 per litre.

 

The budgetary shortfalls for each of the options are as follow for the period June – December:

 

Floating price (assuming no change)                 $1,680,000

Fixed 12-month rate                                         $1,580,000

Fixed six month rate                                          $1,790,000

 

Staff monitors the price of diesel fuel on a daily and weekly basis.  In the past, the City and former Region used forward contracts from time to time to limit budget variances. The last time prices were locked in was in 2001/2002. The rationale at that time was that the prices in place were significantly below the budget base and locking in prices allowed a reduction in the budget base. It should be noted that the vast majority of the time fuel pricing has been maintained at the floating rates provided for in the fuel supply contract. The use of floating or spot rates is the most common practice by major consumers of gas according to information received from our suppliers.

 

Since there is little clear or consistent advice on future fuel pricing, staff believes that the use of forward contracts or fixed price contracts should be pursued only from the perspective of limiting budget variances.

 

A further administrative complication exists in that, under the existing delegation of authority, staff cannot issue a contract locking in pricing if it will result in an over-expenditure of the budget. That situation currently prevents an administrative issuance of a fixed price forward contract.

 

Options:

 

  1. Lock in future pricing for a twelve-month period covering the balance of 2004 and part of 2005. This option brings certainty for the balance of the year at a rate slightly lower than the floating rate currently in place. This option protects against higher gas rates for the balance of the year but also eliminates any gains on the gas rate should it decrease over the balance of the year. This option also provides price certainty for the first half year for the 2005 budget.

 

  1. Lock in future pricing for balance of year (six months). This option brings certainty for the balance of the year; however, it also fixes the price at a rate higher than the twelve month fixed price option. This option protects against higher gas rates for the balance of the year but also eliminates any gains on the gas rate should it decrease over the balance of the year. This option provides no certainty for the 2005 budget.

 

  1. Continue to purchase under the contract. There is some smoothing through the use of the monthly rates, however, there is no budget certainty under this option. The budget variance will only be known at year-end. Should rates decrease, there can be some gain on the variance shown in this report, however, if gas prices increase there will be further budgetary shortfalls.

 

  1. Lock in partial volumes for the balance of the year. This is a compromise position that provides some certainty while allowing for some gains should rates improve. Future contracts can be bought in various quantities thus providing an opportunity to lock in should rates escalate or fall. The negative aspect of this is that the current pricing structure on forward contracts has shorter-term contracts at higher prices than long-term prices.

 

  1. Continue to purchase on the floating rates unless prices start to escalate again, at which time staff be delegated the authority to contract for fixed prices in order to minimize the budgetary shortfall. This options allows the City to achieve any price gains should prices reduce while limiting the upside exposure on the price.

 

It is recommended that Committee and Council approve option 5 which provides the best combination of price flexibility and budget minimization.

 

The pricing that currently exists will result in a significant budget shortfall unless prices reduce substantially. The shortfall is estimated at $3.0 million based on the current prices remaining in place for the balance of the year. This is approximately $2.3 million for transit and $.7 million for all other fleet.

 

Staff also looked at what operational mitigation strategies could be implemented. The use of vehicles, and therefore fuel, is a critical part of the program delivery of many of the City’s programs such as fire, police, paramedic service, road maintenance, by-law and traffic enforcement and public transit. The ability to reduce usage without significantly decreasing the service is very limited.

 

The KPMG municipal fuel standardization study completed in January 2004 identified that overall, fuel is cheaper when purchased in bulk for City owned fuel sites instead of purchasing it through retail stations.  The price difference varies significantly depending on the site and the type of fuel (with diesel prices for example in the first 4 months of 2004 approximately 10 cents per litre cheaper, while ethanol was about 5.5 cents per litre cheaper).  

 

Reasons for using retail filling stations instead of City owned sites include: (1) vehicle operators unproductively traveling out of their way to a City owned site; (2) vehicle operators and supervisors not yet aware of locations of City owned sites across the City; (3) City owned sites cannot be used interchangeably due to current incompatible legacy fuel systems; and (4) Paramedic Services - potential contamination for Paramedic staff handling fuel.

 

In order to mitigate some of the shortfall staff recommends the following mitigation practices:

 

  1. City staff be directed to use City owned sites whenever practical, for potential savings of $130K for the second half of 2004.

 

  1. The Ottawa Police Services be asked to use City owned sites instead of retail fuel cards whenever possible.

 

The majority of the City owned fuel sites dispense ethanol blend instead of gasoline, consistent with the City’s emission reduction strategy approved by Council in 2003.  Bulk ethanol fuel on average this year has cost 2.4 cents a litre more than bulk gasoline. If all fuel for gas vehicles was shifted to City owned sites, and gas was stocked at City sites instead of ethanol, the City could save $58K for the last half of 2004.  This potential mitigation method is not recommended given the fuel emission advantages outlined in the strategy.

 

These will provide modest savings in comparison of the magnitude of the shortfall and it is further recommended that a portion of the Provincial gas tax earmarked for transit use be used to offset the shortfall within transit operations for 2004.

 

 

FINANCIAL IMPLICATIONS

 

The financial implications of this issue are indicated in the report. The recommendations of staff will help mitigate the budgetary shortfall related to the increase in fuel prices. If fuel prices remain at current levels, the impact on the 2005 operating budgets will be approximately $3.7 million.