Fuel Hedging

[demomonkey]

Hello

I have a small question re fuel hedging and would appreciate any input from someone who preferably has direct knowledge/experience of the commercial realities of hedging, not just those who care to share their informed guesses! ;-)

As an airline, would I setup a hedging agreement directly with a supplier, e.g. BP or via a 3rd party fuel broker?

If I agree to purchase X million litres of fuel at $10/litre (hypothetical) and then the price falls to $8/litre on the open market, what is there to stop me buying my fuel on the open market at the spot rate and then only returning to the hedged fuel when the market price had once again risen above $10? Contractual obligations/financial penalties etc?

Many thanks, DM

PS: Don't mean to upset those of you who volunteer your time and effort giving informed guesses, it's just I am looking for hard answers on this one.

[Bealzebub]

If you want "hard answers", do some hard research. Here is a 22 page article (http://www.kellogg.northwestern.edu/research/fimrc/papers/jet_fuel.pdf) to be going on with.

[easy1]

you'r not the bloke in charge of easyJets fuel are you?!!?!?!:eek:

[demomonkey]

Thank you Beazlebub.

In looking for hard answers, I was hoping for more than a quick search of Google (which incidentally I am more than capable of doing myself). However thank you for the sentiment you convey within your post. I shall treat it with the value it deserves.

Yours kindly, DM.

[whyisitsohard]

Nothing stops you, but you've still got to buy the fuel you agreed to buy in the time frame you agreed to.

My company (not reaally mine, but they own me) hedge fuel and crude, but not ALL our fuel and crude. Apparently they've been pretty good at it. Makes a change.

D

[Bealzebub]

Demonmonkey,

Perhaps the sentiment came across poorly, so let me try and redeem myself.

The question is analogous to one of "If I take out a mortgage and interest rates fall will I be able to take advantage of those falls?" The answer would depend on the type of mortgage contract you had taken out, such as fixed, capped, tracker, capped and collared, or variable. In other words, "it all depends."

"Hedging," incorporates a variety of strategies and contracts, that the term is used as a wrapper for. For example Futures contracts, swap contracts, call options and collars. The flexibility and penalty risk of each type of contract varies considerably, and an airline may very well employ a mix of these contracts to mitigate it's risk.

It is difficult to answer your question as the answer would depend on the type of the contract. Some contracts can be deferred. At the risk of pointing you back out into the internet, there is a video article Here (http://uk.youtube.com/watch?v=_h4jCROXep4&feature=related) that may be of interest to you? The follow on article is Here. (http://uk.youtube.com/watch?v=hQeIxXmlKdI&feature=related)

The problem (as I have also discovered researching this subject) is that as with many types of derivative trading, the subject is complex. Hedging is a general term used to encompass a variety of different strategies, and the answer to questions often depends on the strategy employed.

[demomonkey]

whyisitsohard (http://www.pprune.org/members/196512-whyisitsohard) / Beazlebub

Thank you very much for you very helpful answers. I will follow them up. Beazlebub, sorry for the flame-mail.

Best regards, DM