FATFlyer
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NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 4:39 am

The NY Times has posted a new article on its website about WN's fuel hedges. I know this is a topic that has been batted around on the board many times.

The article is titled "An Airline Shrugs at Oil Prices".
http://www.nytimes.com/2007/11/29/business/29hedge.html
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atrude777
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 4:50 am

I believe Southwest Airlines already extended the hdges to 2012 now.

I read this online somewhere, but I believe I saw some percentages of what was hedged.

So this does not end at 2009 and DOES indeed go on to 2012 now.

Alex
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Indy
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 4:01 pm

I'd love someone with real experience with hedge funds to chime in on this question. If WN has contracted for future delivery based on $52 per barrel and the price is actually $100 per barrel at the time who eats the $48 per barrel difference? Or do they get theirs at $52 and the result of that is that it makes fuel more expensive for everyone else? Also why is this based on oil when the airlines don't buy oil like that. Or do they?
Indy = Indianapolis and not Independence Air
 
PanAm747
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 4:38 pm



Quote:
If WN has contracted for future delivery based on $52 per barrel and the price is actually $100 per barrel at the time who eats the $48 per barrel difference?

The cost is passed on to the rest of the public. In business, volume discounts = lower prices. Because of WN's long-term commitment, the people that produce the fuel - from suppliers to refiners to shippers - all have a guaranteed income.

With airlines that do NOT hedge, they must do what the driving public has to do - pay the price at the pump. That goes up and down (yes, it does go down occasionally!!) depending on market forces.

Quote:
Also why is this based on oil when the airlines don't buy oil like that?

All hydrocarbon-based transportation fuel comes from crude oil, just like gasoline. The key is the REFINING process, where the crude oil is turned into the various types of fuel.

The key, at least in the U.S., is a "high and tight" supply - Americans love their gasoline, but they dislike refineries, to the joy of refinery owners who can manage the supply of refined product. Less product = higher demand = higher prices. If there were twice as many refineries, gas prices would drop - but in California for example, no new refinery has been built in the last 30 years, so the old ones must be kept going 24/7/365 to supply the insatiable demands of an ever-increasing number of vehicles that require California's special blend.

With airlines, it's the same thing - the special fuel needed for airplanes must be refined, but there is limited capacity. Because of the copious amounts of fuel needed by an airline, volume discounts apply - but it requires a long term contract. Now, call me cynical, but I rarely if ever see ANY government, company, or private individual anymore doing anything with long-term considerations in mind, but Southwest is quite the opposite - their motto is "how can we sustain long-term profitability?" and not "how can we make shareholders happiest for this quarter?"
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OPNLguy
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 4:42 pm



Quoting Indy (Reply 2):
I'd love someone with real experience with hedge funds to chime in on this question.

I believe that they already have--in past threads on the topic. You might try a search..  Wink
ALL views, opinions expressed are mine ONLY and are NOT representative of those shared by Southwest Airlines Co.
 
Indy
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 4:50 pm



Quoting PanAm747 (Reply 3):
All hydrocarbon-based transportation fuel comes from crude oil, just like gasoline. The key is the REFINING process, where the crude oil is turned into the various types of fuel.

I understand that. But airlines buy jet fuel. They don't buy oil. Or do they buy the oil and then contract with refineries to refine the product? Then again that wouldn't make sense either since there are endless products that come out during the refining process. I believe this is far more complex than WN has oil hedge at $x per barrel for x number of years. Unless of course the airline is in the business of taking the product from raw oil through the refining process and taking the jet fuel from there and selling off the other products produced during the refining process.
Indy = Indianapolis and not Independence Air
 
atmx2000
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RE: NYTimes Posts Article On Southwest's Fuel Hedg

Thu Nov 29, 2007 4:51 pm

Quoting Indy (Reply 2):
I'd love someone with real experience with hedge funds to chime in on this question. If WN has contracted for future delivery based on $52 per barrel and the price is actually $100 per barrel at the time who eats the $48 per barrel difference? Or do they get theirs at $52 and the result of that is that it makes fuel more expensive for everyone else? Also why is this based on oil when the airlines don't buy oil like that. Or do they?

