Hedging

[blee256]

Whats it mean when they say certain airlines are hedging their fuel costs? How does it work?

[kellwolf]

Airlines basically buy fuel contracts on the futures market expecting prices to rise later on. This way, they lock in prices at the time of purchase. Now, if prices go down (yeah, right), then the airlines get burned. What I want to know is, what's in it for the people that SELL the contracts.

[Naluryder]

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Airlines basically buy fuel contracts on the futures market expecting prices to rise later on. This way, they lock in prices at the time of purchase. Now, if prices go down (yeah, right), then the airlines get burned. What I want to know is, what's in it for the people that SELL the contracts.

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I have a questioin ? If you wanted to start an Airline or a Cargo company,does it make more sense to invest a good portion of your start up capital on fuel? To hedge the fuel market ? I wonder if it will work? Just a thought..

Nalu

[flyover]

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what's in it for the people that SELL the contracts.

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It's a simple market transaction. If there is no one in the market betting that fuel prices will go down, then you won't be able to buy/sell those contracts. That's why if fuel prices stabilize or keep moving higher it will become more difficult to hedge against.

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I have a questioin ? If you wanted to start an Airline or a Cargo company,does it make more sense to invest a good portion of your start up capital on fuel? To hedge the fuel market ? I wonder if it will work? Just a thought..

Nalu

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No. A better idea would be to stay out of the airline business and make your money on the futures market. Most of these transactions are heavily leveraged. You are making a committment to do something in the future. You don't have to put all the money up now, but you do have to have it set aside or have very good credit. That's why most of the failing airlines can't do it.

Plus fuel hedging can't be counted on very far into the future, see above. So if you are starting an airline and can't make money at these fuel prices, you'd better not do it.

[Minnesota_Flyer]

[ QUOTE ]
Airlines basically buy fuel contracts on the futures market expecting prices to rise later on. This way, they lock in prices at the time of purchase. Now, if prices go down (yeah, right), then the airlines get burned. What I want to know is, what's in it for the people that SELL the contracts.

[/ QUOTE ]It's not just betting on whether fuel costs will go up or down; if everyone agrees that fuel costs will go up, there still is uncertainty over how much fuel costs might go up. And businesses like Southwest aren't hedging solely to keep costs down (although that's obviously a goal) but also to ensure a constant supply at a known price so that they can budget for fuel costs, which businesses which don't hedge can't do.

Basically, hedging is gambling on the future. You don't want to get into it unless you (a) know what the heck you're doing and (b) have a lot of money to lose. Because hedging tends to be so highly leveraged, you can lose a lot of money very quickly if you bet wrong.

MF

[Ophir]

Another major benefit hedging has is that is stablizes and secures prices for budgeting purposes in the future. You might by a option on fuel for some large quantity and over the course of the next year, you are guaranteed of that price. Now for the supplier the price will go up and down, but for the airline it stays the same. Being able to absolutely lock in a price, even if it may be slighty high, is an incredibly stablizing force when it comes to budgeting.

An example: I bought an extended warranty for my car. It cost $2500 for zero deductible up to 100,000 miles. I currently have 42,000 miles on it. This covers everything, brakes, oil changes, the whole nine yards. So what I have done is paid up front for all my maintanence for next few years (a lot of years actually becuase I don't drive that much). Plus I can sell the warranty with the car or cash out, so it is added value. My thoughts were that I have an expensive car and I would like to lock in the price of the ownership of that car for a long time since I won't be making much money in the next few years. So it made sense to me.

[Naluryder]

[ QUOTE ]
Another major benefit hedging has is that is stablizes and secures prices for budgeting purposes in the future. You might by a option on fuel for some large quantity and over the course of the next year, you are guaranteed of that price. Now for the supplier the price will go up and down, but for the airline it stays the same. Being able to absolutely lock in a price, even if it may be slighty high, is an incredibly stablizing force when it comes to budgeting.


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I think "Hedging" fuel prices is a great technique. If I were a start up LCC or Cargo airline I would use this method my first couple of years in business. I think its safe because your only forcasting a years of fluctuations. I don't think the price of oil is going to plunge so drastically that you would have lost your money? It seems like its on an up trend and if it stablizes then you would still break even, in theory??


