Sponsor Message:
Civil Aviation Forum
My Starred Topics | Profile | New Topic | Forum Index | Help | Search 
Oil Price Hedging  
User currently offlineQantas787 From , joined Dec 1969, posts, RR:
Posted (7 years 6 months 2 days 2 hours ago) and read 2710 times:

After the recent drop in oil prices of about 20%, is it now at these prices, prudent for the airlines to start hedging, or is it still too expensive. If for example oil dropped to $50 a barrel, and airlines enmasse started to hedge, is there a limit to the amount of fuel that would be available to hedge. Any input would be appreciated. BTW I did do a search and didn't find any recent threads on this subject. Thanks. Smile

33 replies: All unread, showing first 25:
 
User currently offlinePanHAM From Germany, joined May 2005, 8740 posts, RR: 28
Reply 1, posted (7 years 6 months 2 days 2 hours ago) and read 2700 times:

OPEC just announced a 1 Million barrel a day production cut to stabilize prices. That announcement allone will affect the market and any, so any contract mnot made yetsreday should wait a couple of days to test market reaction.


I'm not fishing for compliments
User currently offlineBaroque From Australia, joined Apr 2006, 15380 posts, RR: 59
Reply 2, posted (7 years 6 months 2 days 2 hours ago) and read 2687 times:

As I understand it, QF have hedged again, but at something close to USD70 a barrel which means they are losing at present prices.

http://www.smh.com.au/news/business/...umbo/2006/09/27/1159337221124.html

"QANTAS is not placing much store by the recent dive in oil prices, having just boosted its fuel hedging level to 90 per cent of its needs for 2006-07 compared with 60 per cent when it announced its annual profit five weeks ago.

Qantas is at present enjoying the benefits of lower fuel prices but is playing a conservative game, having used the lull to boost hedging.

Recent deals have been slightly more favourable as the new average hedge price is $US70.50 a barrel for oil, down from $US71 when the full-year result was announced."

Hedging looks clever when you get a clear run up in prices and you hedged as Qantas did at about 32$ a barrel. Hedging at 70 could look great or ugly, depends on King Frost, and King Bush.

Will there be a cold northern winter, will Bush try and fight Iran, or even being nasty again to Chavez could bring Qantas hedging in as a smart move. If oil declines during a mild winter and calmer politics to below $60, it will not look so smart.

No idea what the other airlines are doing. The other thing to look at is what the oil companies are doing. Oil Search some years ago hedged their production at something horrid like 18$ while prices went north of 30. They will not do that again. Woodside had a nasty bout of hedging too, not sure what they are doing at present.


User currently offlineAF022 From France, joined Dec 2003, 2135 posts, RR: 1
Reply 3, posted (7 years 6 months 1 day 15 hours ago) and read 2584 times:

Quoting PanHAM (Reply 1):
OPEC just announced a 1 Million barrel a day production cut to stabilize prices. That announcement allone will affect the market and any, so any contract mnot made yetsreday should wait a couple of days to test market reaction.

Despite this, prices don't seem to have moved much. I don't think OPEC is the most cohesive of organizations.

Check out this site with recent price activity.
http://www.seat9k.com/crudeblog.html


User currently offlineBaroque From Australia, joined Apr 2006, 15380 posts, RR: 59
Reply 4, posted (7 years 6 months 1 day 15 hours ago) and read 2571 times:

Quoting AF022 (Reply 3):
Despite this, prices don't seem to have moved much. I don't think OPEC is the most cohesive of organizations.

No, well the prices will not move much until we find out how much the overproduction will be. If it is 1 million a day, they may even fall, but if some of that million really IS taken off the market, prices will rise, probably slowly, but expect jumpy prices while the politics remain uncertain.

OPEC is rarely cohesive. The most dutiful now do not control the excess capacity, that is with the Gulf states and Saudi. In most circumstance the Gulf states overproduce. We shall see if it is different this time.


User currently offlineSupa7E7 From , joined Dec 1969, posts, RR:
Reply 5, posted (7 years 6 months 1 day 15 hours ago) and read 2566 times:

You don't hedge expecting to make money. You hedge to remove volatility from your spending.

In principle, and over any highly repetitive cycle, hedging oil is a money loser to transaction losses. Just like buying insurance is generally a money loser. But buying insurance can be smart business to reduce your volatility.

