Questions may sound very basic, but cannot search them on the web. Will much appreciate your advice!
1. Do airlines hedge directly with their suppliers in the airports or through banks / commodity exchanges?
I just cannot understand how hedging works. From one side airline has say future forward contract for crude oil. From another side the jet comes to the physical airport, gets fueled their and airline pays to supplier. How does one reconcile with another?
2. Is the fuel hedging for airlines different to other industries or it is similar among airlines, transport, logistic companies, etc.
3. Is there any software traditionally in place that helps to hedge fuel? Particularly interested in any arificial intelligence driven solutions.
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Re: Fuel hedging (basic questions)
Sorry but I don't have an answer for your specific questions, but you might Google Delta Air Lines fuel hedging as there has been a lot of press about that over the last five years. They actually own a refinery on the east coast so you say that they took it one step further. The answers might not be right there but the information trail could be worth a look.
Re: Fuel hedging (basic questions)
Basically the airline buys future of a commodity similar to jet fuel, in the case of WN it is heating oil. Any money made when they sell the future goes against the cost of jet fuel. Of course if the price of the commodity goes down, which has happened, then the loss also goes against the cost of fuel. The airline is betting that buying low and selling high will reduce the overall amount of money they have to spend on jet fuel. Hedging is a way of controlling overall fuel cost but it is a gamble.
Re: Fuel hedging (basic questions)
My understanding of fuel hedging is to obtain a degree of certainty over fuel prices, as fuel is priced at the time it is delivered, but the has been costed into the price of the ticket several months previously. WN used heating oil as a proxy for aviation fuel, as the spot prices historically moved in parallel.
The airline enters a contract to purchase an amount of heating oil for delivery at a future date at an agreed price. I believe that this is done with a specialist trader, which might be a division of a bank or a commodity trader.
If the price of heating oil/aviation fuel has risen by expiry, the airline takes delivery under the contract and sells into the spot market at the higher price. The profit offsets to extra cost of aviation fuel against budgeted cost. Similarly, if the price has fallen, the loss on the heating oil is offset by paying less than budget for aviation fuel.
The problem for airlines is that the future contract will often cover several accounting periods. Accounting standards require these contracts be valued as if they were sold on the commodity exchanges on the accounting date, thus producing a paper profit or loss.
Is hedging a bigger gamble than selling your product priced at today's cost and delivering it some time in the future at then ruling costs ? Different people have different views.
The theory would be similar for other transport industries, but the practicalities probably outweigh the benefits. I know that the bus company I worked for did look into getting effectively a future contract on its diesel requirements, but the distributor was not interested, as they paid spot prices to the oil company and were not prepared to take the risk themselves. It takes two to tango !!
Hope this helps.
The airline enters a contract to purchase an amount of heating oil for delivery at a future date at an agreed price. I believe that this is done with a specialist trader, which might be a division of a bank or a commodity trader.
If the price of heating oil/aviation fuel has risen by expiry, the airline takes delivery under the contract and sells into the spot market at the higher price. The profit offsets to extra cost of aviation fuel against budgeted cost. Similarly, if the price has fallen, the loss on the heating oil is offset by paying less than budget for aviation fuel.
The problem for airlines is that the future contract will often cover several accounting periods. Accounting standards require these contracts be valued as if they were sold on the commodity exchanges on the accounting date, thus producing a paper profit or loss.
Is hedging a bigger gamble than selling your product priced at today's cost and delivering it some time in the future at then ruling costs ? Different people have different views.
The theory would be similar for other transport industries, but the practicalities probably outweigh the benefits. I know that the bus company I worked for did look into getting effectively a future contract on its diesel requirements, but the distributor was not interested, as they paid spot prices to the oil company and were not prepared to take the risk themselves. It takes two to tango !!
Hope this helps.