Fuel hedging is a
contractual
A contract is a legally enforceable agreement between two or more parties that creates, defines, and governs mutual rights and obligations between them. A contract typically involves the transfer of goods, services, money, or a promise to tran ...
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
A hedge or hedgerow is a line of closely spaced shrubs and sometimes trees, planted and trained to form a barrier or to mark the boundary of an area, such as between neighbouring properties. Hedges that are used to separate a road from adjoini ...
contract is a
futures contract
In finance, a futures contract (sometimes called a futures) is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The asset ...
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
In finance, a call option, often simply labeled a "call", is a contract between the buyer and the seller of the call option to exchange a security at a set price. The buyer of the call option has the right, but not the obligation, to buy an ...
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.
Background
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
Petroleum, also known as crude oil, or simply oil, is a naturally occurring yellowish-black liquid mixture of mainly hydrocarbons, and is found in geological formations. The name ''petroleum'' covers both naturally occurring unprocessed crude ...
. Because crude oil is the source of
jet fuel
Jet fuel or aviation turbine fuel (ATF, also abbreviated avtur) is a type of aviation fuel designed for use in aircraft powered by gas-turbine engines. It is colorless to straw-colored in appearance. The most commonly used fuels for commercial a ...
, the prices of crude oil and jet fuel are normally correlated. However, other factors, such as difficulties regarding
refinery
A refinery is a production facility composed of a group of chemical engineering unit processes and unit operations refining certain materials or converting raw material into products of value.
Types of refineries
Different types of refineries ...
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:
# 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.
# 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.
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
Southwest Airlines Co., typically referred to as Southwest, is one of the major airlines of the United States and the world's largest low-cost carrier. It is headquartered in Dallas, Texas, and has scheduled service to 121 destinations in the U ...
has tended to hedge a greater portion of its fuel needs as compared to other major
U.S. domestic carriers. 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
From the mid-1980s to September 2003, the inflation-adjusted price of a barrel of crude oil on NYMEX was generally under US$25/barrel in 2008 dollars. During 2003, the price rose above $30, reached $60 by 11 August 2005, and peaked at $147. ...
). 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).
Providers of fuel hedging
Fuel hedging services are predominantly provided by specialist teams within fuel management companies, large oil companies and financial services institutions. Examples include:
# Fuel management companies -
Onyx Capital Advisory,
Mercator Energy Advisors,
World Fuel Services
World Fuel Services Corporation (WFS, World Fuel) is an energy, commodities, and services company based in Doral, Florida. The company ranked No. 91 in the 2018 Fortune 500 list of the largest United States corporations. WFS focuses on the mark ...
,
Pricelock,
Global Risk Management
United Shipping & Trading Company (USTC) is a family-owned global group of companies headquartered in Middelfart, Denmark. USTC holds a portfolio of activities that includes oil & energy, shipping & logistics, ship owning, risk management, car acti ...
# Oil companies -
Total S.A
TotalEnergies SE is a French multinational integrated energy and petroleum company founded in 1924 and one of the seven supermajor oil companies. Its businesses cover the entire oil and gas chain, from crude oil and natural gas exploration and ...
.,
Royal Dutch Shell
Shell plc is a British multinational oil and gas company headquartered in London, England. Shell is a public limited company with a primary listing on the London Stock Exchange (LSE) and secondary listings on Euronext Amsterdam and the New Yo ...
,
ExxonMobil
ExxonMobil Corporation (commonly shortened to Exxon) is an American multinational oil and gas corporation headquartered in Irving, Texas. It is the largest direct descendant of John D. Rockefeller's Standard Oil, and was formed on November 30, ...
,
Koch Industries
Koch Industries, Inc. ( ) is an American privately held multinational conglomerate corporation based in Wichita, Kansas and is the second-largest privately held company in the United States, after Cargill. Its subsidiaries are involved in th ...
,
BP
# Financial institutions -
BNP Paribas
BNP Paribas is a French international banking group, founded in 2000 from the merger between Banque Nationale de Paris (BNP, "National Bank of Paris") and Paribas, formerly known as the Banque de Paris et des Pays-Bas. The full name of the grou ...
,
Goldman Sachs
Goldman Sachs () is an American multinational investment bank and financial services company. Founded in 1869, Goldman Sachs is headquartered at 200 West Street in Lower Manhattan, with regional headquarters in London, Warsaw, Bangalore, H ...
,
Barclays plc
Barclays () is a British multinational universal bank, headquartered in London, England. Barclays operates as two divisions, Barclays UK and Barclays International, supported by a service company, Barclays Execution Services.
Barclays traces ...
,
Macquarie Bank
Macquarie Group Limited () is an Australian global financial services group. Headquartered and listed in Australia (), Macquarie employs more than 17,000 staff in 33 markets, is the world's largest infrastructure asset manager and Australia's ...
,
Citigroup
Citigroup Inc. or Citi (Style (visual arts), stylized as citi) is an American multinational investment banking, investment bank and financial services corporation headquartered in New York City. The company was formed by the merger of banking ...
,
Morgan Stanley
Morgan Stanley is an American multinational investment management and financial services company headquartered at 1585 Broadway in Midtown Manhattan, New York City. With offices in more than 41 countries and more than 75,000 employees, the fir ...
,
Wells Fargo
Wells Fargo & Company is an American multinational financial services company with corporate headquarters in San Francisco, California; operational headquarters in Manhattan; and managerial offices throughout the United States and intern ...
,
Marex Spectron
Marex is a UK-based diversified global financial services platform, connecting clients to global energy, metals, agricultural and financial markets. Across its businesses, Marex provides high value add services in Market Making, Execution and ...
# Utilities-
Électricité de France
Électricité de France S.A. (literally ''Electricity of France''), commonly known as EDF, is a French multinational electric utility company, largely owned by the French state. Headquartered in Paris, with €71.2 billion in revenues in 2 ...
,
NextEra Energy
NextEra Energy, Inc. is an American energy company with about 58 GW of generating capacity (24 GW of which were from fossil fuel sources), revenues of over $18 billion in 2020, and about 14,900 employees throughout the US and Canada. It is the ...
See also
*
Fuel price risk management Fuel price risk management, a specialization of both financial risk management and oil price analysis and similar to conventional risk management practice, is a continual cyclic process that includes risk assessment, risk decision making and the i ...
References
{{reflist
Aircraft finance
Derivatives (finance)