Fuel Hedging
The profitability of the airline sector depends on the cost of fuel, and yet there are limited resources available to mitigate the risks of a volatile oil market. Fuel hedging is a valuable tool that is employed to gap the risks associated with the oil industry; besides, the available resources needed for this purpose are in limited supply. The device requires that an agreement made ensures that the oil market price is predetermined and stable despite possible fluctuations in the future; this made it possible with the purchase of future contracts.
The passenger cost of airlines remains low as long as the fuel price is low, and on the other hand, passenger cost increases with the rise in fuel prices. Interestingly, the hedging tool tends to maintain oil prices, therefore, affecting the damage on the passenger positively. Therefore, most airlines prefer fuel hedging for speculation reasons to secure their customers’ interest. This thoughtful approach, also referred to as a forward contract, is a type of business contract; in this case, the airlines agree with the oil industries to buy their fuel at a set price for a given period, as stated in the contract. For example, at the beginning of 2019, airlines were expecting a rise in oil prices. However, vendors of the aircraft fuel like Air BP, Shell, or Exxon Mobil had intended to make a forward contract with the aviation oil market.
According to its annual report, Ryanair is well known for its use of hedging to maintain stable avenues of oil prices even during the rise in prices in the oil market. It applies forward contracts for a period of up to 18months of speculated jet fuel requirements; thus, it is well known for protecting airlines against unexpected fluctuation in the oil industry. The Irish LCC hedged 90% of its estimated jet fuel requirements for the fiscal year that ended on March 31, 2020. However, it has hedged 37% of the fuel requirements for the next financial year.
The price for the financial year 2020 Ryanair futures is $709 per metric ton. The cost would otherwise mean Ryanair is currently overpaying by around $80 per metric ton of kerosene considering the IATA’s jet fuel price policy for December quoting a price of $630 per metric ton. Unlike Ryanair, Lufthansa Airlines uses both futures and options in its hedging activities; the approach varies depending on the carrier within the group. For instance, all charter flights are fully hedged at the moment the contract is signed. As of February 22, 2019, the form for futures and options indicated 76% hedges for oil and kerosene at $66.41 per barrel. Whereas, for the year 2020, about 29% of the forecasted fuel requirement hedge for $70.09 per barrel. The current price per barrel is $79; therefore, Lufthansa’s Group hedges remain highly profitable for the group.
Also, reducing aircraft weight reduces the consumption rate of fuel by the aircraft. To reduce fuel costs, other approaches to reduce expenditure on the side of airlines include; reducing the number of magazines on each plane as well as ensuring they get paid according to the weight of the items airlifted. Even though weight reduction measures seem minor, airlines argue that weight savings of even 2 Kilograms are enormous for an airline with more than 1000 flights daily. Aside from that, to reduce weight, all watercraft equipment is removed if an airline does not fly over water.
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