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Jet Fuel Hedging: Who Does It & How Does It Work?  
User currently offlineIslandHopper From United States of America, joined Feb 2003, 327 posts, RR: 2
Posted (11 years 4 months 2 weeks 4 days 14 hours ago) and read 9050 times:

I read in the post about United's latest woes that they did not hedge their jet fuel this year. I imagine the airlines that haven't are really feeling the pain right now. Who besides United didn't hedge their Jet A? Why wouldn't an airline hedge it's fuel...doesn't this make thier costs more consistent and manageable?

Pardon my ignorance, but how does jet fuel hedging work? Does the airline sign a contract with the Jet A provider for a certain cost per gallon, or is it like an insurance policy they buy, guaranteeing that jet fuel won't go above a certain price? Or do they literally have huge storage tanks that store fuel when it's cheap and dispense fuel when it's not?



11 replies: All unread, jump to last
 
User currently offlineEstablished02 From Belgium, joined Jan 2002, 536 posts, RR: 2
Reply 1, posted (11 years 4 months 2 weeks 4 days 14 hours ago) and read 9029 times:

> Who besides United didn't hedge their Jet A?

I read a comment that at some point (now defunct) Sabena did not hedge their fuel purchases or at least insufficiently .

> Why wouldn't an airline hedge it's fuel...

It comes at a price. Companies may prefer (or have no other choice but) to reduce their financial costs by not hedging, while at the same time making themselves vulnerable to fuel price fluctuations.

> Or do they literally have huge storage tanks

I know little about the subject, however I would be very surprised if airlines would own and manage fuel storage tanks by themselves.

I guess the hedging contracts are negotiated (and traded?) in a similar way as on the option & future markets.


User currently offlineIslandHopper From United States of America, joined Feb 2003, 327 posts, RR: 2
Reply 2, posted (11 years 4 months 2 weeks 4 days 7 hours ago) and read 8950 times:

>I know little about the subject, however I would be very surprised if airlines would own and manage fuel storage tanks by themselves.

Yeah, that was just a wild guess...

So do almost all airlines hedge their fuel?


User currently offlineBusinessflyer From Singapore, joined Aug 2001, 288 posts, RR: 0
Reply 3, posted (11 years 4 months 2 weeks 4 days 7 hours ago) and read 8931 times:

Hedging of fuel is relatively simple. Basically, airlines can enter into agreement with suppliers of fuel to have the option to acquire a defined amount of fuel for a predefined period, i.e if the market price is x, but the airline believes that fuel prices will increase to x+5 in two months, it can enter into an option to buy fuel at x+2 in two months instead - if, of course, it can find a supplier prepared to enter the contract. These are termed call options, i.e. the airline has the option to acquire their fuel - different from a put option where you have the option to supply a good. Alternative there are swaps in which the airline has to acquire the fuel in return for cash payment.

There are, however, costs incurred in hedging and costs. The nature of the costs vary by type of option or contract entered into. However, at the simplest version an acquirer of a call option has to pay a commission or deposit for the right to enter into the contract. If the seller considers the agreement to be potentially risky the deposit as a % of the total value will be increased. It is not unusual for deposits to range between 1.5% and 15% of the face value of the contract. Furthermore, the longer the time period the option covers, the greater the deposit.

It is the cost that can discourage airlines from hedging their costs. Basically they have to calculate that the savings from the hedging are greater than the costs of the options. However, given the recent strong volatility in the oil industry, many airline companies have sought to reduce their exposure to dramatic spikes by hedging. I would be very surprised if any of the major airlines did not do this, but the percentage of fuel hedged will vary significantly.


User currently offlineAirsicknessbag From Germany, joined Aug 2000, 4723 posts, RR: 34
Reply 4, posted (11 years 4 months 2 weeks 4 days 4 hours ago) and read 8883 times:


I have some insight into another industry (non-aviation) which needs large amounts of oil.

Some of their representatives believe in hedging, some don´t. Those who don´t argue as follows:

- it´s like betting. You need to beat the seller concerning the accuracy of their predictions of the market price in half a year or a year.

- if you want to outsmart the seller, you need trained staff dedicated at professionally foreseeing the oil market´s future development. Their cost might offset the gain you have by getting cheaper oil.

- the seller´s predicting abilities are usually superior to yours, because he does this for a living, all the time.

- imagine the oil price falls and you have hedged at a high price - your busted, because your superiors won´t appreciate your paying high oil prices in a low market. If however you haven´t hedged and thus have to pay the current market prices, everybody will understand that.