The whole notion of "timing the market" is way beyond the expertise of any airline including WN. Oil companies have far more, higher paid, smarter people working on that than any airline could dream of. You can get lucky, but just like any commodity market... it's a hedge, not a decent investment!! Expected growth is below 0% on any hedge.

Many airlines hedge today for political reasons (to appease investors and worker groups who saw WN's windfall). They barely know what they are doing IMO.


User currently offlineN328KF From United States of America, joined May 2004, 6482 posts, RR: 3
Reply 6, posted (7 years 6 months 1 day 15 hours ago) and read 2561 times:

The problem with hedging is that when you buy a hedge, you do it at the market rate. If you have hedges from when oil was lower, that's great. But you can only hedge at the lmarket price, since nobody will be stupid enough to sell you a contract for less than the going rate. They'd lose money.

With that said, this might not be a bad time for airlines to hedge fuel oil (they cannot hedge Jet-A, but fuel oil is pretty much the same price) for future occurrances.



When they call the roll in the Senate, the Senators do not know whether to answer 'Present' or 'Not guilty.' T.Roosevelt
User currently offlineBaroque From Australia, joined Apr 2006, 15380 posts, RR: 59
Reply 7, posted (7 years 6 months 1 day 14 hours ago) and read 2530 times:

QFs hedging seems poorly timed. Mind if W had invaded Iran, it would have been brilliant. But just at present, not so good.

User currently onlineTVNWZ From United States of America, joined Feb 2006, 2309 posts, RR: 2
Reply 8, posted (7 years 6 months 1 day 8 hours ago) and read 2463 times:

Most of the major airlines have been hedging all along

Many as the cost of oil shot up considerably. And now, many of those airlines have been stuck with hedges that are upside down: the value of the hedge is higher than the current spot market cost.


User currently offlineCory6188 From United States of America, joined Feb 2004, 2686 posts, RR: 6
Reply 9, posted (7 years 6 months 1 day 8 hours ago) and read 2450 times:

Quoting TVNWZ (Reply 8):
And now, many of those airlines have been stuck with hedges that are upside down: the value of the hedge is higher than the current spot market cost.

I was wondering about this....is it feasible for carriers in this situation to buy fuel at the current market price and then only draw from their hedge when the market price rises above their hedge price? Or are they stuck into purchasing fuel at the hedge price regardless of what happens to the market price?


User currently offlineBaroque From Australia, joined Apr 2006, 15380 posts, RR: 59
Reply 10, posted (7 years 6 months 16 hours ago) and read 2354 times:

Quoting TVNWZ (Reply 8):
And now, many of those airlines have been stuck with hedges that are upside down: the value of the hedge is higher than the current spot market cost.

I assume that is how financial hedges got their name, full of bloody prickles, you usually get stabbed as you go in, and stabbed again as you get out.


User currently offlinePolymerPlane From United States of America, joined May 2006, 991 posts, RR: 3
Reply 11, posted (7 years 6 months 15 hours ago) and read 2334 times:

Quoting TVNWZ (Reply 8):
Many as the cost of oil shot up considerably. And now, many of those airlines have been stuck with hedges that are upside down: the value of the hedge is higher than the current spot market cost.



Quoting Baroque (Reply 2):
As I understand it, QF have hedged again, but at something close to USD70 a barrel which means they are losing at present prices.



Quoting Cory6188 (Reply 9):
I was wondering about this....is it feasible for carriers in this situation to buy fuel at the current market price and then only draw from their hedge when the market price rises above their hedge price? Or are they stuck into purchasing fuel at the hedge price regardless of what happens to the market price?

I don't think when you hedge your fuel price you actually buy the fuel at that price. What you actually buy is a future, which means, whoever sells it agrees to sell you fuel at say $70/barrel.

It does not mean you HAVE TO buy it from them for that price. You can choose not to exercise that future contract, which means you can buy fuel at market price. That is why it's more like an insurance policy rather than contract to buy.

However, there's a fee associated with the hedging, and you will lose it no matter what happens.

Also, the fuel price from future contract does not depend on the current oil price. Say, current oil price is at $50/barrel, You probably cannot buy a future at this price. It's all on the expected future value of oil price. If the market see this price drop is only temporary, nobody will ever sell a future contract at this price.

Cheers,
PP



One day there will be 100% polymer plane
User currently offlineBaroque From Australia, joined Apr 2006, 15380 posts, RR: 59
Reply 12, posted (7 years 6 months 14 hours ago) and read 2330 times:

Quoting PolymerPlane (Reply 11):
However, there's a fee associated with the hedging, and you will lose it no matter what happens.

