Fuel hedging

Fuel hedging

Fuel Hedging is a contractual tool used by some airlines to stabilize jet fuel costs. A fuel hedge contract commits an airline to paying a pre-determined price for future jet fuel purchases. Airlines enter into such contracts as a bet that future jet fuel prices will be higher than current prices or to reduce the turbulence of confronting future expenses of unknown size. If the price of jet fuel falls and the airline hedged for a higher price, the airline will be forced to pay an above-market rate for jet fuel.

Background

The cost of fuel hedging depends on the predicted future price of fuel. Airlines may place hedges either based on future prices of jet fuel or on future prices of crude oil. [Some Airlines Turning To Fuel Hedging Again, http://www.komonews.com/news/archive/4196026.html] Since crude oil is the source of jet fuel, the prices of crude oil and jet fuel are normally correlated, however, other factors (such as difficulties regarding refinery capacity) may cause divergence in the trends of crude oil and jet fuel.

Typically, airlines will hedge only a certain portion of their fuel requirements for a certain period. Oftentimes, contracts for portions of an airline's jet fuel needs will overlap, with different levels of hedging expiring over time.

Southwest Airlines has tended to hedge a greater portion of its fuel needs than other major U.S. domestic carriers. [Can fuel hedges keep Southwest in the money?, http://www.usatoday.com/money/industries/travel/2008-07-23-southwest-jet-fuel_N.htm] Southwest's aggressive fuel hedging has helped the airline avoid some of the pain of the recent airline industry downturn resulting from high fuel costs. Between 1999 and 2008, Southwest saved approximately $3.5 billion through fuel hedging. [United may not be alone with fuel hedge losses, http://www.msnbc.msn.com/id/26761843/]

References


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