Daniel Smile


User currently offlineTrey From United States of America, joined Nov 1999, 250 posts, RR: 5
Reply 5, posted (11 years 4 months 2 weeks 4 days 2 hours ago) and read 8852 times:

Most of these are done using swaps with major financial institutions. Options contracts are used however. For further reading, go to www.ipe.co.uk or www.cme.com, www.cbot.com, www.nymex.com. intersting stuff, can be made very complicated, but in general the concept is rather simple as stated in the above replies.

User currently offlineBeltwayBandit From United States of America, joined Mar 2003, 495 posts, RR: 0
Reply 6, posted (11 years 4 months 2 weeks 3 days 23 hours ago) and read 8792 times:

Daniel's point is well-taken. Hedging is a gamble, but it's not like a slot machine. It's very much like insurance. Every month you don't die, you wasted your life insurance premium. That does not make it a bad move to have life insurance, however there is a downside.

Hedging allows an airline to understand its "worst case" exposure. If you hedge, and fuel cost stay low, then you paid for insurance you did not need. BUT, you have the offsetting benefit of lower fuel costs. Without a hedge, there is no limit on how high your fuel costs may go.

In the airline business, particularly today, operating costs are everything because the lowest cost carrier will set the market on pricing for a particular market/route. In the current market, hedging looks brilliant. In a flat or declining market, hedging looks like a stupid expense. Hindsight is 20/20.

The most damaging element, however, is that it takes a LOT of capital and financial strength to be able to hedge. As a result, smaller airlines often cannot hedge fuel, or cannot hedge sufficiently.


User currently offlineScottb From United States of America, joined Jul 2000, 6713 posts, RR: 32
Reply 7, posted (11 years 4 months 2 weeks 3 days 17 hours ago) and read 8731 times:

It's also the case that airlines often hedge the price of jet fuel indirectly using heating oil futures; i.e. they use the profits from hedged heating oil to offset the increased costs of jet fuel. The cost of hedging also depends on whether or not the airline is purchasing options or futures; if they buy futures, they're stuck with the fuel/heating oil at the agreed price. With options, they can choose whether or not to exercise the option at the appropriate date; if fuel prices are lower, they're really only out the price of the option. I think BeltwayBandit's assessment of hedging being more like insurance is correct; while you do incur a cost from hedging, you also ensure that your fuel costs will not go above a certain level.

User currently offlineDL737 From United States of America, joined Mar 2003, 65 posts, RR: 0
Reply 8, posted (11 years 4 months 2 weeks 1 day 22 hours ago) and read 8671 times:

ey Guys:

This is a subject that has interested me to the point where it has become my career goal. First of all, very few of the airlines in the United States has subscribed to this type of "defensive pricing activity". One of these airlines is Delta which has had a tremendous success in cost savings using this concept. I do not believe that AA has this program, however on the international front, Lufthansa, British Airways, Air France and Japan Airlines have been very strong players in this field because of their susceptibility to violent pricing spikes due to their locales. The concept of hedging by using a forward negotiated fixed price is a dual edged sword as the airlines have now found out. This idea leaves open the idea of "betting on the future" and is a topic very difficult to ascertain because of sporadic market events. However,
by investing in the futures markets in contracts such as Crude Oil Futures, which are traded on the NYNEX in NYC, the airline's professional traders dedicated to this field have a MUCH higher probability in attaining the desired results that reflect on an airline's bottom line. To be more specific, there are now very high powered software packages that have become available in the past few years that players such as OPEC, Oil Companies and even individual traders can use to take advantage of any price moves that may come about without having to own or be contractually bound to the product. This is an everyday occurence, and this concept is known within its field as Technical Analysis of the Futures Markets. As some of you stock traders may know, it still uses the same bar charts as before but now with the great assistence of various studies that have their own inherent formulas which uses pricing over different periods of time that promote true speculating rather than betting, to capture the next price move to one's profitable advantage. For example, the various studies that are used are the following: Exponential Moving Averages,Parabolic Studies, Relative Strength Index Studies, Stochastics Indicators, Moving Average Convergence/Divergence Studies and Volume Analysis all converging into one major trading plan that heavily compliments the old fashioned bar chart into a formidable force for profitability. Intensive training is required which is available in both Chicago and New York City at the various Futures Exchanges as well as the New York Institute of Finance. The days of betting is totally over in the crude oil markets. In order to remain alive in a business which is highly reliable upon a price weighted commodity such as fuel oil, a company must subscribe to a business plan which is highly technical in nature and which can be proven and acted upon immediately on a moment by moment basis by utilizing the above mentioned criteria. All of the aforementioned airlines, should be complimented highly for their business prowess, especially for Delta who initiated this pricing practice years before any USA based airline.