Nalu

[kellwolf]

I wonder how many places are hedging fuel right now at these prices? Might be a pseudo smart thing to do if you think prices are going to keep going up, and I bet a lot of futures contracts are on the market right now. However, if the price DOES manage to drop, then you're screwed and the broker makes off like a bandit.

[Naluryder]

If I were a new start up right now I would have no choice but to by fuel at the current rate and hedge at this current rate right? What if it keeps going up one more year? Should I wait until next year? If the market stables then you would still break even,but if it rises then your a winner..I doubt that OPEC would let it drop under the average..but that's just my opinion. I would take the risk.

Nalu

[kellwolf]

I'm hoping for sources other than OPEC, or a more fuel efficient engine technology. That's the short term fix. The long term fix would be something that didn't burn on an oil product at all. If I were a startup, I'm not sure I'd a) start right now or b) hedge at all right now. The oil market is way too unpredictable right now. Prices will probably continue to go up, but any airline that stays on this oil trend will be gone in 15 years.

[flyover]

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The oil market is way too unpredictable right now. Prices will probably continue to go up, but any airline that stays on this oil trend will be gone in 15 years.

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So we've just got 15 years to figure out some alternative to JetA? This does not look good.

[Naluryder]

Well I guess my dreams of becoming an employed airline pilot in the future is shot...LOL..If all fails after aquiring all my training then I guess I'll have no choice but to start my own cargo liner solo..using a fuel efficient, cost-effective single engine turbo-prop Pilatus PC-12 doing island hops here in Hawaii??...LOL.. I've heard people saying you make more money transporting cargo than pax...



Nalu..

[kellwolf]

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So we've just got 15 years to figure out some alternative to JetA? This does not look good.

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Ah, I pulled 15 years outta my a$$. It'll probably take longer than that. Point is, aviation fuel is gonna keep going up, so either airlines are going to have to squeeze labor to get more blood from that turnip or come up with something else to keep costs done. The other alternative is for Joe Sixpack to pay decent fares again.

If I pull a couple more numbers like the "15 years" and say "it doesn't look good for XYZ Air" think I could get a job as an analyst?

[Doug Taylor]

Ahh yes, Joe Six Pack likes to marvel over the $80 far from LAX to DFW, then complain about the lack of a onboard hot meal while holding a $400 iPod and a $4.30 cup of Starbucks.

[flyover]

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So we've just got 15 years to figure out some alternative to JetA? This does not look good.

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Ah, I pulled 15 years outta my a$$. It'll probably take longer than that. Point is, aviation fuel is gonna keep going up, so either airlines are going to have to squeeze labor to get more blood from that turnip or come up with something else to keep costs done. The other alternative is for Joe Sixpack to pay decent fares again.

If I pull a couple more numbers like the "15 years" and say "it doesn't look good for XYZ Air" think I could get a job as an analyst?

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Definitely! Just print up some cards and start calling yourself an analyst. Pretty soom someone quotes you and you are on your way.

But I agree with you. The industry, like all others will have to deal with fuel prices. At some point the attrition of competitors will end up in some kind of mix that can make money, for awhile anyway.

I was just reading that at some airlines fuel is getting close to overtaking labor as the top cost. That's amazing considering it's never been more than half of labor costs and airplanes are getting more efficient.

[dingo222]

Yup, leave the hedging to the pro's. One bad contract and that Futures/options broker is out of business, as well as the person who bought the contract! I was a commodities broker out of college, but I traded LGP and fuel oil. Hedging is a very high risk investment. It usually only requires 10% down on the contract, but you lose 100% if things go wrong. Options are usually the safer way to go. The entire futures market is based upon speculation, or what the investors and traders THINK will happen in the future.

For companies like Southwest, this is very beneficial, because the bean counters can predict to a very high degree as to what their annual fuel costs will be, and once they own the fuel, they are less likely to get burned by fuel price spikes on the spot market. The downside, it requires a ton of cash up front, they have to pay to store the fuel somewhere, and if fuel prices drop below what they paid for it, they are sitting on fuel that they cannot offload.

I wouldn't recommend hedging to anyone unless you have a really good trader or broker, and you are fully prepared to toss whatever cash that you have invested when things go south.

Hope this puts it into every day terms and helps