That is indeed correct in terms of a hedge for purchase. However, sellers do indeed have to deliver at the hedge price. So QANTAS faced with the option of losing a few dollars of hedge costs and buying oil at USD70 will clearly chose to forfeit that money. However an oil company that had hedged to sell at USD70, will indeed claim that money. I don't know of any that oil producers who did hedge that way, but I am willing to bet that there are some. But equally, if you had hedged to sell at 70 and the price was 78, you had to deliver at 70.

Just as Placer for about 3 or so years had hedged sales of gold at anywhere up to (from memory, but I could find the actual numbers) USD80 an ounce above the then market prices.

Some of the largest players have a policy of going with the tide - Rio Tinto is one I believe. This is much the same as EXXON which some years ago did not let you take out insurance when you hired a car to do work for them, because they self insure - it pays to do so when you are as large as EXXON. Don't know how they went with the EXXON Valdez however!


User currently offlineSupa7E7 From , joined Dec 1969, posts, RR:
Reply 13, posted (7 years 6 months 14 hours ago) and read 2315 times:

Quoting Baroque (Reply 12):
This is much the same as EXXON which some years ago did not let you take out insurance when you hired a car to do work for them, because they self insure - it pays to do so when you are as large as EXXON

Right. Ideally you don't buy any insurance or hedges, because overall they are money losers. You only insure what you cannot afford to lose.

Airlines would be better off if they all signed a pact saying "I will not hedge fuel, no matter what." Then, airlines would not be paranoid about keeping up with other airlines' hedges. If fuel went to $100, all would face it simultaneously, and nobody would be at a competitive disadvantage. It is competitive fears that spur fuel hedges IMO, not just expensive fuel itself but the prospect your rival will destroy you if they hedged well.


User currently offlineBaroque From Australia, joined Apr 2006, 15380 posts, RR: 59
Reply 14, posted (7 years 6 months 14 hours ago) and read 2299 times:

Quoting Supa7E7 (Reply 13):
Airlines would be better off if they all signed a pact saying "I will not hedge fuel, no matter what."

What can I say, you are right!!  checkmark 

The only other comment is that there is a country not so far from Aus where it is possible to do really stupid things while driving and have other drivers avoid you instead of, as in Aus crashing straight into you, and asking why you did something so stupid. Is this because the population of country X is strangely tolerant? Well they are pretty tolerant, but no, it is because very, very few have car insurance, so they are just as keen not to hit you as you are not to be hit. There is probably a lesson in that!!


User currently offlinePolymerPlane From United States of America, joined May 2006, 991 posts, RR: 3
Reply 15, posted (7 years 6 months 13 hours ago) and read 2298 times:

Quoting Supa7E7 (Reply 13):
Right. Ideally you don't buy any insurance or hedges, because overall they are money losers. You only insure what you cannot afford to lose.

No, you buy insurance to reduce the risk of doing business, and spread the risk among the industry. It is a money loser, but it's better than having to take the risk. Remember, you'll never get the expected value of the risk. If you insure your car, you can never get 1/2 crash or 0.02 crash. The result will be either u crash or u don't. You take insurance so when u crash, you don't go broke.

Cheers,
PP



One day there will be 100% polymer plane
User currently offlineF9Animal From United States of America, joined Dec 2004, 4947 posts, RR: 28
Reply 16, posted (7 years 6 months 13 hours ago) and read 2293 times:

While OPEC did state a 1 million barrel production cut, prices dropped almost $2.00. Airlines would be smart if it drops to $45-$50 range to hedge. While we face next summer and hurricane season, I am sure the prices will rise again. Seems like any reason for a season is a reason these days.


I Am A Different Animal!!
User currently offlineANother From , joined Dec 1969, posts, RR:
Reply 17, posted (7 years 6 months 13 hours ago) and read 2293 times:

Don't forget that despite the large drop in per barrel cost of oil, the cost of refined Jet A kerosene has seen smaller reductions. This weeks price of Jet A is still north of $75 and the average price for '06 is still north of $85.

If QF is hedging at $70 for kerosene - Great!


User currently onlineTVNWZ From United States of America, joined Feb 2006, 2309 posts, RR: 2
Reply 18, posted (7 years 6 months 13 hours ago) and read 2280 times:

Hedging is a way to smooth out the cost of fuel. It is not about winning and losing per se, even though WN won with their hedging strategy. Airlines want and need predictability in their cost structure. Because of the volitility of oil, hedging can do that if done properly. It is/can be a very good business. They should stay with it.

