Fuel hedging
Fuel hedging is a contractual tool some large fuel consuming companies, such as airlines, cruise lines and
trucking companies, use to reduce their exposure to volatile and potentially rising fuel costs. A
fuel hedge contract is a futures contract that allows a fuel-consuming company to establish a fixed or
capped cost, via a commodity swap or option. The companies enter into hedging contracts to mitigate
their exposure to future fuel prices that may be higher than current prices and/or to establish a known
fuel cost for budgeting purposes. If such a company buys a fuel swap and the price of fuel declines, the
company will effectively be forced to pay an above-market rate for fuel. If the company buys a fuel call
option and the price of fuel increases, the company will receive a return on the option that offsets their
actual cost of fuel. If the company buys a fuel call option, which requires an upfront premium cost, much
like insurance, and the price of fuel decreases, the company will not receive a return on the option but
they will benefit from buying fuel at the then-lower cost.
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.[1] Because 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 unusual divergence in the trends of crude oil and jet
fuel.
Companies which consume large volumes of fuel and do not hedge their 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. [2]
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.
During the 2009-2010 period, the studies for the airline industry have shown the average hedging ratio
to be 64%. Especially during the peak stress periods, the ratio tends to increase.
Southwest Airlines has tended to hedge a greater portion of its fuel needs as compared to other
major U.S. domestic carriers.[3] Southwest's aggressive fuel hedging has helped the airline partially avoid
financial consequences caused by airline industry downturns (e.g., the downturn caused by the 2000s
energy crisis). Between 1999 and 2008, Southwest saved more than $4 billion through fuel hedging
under the strategic leadership of former CFO Kelly (who became CEO in 2004, and President and
Chairman in 2008).[4][5]
Providers of fuel hedging [edit]
Fuel hedging services are predominantly provided by specialist teams within fuel management
companies, large oil companies and financial services institutions. Examples include:
1. Fuel management companies - Mercator Energy Advisors, World Fuel Services, Pricelock, Global
Risk Management
2. Oil companies - Total S.A., Royal Dutch Shell, ExxonMobil, Koch Industries, BP
3. Financial institutions - BNP Paribas, Goldman Sachs, Barclays plc, Macquarie
Bank, Citigroup, Morgan Stanley, Wells Fargo
4. Utilities- Électricité de France, NextEra Energy
Fuel price risk management
A specialization of both financial risk management and oil price analysis – and similar to
conventional risk management practice – fuel price risk management is a continual cyclic process that
includes risk assessment, risk decision making, and the implementation of risk controls. Fuel price risk
management focuses primarily on when and how an organization can best hedge against exposure to
fuel price volatility. Fuel price risk management is generally referred to as bunker hedging in marine and
shipping contexts and fuel hedging in aviation and trucking contexts.
The fuel price risk management process[edit]
Similar to conventional risk management practice, [1] fuel price risk management is considered a
continual cyclic process that includes the following:
1. Establishing the context
current and future business environment
financial position and budgets
objectives and needs
required fuel consumption, etc.
2. Risk assessment
fuel cost calculations
risk identification
the organization's attitude to risk
exposure analysis to fuel price fluctuations
scenarios of various hedging strategies
3. Risk treatment
implementation of a fuel price risk strategy
4. Monitor and review
An alternative to the above described process is the following: [2]
1. Identify, analyze and quantify the fuel related risks
2. Determine tolerance for risk and develop a fuel price risk management policy
3. Develop fuel price risk management implementation strategies
4. Establish controls and procedures
5. Initial implementation of fuel price risk management strategies
6. Monitor, analyze and reporting
7. Repeat the process on as needed basis
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