Whoever is selling the contracts is making a bet that oil prices will come down (or had made a bet that oil prices wouldn't have gone up). These parties will simply lose that money, minus whatever premium they took in above and beyond the delivery price (assuming that $52 doesn't include the premium). If these parties are having to buy oil at current prices to satisfy these contracts, then they are losing big. If they either bought oil in the past at a lower price or are themselves producing oil at a lower cost, then they also avoid losing as big or simply make a smaller profit.

The reason this is based on oil is because there is no options/futures market on jet fuel. Oil, being the primary ingredient in the production of jet fuel, is its primary price determinant and increases in jet fuel prices will track crude oil prices. Theoretically, oil prices should actually go up more percentage wise, as a significant component of jet fuel prices is the cost of refinement which should be roughly constant or at least go up less, lowering the percentage rise in jet fuel prices. An airline will sell the contracts to a party that will actually use or trade the oil such as a refiner when it wants to realize profits from the hedging instrument. They will then buy their jet fuel through their normal distribution channels.

[Edited 2007-11-29 08:56:35]
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EA CO AS
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 4:58 pm



Quoting PanAm747 (Reply 3):
With airlines that do NOT hedge, they must do what the driving public has to do - pay the price at the pump.

Unless I'm mistaken, hedges don't mean you pay less at the pump - you still pay today's rates for fuel, but are paid the difference back later, which is then recorded as income.
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OPNLguy
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 5:12 pm



Quoting EA CO AS (Reply 7):
Unless I'm mistaken, hedges don't mean you pay less at the pump - you still pay today's rates for fuel, but are paid the difference back later, which is then recorded as income.

Correct. You pay the same price at the pump, and once the gain from the hedges is cranked-in, it offsets the overall fuel cost, resulting to a lower cost.
ALL views, opinions expressed are mine ONLY and are NOT representative of those shared by Southwest Airlines Co.
 
jacobin777
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RE: NYTimes Posts Article On Southwest's Fuel Hedg

Thu Nov 29, 2007 5:18 pm



Quoting Atmx2000 (Reply 6):
there is no options/futures market on jet fuel.

..Atmx2000, you post was basically correct except for the quote above...there are futures markets on jet fuel..

for example:

" Gulf Coast Jet Fuel Calendar Swap Futures
Gulf Coast jet fuel calendar swap futures give market participants the opportunity to target their risk management coverage for jet fuel traded on the Gulf Coast, the most liquid physical jet fuel market. Price settlement is based on the arithmetic average of the high and low quotations from PlattsOilgram Price Report for Gulf Coast unleaded 87 gasoline (pipeline) for each business day that it is determined during the contract month.

Prices are quoted free-on-board (f.o.b.) the Colonial pipeline on the Gulf Coast.

The 42,000-gallon contract size represents a commonly traded market unit, and is the same as the Exchange's other petroleum futures contracts. "*

---

*-nymex.com

---------
...that being said, you are correct, for practical purposes, Jet-A future contract doesn't exist and AFAIK, hedging is done via the crude oil contracts (@CL).

-------

Quoting EA CO AS (Reply 7):
Unless I'm mistaken, hedges don't mean you pay less at the pump - you still pay today's rates for fuel, but are paid the difference back later, which is then recorded as income.

I do not know how the "deliveries" of the physical commodity is done as when I trade oil, I don't expect 40,000+ barrels of oil being delivered to my house  spin  and contracts (at the time of contract expiration) are closed regardless of profit/loss.

If WN is taking their deliveries of Jet-A vis-a-vis the cost of the original crude contract , then they would be taking Jet-A at the lower price. Again, I'm not so sure what WN does, you very well might be correct... Smile
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TropicBird
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 5:26 pm

I thought I read somewhere that the airlines jet fuel pricing is based on home heating oil prices and that airlines which operate primarily in the West are unfairly impacted by that because fuel oil is not used in the West to heat homes. Go figure.
 