In my opening sentence, I mentioned that I am making this my career goal. This is a relatively new field that would interest those who have a very high sense of self discipline in not deviating away from set trading rules and who are excellent in number crunching. It is a very quickly paced enviornment requiring that the trader/hedger be adaptable to changing market conditions whether it be on a technical level or on a fundamental basis. I have now been "paper trading" for about a year with the coaching of an experienced technical futures trader (another a.net user) with good success. As I enter college next September, I only anticipate on getting more proficient in this field to the extent that this area of expertise will be a source of substantial gain. For those of us that aspire to be in the airline business but on a different level, the above concept could be an interesting idea to consider for future employment.

Best to all,
Jim (DL737)


User currently offlineSingapore_Air From United Kingdom, joined Nov 2000, 13738 posts, RR: 19
Reply 9, posted (11 years 4 months 2 weeks 1 day 22 hours ago) and read 8652 times:

Singapore Air/Fuel Bil

SINGAPORE (Dow Jones)--Singapore Airlines Ltd. (P.SAL) said Thursday longer flight routes to Europe and the U.S. will lead to a higher fuel bill, but the carrier declined to quantify any costs from the war in Iraq.
"A larger fuel bill is inevitable with the alternative longer routings of flights due to the Mid-east conflict," the airline said in response to a query from Dow Jones Newswires.

The airline said Thursday it planned to fly alternative routes to Europe and the U.S. and also suspended up to 65 flights, or about 10% of its weekly schedule, because of the war in Iraq.

The airline has traditionally hedged up to 50% of its fuel needs. In the financial year ended March 31, 2002, a one U.S. cent per gallon rise in fuel cost lead to a S$19 million rise in cost, it said.



Anyone can fly, only the best Soar.
User currently offlineDL737 From United States of America, joined Mar 2003, 65 posts, RR: 0
Reply 10, posted (11 years 4 months 1 week 4 days 19 hours ago) and read 8592 times:

Totally forgot about Singapore Airlines. They are also major players in Jet Fuel Hedging.

My Bad.
Jim  Big thumbs up
(DL737)


User currently offlineCloudy From , joined Dec 1969, posts, RR:
Reply 11, posted (11 years 4 months 1 week 4 days 7 hours ago) and read 8531 times:

Airsicknessbag said -

- imagine the oil price falls and you have hedged at a high price - your busted, because your superiors won´t appreciate your paying high oil prices in a low market. If however you haven´t hedged and thus have to pay the current market prices, everybody will understand that.

------

From what I understand - hedging gives you the RIGHT to buy fuel at a certain time but not the OBLIGATION. Say gass costs $12 a unit. You buy a hedge for 100 gallons at $12 a unit. If the the price of oil falls to say, 10 dollars per unit, you can simply not exercise your right to buy it at 12 dollars per unit. In this case - you buy the fuel on the open market. When you hedge, you are buying an insurance policy against fuel going over a certain price per unit. Like with any insurance policy, the money you put into it goes down the drain if you don't make a claim. Yet you are never forced to make a claim. And you shouldn't do so if it is not in your best interests - it makes no sense to exercise a right to buy fuel at $12 a gallon when the market price is $10.

--------
- it´s like betting. You need to beat the seller concerning the accuracy of their predictions of the market price in half a year or a year.
---------
What you are describing is not a "hedge" or a "call option". It is more like a "fixed-price contract". A fixed price contract gives you the OBLIGATION to buy - and because of this is more like gambling than insurance.

Gambling is indeed a zero-sum game as you described. Insurance is not. Both buyer and seller can profit from insurance. The buyer gets to put the risk of an unpredictable cost(fuel in this case) on the seller's balance sheet. The seller can manage this risk by selling many different kinds of hedges for many different commodities - and if he is successfull - he can convert these risks into predictable costs and charge accordingly for his product. So both parties get what they want.

With insurance-like products such as hedges, you are not betting that you know more about the risk than the seller. What you are doing is paying the seller to accept a risk for you that he is better able to bear than you are. He uses many clever tactics to protect himself from the risk he takes on. He invests the money you pay in premiums. He buys insurance himself from what is called a re-insurance company. He uses clever tactics like selling hedges to airlines and "reverse-hedges" to oil companies at the same time. If the price goes up, he (in effect) has to pay the airlines but not the oil companies. If the price goes down, he pays the oil companies but not the airlines. Since the price can't go up and down at the same time, his total risk is reduced. And there are many other tricks an insurance/hedge seller can play on the market to improve his profit. The more skillfull the insurance/hedging industry is at doing so, the better it will be for you as a buyer, because that will lower premiums in the long term. So the seller's skill works to your advantage.

In short - hedges/options/insurance can be abused, but when used correctly can bring benefits to both the buyer and the seller as well as the economy as a whole. They are not neccesarily a zero-sum game.


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