What is Fuel Hedging?

[dueguard1]

Can Someone tell me what is Fuel Hedging? Is it a constant practice or something Airlines just do when times aren't so hot?

 

[munson]

its what kept SWA from loosing money last year

 

[swait]

Its buying oil futures at a low price, then hoping that when they come due, they are cheaper than the current price per barrel. You could do the same thing with any other futures options, but airlines tend to follow the oil prices a bit closer than something like pork-bellies. But if they wanted, they could do the same with pork-bellies. They get their money when they sell the options. It does not really affect the price they pay for fuel, but if you buy a barrel of oil at $20 and sell it at $70, you use that $50 profit to offset the higher price you are paying for the refined product.

That's what I can remember from when it was explained to me a couple of months ago. If anyone has a better take on it, feel free to chime in.

 

[ualdriver]

Can Someone tell me what is Fuel Hedging? Is it a constant practice or something Airlines just do when times aren't so hot?

Simply put, hedging is a financial technique to "smooth" out the troughs and crests that reflect the prices you would otherwise have to pay for a particular product or commodity. That commodity could be anything from heating oil to currency.

Airlines for Southwest, for example, buy "contracts" in order to execute their hedging policy. These "contracts" give them the right to buy, for example, XXXXX gallons of heating oil (or unleaded gas, I don't think you can buy contracts on Jet A) at $X.XX price at a specific date in the future. This contract, however costs them a fee. The larger the contract, the larger the fee.

Southwest will buy a contract in a product, like heating oil, they think will directly (or most directly) rise and fall with the price of Jet A since they can't hedge Jet A directly.

When that specific date in the future rolls around, Southwest (in our example) has a choice, and the value of that contract will have changed. If they purchased the above contract thinking that the price of heating oil will go up by their specific date, and it does, that contract is now very valuable because it gives them the right to buy that heating oil at a very cheap (previously contracted) price compared to others currently on the market. Now Southwest can sell that contract on the open market to someone else who wants to buy that cheap heating oil and use the proceeds from the sale of the contract to buy something else- like Jet A.

If the price of heating oil went down since Southwest purchased the contract, their contract will probably become worthless at their contract's specific date. Generally speaking, now they can either follow through on their contract and buy the heating oil at the higher price they agreed to when they signed the contract, or walk away from the contract. By walking away from the contract, however, they lose the money they used to purchase the contract in the first place, which won't be pocket change. But then they can buy that heating oil at the cheaper prevailing market rate anyway, which can be some consolation for their loss of the fee.

And it gets much, much more complicated than that. Put very generally that's the process.

 

[bizicmo]

From the explainations above it seems like a relatively painless risk for a such a high reward. Why haven't other airlines looked at this option? I understand that this is practice is not standard, but in times when many airlines are having problems maybe a non-standard solution is what they need.

 

[radarlove]

Its buying oil futures at a low price, then hoping that when they come due, they are cheaper than the current price per barrel. .

No it's not.

For the thirtyith time on this board, a futures price of a commodity equals todays (!) spot rate, plus the cost of borrowed money, plus storage costs, if any.

There is no such thing as buying oil futures at a low price. You buy them at today's price, plus a small premium.

 

[Ben Dover]

From the explainations above it seems like a relatively painless risk for a such a high reward. Why haven't other airlines looked at this option? I understand that this is practice is not standard, but in times when many airlines are having problems maybe a non-standard solution is what they need.

Anyone who has traded futures will tell you it's NOT characterized as low risk and high reward. Also, many on these boards have criticized airlines for not using fuel hedging strategies. They seem to forget the cost associated with it. If the price of oil/jet fuel doesn't move up, you just cost your company a bunch of money. Think of it as an insurance policy for high fuel prices. If you can afford it, insurance is always nice to have. Luckily for SouthWest they could afford the insurance.

 

[Midnight Flyer]

its what kept SWA from loosing money last year

Is it true that AA sold SW their hedged fuel and now AA is kicking themselves in the AAss for doing it? I've heard AA would have had much higher profits if it wasnt for them getting rid of the hedged fuel.

 

[SWA GUY]

All the above posts are correct! Well done guys.

In addition, much like the stock exchanges, these commodities(or rather commodity contracts) are traded on the Mercantile Exchange. Jet fuel, which is really filtered diesel fuel(or number 2 heating oil), is not traded on the Mercantile. You cannot buy, trade or sell jet fuel contracts on the exchange, because they don't exist.

I can tell you that trading crude oil futures is VERY risky business. Crude oil prices are affected by many variables, some foreseeable, some not. More than a few individuals and corporartions have gone belly up playing this game. In fact if you are a crude oil/butane/isobutane/heating oil/etc., trader you may not get a lot of sleep at night.

Gary Kelly's specialty prior to SWA was trading crude oil. Frankly, I'm surprised the man doesn't have a hundred ulcers from his former occupation.

 

[G4G5]

Don't waste your time with fuel hedging, none of the airlines do (except SWA)

 

[jetpig32]

Huh. Always thought fuel hedging was a way of landscaping. I better stop burning the bushes in my front yard. Neighbors thought I was crazy. I thought I was saving money somehow.

 

[Erndogg]

Don't waste your time with fuel hedging, none of the airlines do (except SWA)

Wrong! Hawaiian Airlines has 46% of it's estimated fuel hedged for this year.

 

[castle bravo]

Also, many on these boards have criticized airlines for not using fuel hedging strategies. They seem to forget the cost associated with it.


NWA senior mgmt deserves any criticism directed at it for failing to hedge. They cried big crocodile tears about not having capital to hedge fuel with, but had no trouble finding over $100m to hire and train the scab mechanics.