Contrary to the subject line, fuel hedging is not necessarily a smart practice. It involves significant risk on a number of levels.
WN didn't begin engaging in fuel hedges as a bet that fuel prices would skyrocket. Their goal was to have predictability in fuel costs, even if it meant spending a little more on fuel, because the predictability allows for better long-range planning. That they hit the jackpot with that approach is a (really big) side-benefit.
Contrary to the subject line, fuel hedging is not necessarily a smart practice. It involves significant risk on a number of levels.
WN didn't begin engaging in fuel hedges as a bet that fuel prices would skyrocket. Their goal was to have predictability in fuel costs, even if it meant spending a little more on fuel, because the predictability allows for better long-range planning. That they hit the jackpot with that approach is a (really big) side-benefit.
I find it odd that the other airlines did'nt share this goal back then. Why were'nt they willing to take this risk? Were they expecting? not likely!, or hoping?more likely!, that the price of fuel would come down? Usually when one airline does something others tend to follow. But in this instance it does'nt seem to be the case.
First of all, the risk could result in a great deal of pain if fuel prices dropped. On the highly competitive long-haul service through hubs, what was otherwise marginally profitable service would suddenly become money-losing service. WN didn't have to worry about this, since nobody else was competing with them on a cost basis. If they missed, it wouldn't drain their cash reserves.
Secondly, legacy carriers haven't had much of a history of long-term planning. Hedging requires one to think long-term.
Thirdly, WN was sitting on a pile of cash that supported making these sorts of investments. The legacies weren't.
Finally, this was something new. There is no market currently for JetA futures, so one had to be cobbled together. It took some serious outside-the-box thinking to develop this in the first place.
Were they expecting? not likely!, or hoping?more likely!, that the price of fuel would come down?
That's not the right question to ask. Futures on heating oil (which are used as the primary component of a JetA hedge) tend to be more expensive than spot prices on heating oil. The bet, if your goal is to profit from changing fuel prices, is that JetA will spike above the price on the futures contract. The thing is, you're betting against people who build these contracts for a living. Today's price on the future reflects the market's best guess as to what the actual price will be when the contract would be fulfilled. This means that you have, in essence, an even-money chance of profiting from it. Of course, there's also an additional set of fees associated with setting up the contracts...so you are actually more likely to lose money from the contracts.
Delta actually had hedges that they sold early last year. The thinking there was that the war in Iraq would cause an increase in supply and a subsequent decrease in price. In hindsight, a bad bet, but what most people were predicting at the time. he biggest hinderance to hedging is cost. You have to lay out a significant portion of the cost of front. Because WN has been consistently profitable, they were able to buy longer range contracts whereas AA, UA, NW, DL, etc. have traditionally bought shorter term contracts. This is more a function of cost than mweiss' theory on long range planning.
I just wonder how much cash has to be paid out in order to hedge? Is it 100% of what you are getting or does the percentage decline the larger your order is? If anyone knows...........Thanks.
