cha747
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Most Profitable: Tankering, Hedging, Or Market?

Thu Jun 14, 2007 12:20 pm

Hello All,

I've struggled with this "airline business" question for a while now so I thought that I'd ask all of you. Here are 3 scenarios...which would, in the long run, be the most profitable? For the purposes of these scenarios, "Yourcity" airline is solely based at "Yourcity" airport and operates a small fleet of, say, E-170's for several 500-800 mile O and D destinations from "Yourcity."

Scenario 1, Tankering: A large fuel tank is built at Yourcity airport. Yourcity airline has bought in bulk and filled that tank with fuel at a substantially discounted price and all flights leave Yourcity airport with enough fuel for the roundtrip plus the necessary reserves. 95-99 percent of the time, the planes are filled from that large tank full of cheap fuel. This decreases turnaround time at destination airports but results in wasteage of fuel, especially on the outbound flight.

Scenario 2, Hedging: Yourcity airline pays big-bucks up front to pay todays fuel prices for the next 5 years of service. Those dollars, however, could have gone into other key (and potentially volatile) portions of the business like security and liability. A key disadvantage here, though, is that at the end of the term, the price would have to be re-adjusted and that could be potentially devastating to the airline.

Secario 3, Market: Yourcity airline flies to its destination with enough fuel to get there plus the necessary reserves and pays market price at destination to buy enough fuel to return. While the fuel is most expensive in this option, it is not wasted like tankering and no large sums of cash are tied-up like with hedging.

You Thoughs...

Chattanooga 747
You land a million planes safely, then you have one little mid-air and you never hear the end of it - Pushing Tin
 
ThePinnacleKid
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RE: Most Profitable: Tankering, Hedging, Or Market?

Thu Jun 14, 2007 1:23 pm

You would need a combination approach like almost all airlines in real life actually use....

Some things you should consider -
Scenario 1. - Tankering - You cannot always put enough fuel to go to the destination, the return trip, plus all the extra needed for alternate requirements, plus contingency fuel amounts. Plus, airplanes (ESPECIALLY airliners) very very rarely top the tanks off for another important reason... you end up costing yourself more money... you have to remember carrying the extra fuel around for the return costs money as it is extra weight resulting in higher fuel burns... in addition, it takes away from the usable payload of the aircraft.... so by filling your tanks up, you might actually cause your aircraft to not be able to take all the passengers and cargo...

Scenario 2. - Hedging - this is a GREAT option... so long as the price of fuel actually increases over the long term that you bought the fuel for... Hedging is simply placing a bet... you are gambling with your airlines money that the fuel WILL in fact get more expensive... works great currently... but there are times fuel does decline and if.. for example.. you make a contract to hedge 100% of your fuel tomorrow for the next 2 years at $2 a gallon... but over the next two years you see the price actually average to be $1.89 a gallon.. you just cost your airline extra money as oppose to just buying it at market value... On the other hand... hedging.. even if it costs you... allows you under most circumstances one key advantage.. it gives you some stability/control on costs in a volatile portion of your airlines budget.

Scenario 3. - Market - It is straight forward, you pay for the gas as you go... great for simplicity... dangerous because market values fluctuate wildly by geography and simply market conditions... you may actually find that "yourcity" gas is actually higher than "citytoserve" and therefor you get a little bit of gas price relief for the return flights... on the flipside.. you actually find as your airline grows it has more "reputation" that it can play off of the cities fuel services.... You start portraying a stable entity and one that "fueler guy" can count on.. it return they offer the fuel at say "market - 5%" etc... this is especially true in cities that you serve with a lot of flights (hubs, focus cities, etc...)



So, my final thought for you... you need to use all 3 options... You first Hedge a portion of your fuel to add stability and reliability to the cost index.... you tanker fuel and put what you can on for cities where the outstation prices are higher than your hub... and finally you market fuel for the cities where you find cheaper gas at the oustations.. and if anything else, you could always reverse tanker from the outstation to avoid paying as much for gas at the hub.. that is, as long as it does not take away from the revenue side of the house... (not being able to take people, bags, or cargo)

-Chris
"Sonny, did we land? or were we shot down?"
 
Flighty
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RE: Most Profitable: Tankering, Hedging, Or Market?

Thu Jun 14, 2007 1:28 pm

Tankering works when it works. It's a pretty simple calculation. Dispatchers do the math for every applicable flight to determine whether it is worth tankering, or not. Or, maybe their daily patterns repeat themselves. Selective tankering inceases your profits compared to a "never tanker" policy, which would be a silly rule depriving you of guaranteed profitable activities.

