Fuel Hedging is a contractual tool used by some airlines to stabilize
jet fuelJet fuel is a type of aviation fuel designed for use in aircraft powered by gas-turbine engines. It is clear to straw colored. The most common fuels are Jet A and Jet A-1 which are produced to an internationally standardized set of specifications...
costs. A fuel
hedgeIn finance, a hedge is a position established in one market in an attempt to offset exposure to price fluctuations in some opposite position in another market with the goal of minimizing one's exposure to unwanted risk...
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.
The cost of fuel hedging depends on the predicted future price of fuel.
Fuel Hedging is a contractual tool used by some airlines to stabilize
jet fuelJet fuel is a type of aviation fuel designed for use in aircraft powered by gas-turbine engines. It is clear to straw colored. The most common fuels are Jet A and Jet A-1 which are produced to an internationally standardized set of specifications...
costs. A fuel
hedgeIn finance, a hedge is a position established in one market in an attempt to offset exposure to price fluctuations in some opposite position in another market with the goal of minimizing one's exposure to unwanted risk...
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. 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
refineryAn oil refinery is an industrial process plant where crude oil is processed and refined into more useful petroleum products, such as gasoline, diesel fuel, asphalt base, heating oil, kerosene and liquefied petroleum gas...
capacity) may cause divergence in the trends of crude oil and jet fuel.
A company that does not hedge its fuel costs generally believes one, if not both, of the following:
1. The company has the ability to pass on any and all increases in fuel prices to their customers, without a negative impact on their profit margins.
2. The company is confident that fuel prices are going to fall and is comfortable paying a higher price for fuel if, in fact, their analysis proves to be incorrect.
Typically, airlines will hedge only a certain portion of their fuel requirements for a certain period. Often, contracts for portions of an airline's jet fuel needs will overlap, with different levels of hedging expiring over time.
Southwest AirlinesSouthwest Airlines Co. is an American low-cost airline. Southwest is the largest airline in the world by number of passengers carried per year . Southwest, the 6th largest U.S. airline by revenue, maintains the third-largest passenger fleet of aircraft among all of the world's commercial airlines....
has tended to hedge a greater portion of its fuel needs than other major
U.S. domestic carriers. 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.