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.(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.