A hedging policy is not guaranteed profitable. It is not even expected to be profitable (since you must pay hefty commissions and profit margins to the option writer). Instead of being profitable, hedging is a strategic exercise to outwit competitors and make your cost structure different from theirs, so in some cases you can hunt them down powered by cheap fuel. But you would only expect that to happen 1/3 of the time.

The other 2/3 of the time, hedging fuel is simply a waste of money and nice cash from you goes into the option writer's bank account, and they buy another mansion. It is tricky to outwit them... but WN did it once.
 
DfwRevolution
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RE: Most Profitable: Tankering, Hedging, Or Market?

Thu Jun 14, 2007 2:13 pm

Quoting Flighty (Reply 2):
A hedging policy is not guaranteed profitable.

And it isn't intended to be. For comparison, insurance policies are never guaranteed to be profitable, but just about every responsible person in the world has some form of auto, home, life, and medical insurance.

For an airline, hedging allows them to lock-in what is otherwise a highly volatile commodity. It allows them to fix a crucial variable in their operating cost. That is something often worth paying for, especially since it can turn an occasional profit.
 
cloudboy
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RE: Most Profitable: Tankering, Hedging, Or Market?

Fri Jun 15, 2007 12:50 am

Hedging is both good and bad. It can save you substantially if fuel prices increase dramatically, which in fact they have recently. HOwever, they can also hurt you if prices go down. You also have to figure in how much you could earn on the money if you invested it. If what you end up saving over the long run is less than what you could have earned with it, then in fact it was a bad proposition.

There is no one answer, and no one strategy - just like any kind of investing a true cost-savings approach would involve using all three when they are most helpful.
"Six becoming three doesn't create more Americans that want to fly." -Adam Pilarski
 
Crewchief
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RE: Most Profitable: Tankering, Hedging, Or Market?

Fri Jun 15, 2007 1:05 am

I thought the point of hedging was to match revenues and costs. In other words, purchase sufficient forward hedges today to match the costs of tickets sold at today's ticket price, thus guaranteeing a margin on the delivered service. If it's done that way, it's reducing risk instead of increasing risk. It simply isn't placing a bet.

Betting is when you don't hedge; you sell a ticket at a given price and assume the risk of an increased cost when the service is delivered.

So, the OP scenario needs a fourth option: true hedging.
 
ThePinnacleKid
Posts: 497
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RE: Most Profitable: Tankering, Hedging, Or Market

Fri Jun 15, 2007 1:23 am

Quoting Crewchief (Reply 5):
It simply isn't placing a bet.

From a standpoint of it being more profitable to hedge or not to hedge it most certainly is a bet... For it to be a revenue generating fuel strategy you are placing a bet when you hedge that the price will go up over long term and buying the fuel today will enable you to actually save/make you money as oppose to going at market price... but, did you read my other part of my original post talking about hedging? It states pretty much exactly what you and others also have said...

Quoting ThePinnacleKid (Reply 1):
On the other hand... hedging.. even if it costs you... allows you under most circumstances one key advantage.. it gives you some stability/control on costs in a volatile portion of your airlines budget.
"Sonny, did we land? or were we shot down?"
 
Flighty
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RE: Most Profitable: Tankering, Hedging, Or Market?

Fri Jun 15, 2007 1:41 am

Does hedging improve stability, yes. Does it harm profits, yes, over time. It really depends on the behavior of the whole group. If there is only 1 airline, it should never hedge. But in a group setting, jealousy and gamesmanship mean you may need a hedge for defense.

When Delta hedges thru 2010 at $69/bbl as a fake example, all the other airlines go "Jeez. If oil hits $120, Delta is going to totally screw me with that hedge and I'll go bankrupt." So airline #2 makes a defensive hedge against Delta. It's not oil prices that scare airlines, it's competition. FedEx does not fear oil prices, they just pass it on.
 
OPNLguy
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RE: Most Profitable: Tankering, Hedging, Or Market?

Fri Jun 15, 2007 2:03 am

ThePinnacleKid is dead-on when he mentions it needing to be a combination of the three, and not just any one of them.