User currently offlineDZ09 From United States of America, joined Sep 2006, 491 posts, RR: 1
Reply 19, posted (7 years 6 months 6 hours ago) and read 2221 times:

If prices drop, then I think it is smart to hedge as long as W is in office. Once the democrats take over in '08, oil prices will free fall.

User currently offlineN328KF From United States of America, joined May 2004, 6482 posts, RR: 3
Reply 20, posted (7 years 6 months 3 hours ago) and read 2197 times:

Quoting DZ09 (Reply 19):
If prices drop, then I think it is smart to hedge as long as W is in office. Once the democrats take over in '08, oil prices will free fall.

That's rather presumptuous. It's a good thing you don't work for commodities brokers.



When they call the roll in the Senate, the Senators do not know whether to answer 'Present' or 'Not guilty.' T.Roosevelt
User currently onlineTVNWZ From United States of America, joined Feb 2006, 2309 posts, RR: 2
Reply 21, posted (7 years 6 months 2 hours ago) and read 2193 times:

OPEC is Democrat?
.
.


User currently offlineSupa7E7 From , joined Dec 1969, posts, RR:
Reply 22, posted (7 years 6 months 1 hour ago) and read 2180 times:

Quoting PolymerPlane (Reply 15):
Remember, you'll never get the expected value of the risk.

If you repeat something 10,000 times, you will get precisely the expected value of the risk. Probably this is why large companies can self-insure small matters.

Of course, if a typical person loses their car, it's disastrous. So they should insure that risk.

Whether fuel hedging is a risk mitigator is confused by the fact that the industry has pricing power. Airlines can slap fuel surcharges, so it's really the consumers who face oil risk, not the airlines. FedEx is a pure example of that. Their customers paid for the oil hike, not FedEx.

Here's an excerpt from a fairly decent though too-optimistic hedging paper online, fair use excerpt:

http://www.kellogg.northwestern.edu/research/fimrc/papers/jet_fuel.pdf

"Making the case against hedging, Rod Eddington, the CEO of British Airways, commented: "a lot is said about hedging strategy, most of it is well wide of the mark. I don't think any sensible airline believes that by hedging it saves on its fuel bills. You just flatten out the bumps and remove
the spikes." He went on to say that there is a case for not doing any hedging at all. "When you hedge all you do is bet against the experts of the oil market and pay the middle man, so you can't save yourself any money long term. You can run from high fuel prices briefly through hedging but
you can't run for very long."

The paper goes on to attempt to say Eddington is wrong. In doing so, the paper neglects to disprove Eddington's central point, that airline hedges are doomed to fail to outperform the market over time. If they could, why wouldn't we all do it and make ourselves billions?

The paper does not examine the transaction losses, which are key. If you pay a 5% fee to make an even-odds gamble with somebody, you're going to lose 5% of let's say $1 billion. So, hope you budget $50 million for hedge fees each year. Good business? Maybe.

Without quantifying that spending, it's hard to say the cost stability is worth it. There is a happy medium between low costs and low volatility, but the paper does not explore that subtlety, instead saying low volatility is always better.

So they simplify an issue with too many moving parts for them to understand. They advise airlines to hedge at the bottom of each oil "cycle." Great plan, Kellogg, wish I thought of that.

A junk paper, but the Eddington quote has the ring of serious mathematics to it. I just get the feeling today's execs are upping the ante, trying to get dealt a royal flush like WN got in 2002. It's expensive, this poker.


User currently offlinePanHAM From Germany, joined May 2005, 8740 posts, RR: 28
Reply 23, posted (7 years 6 months 1 hour ago) and read 2175 times:

Quoting ANother (Reply 17):
Don't forget that despite the large drop in per barrel cost of oil, the cost of refined Jet A kerosene has seen smaller reductions. This weeks price of Jet A is still north of $75 and the average price for '06 is still north of $85.

you can only hedge the commodity, not the refinery costs.



I'm not fishing for compliments
User currently offlinePolymerPlane From United States of America, joined May 2006, 991 posts, RR: 3
Reply 24, posted (7 years 6 months 1 hour ago) and read 2165 times:

Quoting Supa7E7 (Reply 22):
If you repeat something 10,000 times, you will get precisely the expected value of the risk. Probably this is why large companies can self-insure small matters.

