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.(Wikipedia)
Fuel hedging is a gamble against
the future price of jet fuel as despite the seemingly consistent belief that
fuel prices go up, they also come down unexpectedly. If an airline predicts
that the cost of fuel is going to increase in the future, the airline can sign
a fuel hedging contract to purchase fuel at the current price for months or
years ahead of time. However, if the price of jet fuel falls below what an airline hedged to buy it
at, the airline will be contractually forced to pay a higher than market price
for jet fuel thereby losing money. Consequently, the cost of fuel hedging is
dependent on the predicted future fuel price. (Wikipedia)
Fuel make up for over 40% of operating cost for an airline
and airlines hedge to reduce or save costs based on
a bet that future jet fuel prices will be higher than current prices (or the
price that an airline has agreed to purchase jet fuel under a fuel hedge
contract) and to remove the future uncertainty of volatile jet fuel
prices so that the airline can build a business plan knowing fixed or
"locked" fuel costs over a prescribed period. (Wikipedia)
The crisis in 2008 saw
volatility in crude barrel of fuel range from $40 to $150.Hedging has seen airlines like Southwest to reap
benefits worth over $3.5 billion dollars and the industry has also seen Alaska
air and Southwest lose out due to hedging.
Hedging nevertheless continues
to be an important tool available to airlines to better plan financials and
contain volatility in fuel prices, and be an essential part of the business plan.
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