Tankering has certain limitations. First, it has to make economic sense. If fuel at the departure city is $2.50 a gallon and $2.00 at the arrival city, it makes no sense to tanker. Second, even if the fuel cost at the departure city is lower than the arrival city, trip distance affects the calculation. Finally, aircraft fuel capacity versus aailable payload is a factor. Sometimes it's a combination of the above factors--you're much more likely to be able to tanker through MDW on a SEA-MDW-IND flight than you would on am IND-MDW-SEA flight since the fuel requirement for the second leg would be less due to the trip distance.
ALL views, opinions expressed are mine ONLY and are NOT representative of those shared by Southwest Airlines Co.
 
N1120A
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RE: Most Profitable: Tankering, Hedging, Or Market?

Fri Jun 15, 2007 2:42 am

Quoting Cha747 (Thread starter):

Scenario 2, Hedging: Yourcity airline pays big-bucks up front to pay todays fuel prices for the next 5 years of service.

Actually, that is not how it works. Hedging is speculating on the market using an option contract. It just happens that airlines usually hedge on something they buy anyway.
Mangeons les French fries, mais surtout pratiquons avec fierte le French kiss
 
HPAEAA
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RE: Most Profitable: Tankering, Hedging, Or Market?

Fri Jun 15, 2007 10:45 am

Quoting Flighty (Reply 2):
The other 2/3 of the time, hedging fuel is simply a waste of money and nice cash from you goes into the option writer's bank account, and they buy another mansion. It is tricky to outwit them... but WN did it once.
Ok, first off, it's not one person that writes the hedges... these could cost billions, it's many persons pockets...
WN didn't outsmart anyone.. they bought those contracts from AA when the unions forced AMR to pay Cartey's severance package... AA had bought them years earlier and at the time it was reasonable.. I cite any year end conference call from a US airline in 2003 when Fuel prices flew through the roof unexpectedly...

Quoting DfwRevolution (Reply 3):
And it isn't intended to be. For comparison, insurance policies are never guaranteed to be profitable, but just about every responsible person in the world has some form of auto, home, life, and medical insurance.
slightly different... as a sample approaches infinity the data becomes a normal curve. the oil commodity market is very restricted, as opposed to the insurance industry...

Quoting DfwRevolution (Reply 3):
For an airline, hedging allows them to lock-in what is otherwise a highly volatile commodity. It allows them to fix a crucial variable in their operating cost. That is something often worth paying for, especially since it can turn an occasional profit.
It wasn't highly volatile until a few years ago... hedging is a risk mitigation technique... that's why until a year or two ago, most airlines didn't hedge the majority of there fuel consumption...

Quoting ThePinnacleKid (Reply 6):
.. For it to be a revenue generating fuel strategy you are placing a bet when you hedge that the price will go up over long term and buying the fuel today will enable you to actually save/make you money as oppose to going at market price... but
this is not a revenue generating technique, actually, it has nothing to do with revenue... it's all about cost... profit, yes.... the only way you would get revenue is if you later sold off the hedge contracts for more than you paid... no airline does that to date..

Quoting Flighty (Reply 7):
But in a group setting, jealousy and gamesmanship mean you may need a hedge for defense.
no.. you need to mitigate your risk as it relates to the rise in future costs...

Quoting OPNLguy (Reply 8):
First, it has to make economic sense.


Quoting OPNLguy (Reply 8):
If fuel at the departure city is $2.50 a gallon and $2.00 at the arrival city,
only if, Fuel at City B price per gallon>=(Price at city A*Quantity-Consumption during transport (in gallons)*price at city A)/(gallons remaining upon arrival in City B)... Assuming no weight restriction results on a full flight.. that complicates it...

Quoting OPNLguy (Reply 8):
Sometimes it's a combination of the above factors--you're much more likely to be able to tanker through MDW on a SEA-MDW-IND flight than you would on am IND-MDW-SEA flight since the fuel requirement for the second leg would be less due to the trip distance.
huh? the distance would suggest more fuel... I bet a plane could carry enough gas to go IND to circle MDW and back to IND then they would the MDW SEA leg...

[Edited 2007-06-15 04:21:31]
Why do I fly???
 
OPNLguy
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RE: Most Profitable: Tankering, Hedging, Or Market?

Fri Jun 15, 2007 11:17 am

Quoting OPNLguy (Reply 8):
Finally, aircraft fuel capacity versus aailable payload is a factor. Sometimes it's a combination of the above factors--you're much more likely to be able to tanker through MDW on a SEA-MDW-IND flight than you would on am IND-MDW-SEA flight since the fuel requirement for the second leg would be less due to the trip distance.



Quoting HPAEAA (Reply 10):
huh? the distance would suggest more fuel... I bet a airliner coul cary enough gas to go IND to circle MDW and back to IND then they would the MDW SEA leg...