Yes, but how can u explain that big airlines still buy airplane insurance? because it's less risky for them to do so. I know that if you are big, those risk will even out by itself, but it's still a riskier than taking insurance policy.

Quoting Supa7E7 (Reply 22):
Whether fuel hedging is a risk mitigator is confused by the fact that the industry has pricing power. Airlines can slap fuel surcharges, so it's really the consumers who face oil risk, not the airlines. FedEx is a pure example of that. Their customers paid for the oil hike, not FedEx.

You are way off. Parcel carrier and pax airlines are two different industry. In parcel carrier, there's only two market leader, and some small player. Thus, they have stronger pricing power. Airline industry on the other hand, cannot simply pass its costs, especially in the US.

That's why you see those legacy carrier made big loss in the last several years. If your theory is correct, we would not see DL, NW, UA and others entered chapter 11, because they can simply pass the costs, including labor and fuel, to the consumer right?

Quoting Supa7E7 (Reply 22):
I don't think any sensible airline believes that by hedging it saves on its fuel bills. You just flatten out the bumps and remove

Flattening the bumps and remove the spikes are the important point here. I never said that you can make money off fuel hedging. I even admit that if you can get the expected value you actually lose money. But by doing this fuel hedging, you remove the uncertainty, thus you can work on your business plan more accurately.

It's about diversifying your risk. Just like people build portfolio around many different stocks. Airlines hedge some percentage of their fuel, just to spread the risks.

Quoting Supa7E7 (Reply 22):
"When you hedge all you do is bet against the experts of the oil market and pay the middle man

So what? experts loses money in the market all the time. No one stock broker has constantly make money in the market.

Anyway, I do not have time to read this paper, but It looks like a class exercise rather than serious research paper, and I don't think it has been peer reviewed. I would not dig into it too deep.

Cheers,
PP



One day there will be 100% polymer plane
25 Supa7E7 : Hang on, we're talking about fuel. Not labor. NW, UA and DL were quite different from B6, FL, F9, TZ being legacy compared to LCC. But in one respect
26 Scalebuilder : This is very true. Should the option or the future contract expire "out-of-the" money, you're only out the cost of the contract itself. You can still
27 PolymerPlane : Now you said it yourself. Price hike failed because "strong players hoping to destroy the weak", which is a fancy way to describe competition, and ye
28 DZ09 : Wait and see. I am too smart to be working for commodities brokers and they're parasites anyway.
29 Supa7E7 : I am not here to defend pricing policies. Suicidal pricing is quite common. It always goes to the strong party's limit. AirTran was in control of man
30 PolymerPlane : I am not going to argue with you. You can believe whatever you want to believe. Just answer this question: 1. Was Oil spike hurt the bottom line of L
31 Post contains images Scalebuilder : Just an interesting observation related to this topic. I was watching MSNBC on Sunday night. They had a special labeled "A week with American Airlines
32 VV701 : At the time of this announcement an OPEC spokesperson was asked to justify a cut in production of this size while crude prices were still very high i
33 Baroque : Why did I own shares in the oil company from whom they must have hedged!!
Top Of Page
Forum Index

This topic is archived and can not be replied to any more.

Printer friendly format

Similar topics:More similar topics...
JetBlue At HOU: Sale Based On Oil Price posted Tue Aug 15 2006 15:22:31 by JetBluefan1
Oil Price Rising: When Will Airlines Collapse? posted Sat Aug 13 2005 10:15:54 by Udo
Oil Price - Jet Fuel Question posted Sun Feb 27 2005 09:07:45 by SendMEtoLAS
Should Airlines Be Worried About Rising Oil Price? posted Fri Aug 16 2002 06:05:19 by Bobcat
What If The Price Of Oil Continues To Rise? posted Mon Jul 17 2006 20:29:22 by FLY2LIM
Recent Crashes, Price Of Oil & Maintenance posted Wed Aug 24 2005 20:26:44 by CO767FA
AMR's Beer: Fuel Hedging Has Its Price posted Fri Aug 19 2005 04:06:14 by TACAA320
What Price Oil? posted Tue Sep 28 2004 15:34:33 by Scotron11
Delta Stock-price/volume Spike In Sept. posted Wed Nov 15 2006 13:48:58 by Redcordes
Same Price But Big Difference In Service! posted Sat Oct 28 2006 12:14:42 by RootsAir