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STT757
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 5:49 pm

Here's the Chart:

http://graphics8.nytimes.com/images/2007/11/29/business/1129-biz-webHEDGE.jpg

Note some are based on Crude prices and some on home heating oil prices.

[Edited 2007-11-29 09:50:17]
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rojo
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 5:55 pm



Quoting EA CO AS (Reply 7):
Unless I'm mistaken, hedges don't mean you pay less at the pump - you still pay today's rates for fuel, but are paid the difference back later, which is then recorded as income.



Quoting Jacobin777 (Reply 9):
I do not know how the "deliveries" of the physical commodity is done as when I trade oil, I don't expect 40,000+ barrels of oil being delivered to my house and contracts (at the time of contract expiration) are closed regardless of profit/loss.

If WN is taking their deliveries of Jet-A vis-a-vis the cost of the original crude contract , then they would be taking Jet-A at the lower price. Again, I'm not so sure what WN does, you very well might be correct...

From what I have learned in my job at a bank, there is no trade of the commodity when you do hedging. The only thing you deliver is money, which is credited/debited to/from bank accounts of the parties involved in the derivatives (price cap vs. current price). Therefore, what you post in your P&L is the profit or loss you made from the derivative. WN will keep going to Exxon, BP or whoever they get their jet fuel from and pay the market price. WN´s P&L will reflect the cost of the jet fuel and the gain from hedging...
 
bennett123
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 7:01 pm

Seems to me that unless the price drops below $63 by 2010 that all the others have one hand tied behind their backs.
 
jacobin777
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 7:13 pm



Quoting Rojo (Reply 12):
From what I have learned in my job at a bank, there is no trade of the commodity when you do hedging. The only thing you deliver is money, which is credited/debited to/from bank accounts of the parties involved in the derivatives (price cap vs. current price). Therefore, what you post in your P&L is the profit or loss you made from the derivative. WN will keep going to Exxon, BP or whoever they get their jet fuel from and pay the market price. WN´s P&L will reflect the cost of the jet fuel and the gain from hedging...

..that would be basically in-line with what I'm saying..they will profit/loss on the futures contract and actually pay the "going rate" for Jet-A...I'm not so sure how that would work however in terms of taxes....

Quoting STT757 (Reply 11):
Here's the Chart:

..thanks for that chart.. thumbsup ..I had that chart somewhere also but couldn't find it. The bottom line is basically for all carriers, their hedges run out in the next couple of years (even WN's goes substantially down by 2010)....if oil stays >$75/barrel, I think we'll be seeing the aviation landscape change quite a bit.
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WNbob
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 7:16 pm



Quoting Bennett123 (Reply 13):
Seems to me that unless the price drops below $63 by 2010 that all the others have one hand tied behind their backs.

Precisely.

But if WN is such geniuses, someone explain to me why the stock is languising around 13 bux like forever. Really, it's not a rethorical, I really want to know.
 
ScottB
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RE: NYTimes Posts Article On Southwest's Fuel Hedges

Thu Nov 29, 2007 8:35 pm



Quoting WNBob (Reply 15):
But if WN is such geniuses, someone explain to me why the stock is languising around 13 bux like forever. Really, it's not a rethorical, I really want to know.

Well, it's basically because there hasn't been the earnings growth that would be needed to justify a higher stock price -- and add to that the fact that they operate in an industry which is being slammed by high petroleum prices. What's more remarkable is that they haven't destroyed shareholder value.

Quoting STT757 (Reply 11):
Note some are based on Crude prices and some on home heating oil prices.

Though the airlines may quote crude prices, many/most of the contracts are for home heating oil, and the crude price is essentially an estimate obtained by subtracting the crack spread (the cost of cracking, or refining the crude into heating oil). As far as I'm aware, heating oil futures are typically used instead of gasoline futures since the price of home heating oil tracks more closely with the price of jet fuel (given that they are more similar to each other than either is to gasoline).

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