Follow along...

SEA-MDW MIN FUEL 27.0 BURN 18.0 ARVL 8.0
MDW-IND MIN FUEL 10.0 BURN 2.5 ARVL 7.5

If you're going to tanker through MDW on the SEA-MDW flight, you'll need only to take 29.0 on the fuel, just 2,000 lbs more, since the next leg is a short MDW-IND flight.

IND-MDW MIN FUEL 10.0 BURN 2.5 ARVL 7.5
MDW-SEA MIN FUEL 28.0 BURN 19.5 ARVL 8.5

If you're going to try and tanker through MDW on the IND-MDW flight, you'll need to take 30.5 on the fuel, 2,500 lbs more, since the next leg is a long MDW-SEA flight. On a short IND-MDW flight that's full of folks, you'll be overweight if you try to take the 30.5 on the flight since you'll be landing weight limited.

Trust me...
ALL views, opinions expressed are mine ONLY and are NOT representative of those shared by Southwest Airlines Co.
 
HPAEAA
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RE: Most Profitable: Tankering, Hedging, Or Market?

Fri Jun 15, 2007 11:29 am

Quoting OPNLguy (Reply 11):
Follow along...

SEA-MDW MIN FUEL 27.0 BURN 18.0 ARVL 8.0
MDW-IND MIN FUEL 10.0 BURN 2.5 ARVL 7.5

If you're going to tanker through MDW on the SEA-MDW flight, you'll need only to take 29.0 on the fuel, just 2,000 lbs more, since the next leg is a short MDW-IND flight.

IND-MDW MIN FUEL 10.0 BURN 2.5 ARVL 7.5
MDW-SEA MIN FUEL 28.0 BURN 19.5 ARVL 8.5

If you're going to try and tanker through MDW on the IND-MDW flight, you'll need to take 30.5 on the fuel, 2,500 lbs more, since the next leg is a long MDW-SEA flight. On a short IND-MDW flight that's full of folks, you'll be overweight if you try to take the 30.5 on the flight since you'll be landing weight limited.

Trust me...

hmm.. only thing is... that on the the long flight you have a higher Burn to Capacity on the tanker fuel.. I.e. It cost more to carry the weight a longer distance... on a short flight, such as IND to CHI, you have less cost associated with the tanker... I.E. smaller margin of added cost due to the tanker... it's not about filling up for the next leg, it's about saving cash.. if that's a portion, well any airline will take that...
Why do I fly???
 
OPNLguy
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RE: Most Profitable: Tankering, Hedging, Or Market?

Fri Jun 15, 2007 11:42 am

Quoting HPAEAA (Reply 12):
hmm.. only thing is... that on the the long flight you have a higher Burn to Capacity on the tanker fuel.. I.e. It cost more to carry the weight a longer distance...



Quoting HPAEAA (Reply 12):
on a short flight, such as IND to CHI, you have less cost associated with the tanker... I.E. smaller margin of added cost due to the tanker.

Granted, and even with the long trip distance, the price differential between the two cities still might make it economicla to tanker.

Quoting HPAEAA (Reply 12):
it's not about filling up for the next leg, it's about saving cash.. if that's a portion, well any airline will take that...

It's about saving money by carrying the cheaper fuel to minimize (or avoid entirely) the need to buy the more costly gas. As I said earlier, one isn't likely to be able to tanker much (if any) fuel on a short flight where the next flight is a long one.
ALL views, opinions expressed are mine ONLY and are NOT representative of those shared by Southwest Airlines Co.
 
6yjjk
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RE: Most Profitable: Tankering, Hedging, Or Market?

Sat Jun 16, 2007 1:56 am

Quoting Cha747 (Thread starter):
Scenario 1, Tankering: A large fuel tank is built at Yourcity airport. Yourcity airline has bought in bulk and filled that tank with fuel at a substantially discounted price and all flights leave Yourcity airport with enough fuel for the roundtrip plus the necessary reserves. 95-99 percent of the time, the planes are filled from that large tank full of cheap fuel. This decreases turnaround time at destination airports but results in wasteage of fuel, especially on the outbound flight.

I don't know anything about this stuff, but this does sound like a waste of plane. I've got the capability to serve destinations twice as far away - would doing that bring in enough extra revenue to make the remote refuelling worthwhile?

Or, if I only want to serve those closer cities, would it be cheaper overall to buy something with out the range to get there and back, and refuel it at both ends?