[Rhodes22-list] Energy Policy - Oops!

[Saroj Gilbert]

You will laugh your ass off if you click on the link that the list-serv 
created to supposedly point to your attached document.  Buy nuclear waste on 
ebay?

Saroj
----- Original Message ----- 
From: "brad haslett" <flybrad at yahoo.com>
To: <rhodes22-list at rhodes22.org>
Sent: Monday, February 21, 2005 6:48 AM
Subject: [Rhodes22-list] Energy Policy - Oops!


> Ed, forgot you couldn't attach MS Word documents.
> Here's a cut and paste version.  Brad
>
>
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> Passenger Airline Profitability in the Post 9/11
> Environment - How Southwest has Controlled Fuel Costs
> by Hedging and Why Other Airlines Should Hedge Fuel
> Purchases
>
>
>
>
>
> Brad Haslett
> Managerial Finance BA-518
> Embry-Riddle Aeronautical University
> Winter 2004
>
>
> The Search for Profits Post 911
>
> The US passenger airline industry was in trouble in
> 2001 prior to 9/11. A slowing economy and the bursting
> dot-com bubble suggested substantially slowed economic
> growth. With a softening economy and a recent round of
> tough labor negotiations, most major airlines were
> facing a bleak profit outlook. However, industry cash
> reserves totaled $11 billion at the end of the first
> quarter of 2001 and operating revenues had been
> growing nearly 7 per cent annually since 1995.  The
> 9/11 terrorist attacks eliminated any hopes for a 2001
> profit for all but a handful of carriers, and three
> years later, only a rare few have achieved positive
> financial results.  One key to the success of those
> that have not only survived, but also prospered, is
> keeping fuel costs under control. Every one-cent
> increase in the cost of a gallon of jet fuel costs the
> industry $180 million per year. This paper will
> examine the history of airline fuel costs, what
> techniques are available to control and predict jet
> fuel prices, and what the most successful in the
> industry, primarily Southwest Airlines, are doing to
> control fuel costs and maintain profits by using fuel
> hedging strategies.
>
> Oil is a commodity that has always had a volitale
> price history, however, prior to 1973, the inflation
> adjusted price tended to hover around $25 per barrel.
> The rise to power of the OPEC oil producing nations in
> 1973 changed the dynamics and the volitality of crude
> oil prices. OPEC mandated cutbacks in production in
> 1973 and 1979 created substantial rises in worldwide
> crude oil prices.  Airlines suffered substantially as
> a result but the industry was still regulated in 1973
> and de-regulation was in its infancy in 1979.  Crude
> oil prices reached their highest point in nearly two
> decades in 2004. The sudden rise in crude oil was due
> to a complex set of factors including uncertainty
> about the stability of production from the Middle
> East, but few in the oil industry predicted it.
> Almost no US air carriers were financially prepared
> for it. US based airlines were already suffering
> heavily from the post 9/11 environment. The 2003
> industry debt level stood at $100 billion while the
> value of all the outstanding stock of passenger
> airlines was only $3.2 billion. The sudden rise in oil
> prices eliminated all hope for an industry profit for
> the remainder of 2004 and perhaps for the next several
> years for all but a few.  Those carriers that have
> remained profitable, namely Southwest Airlines, have
> done so largely because thay have controlled fuel
> expense through a sophisticated system of hedging jet
> fuel costs.  We will examine why Southwest has been so
> successful and why the other competiters haven't
> followed their example.
>
> Most major air carriers have retired their older, less
> fuel efficient jet fleets for aircraft that burn less
> fuel. Today's jet fleet is nearly three times more
> fuel-efficient than the fleet that was operating at
> the time of the first OPEC fuel crisis. However, fleet
> modernization requires major outlays in capital and
> heavily affects profits when passenger traffic
> declines.  Despite improving fuel requirements, jet
> fuel expenses still account for 12 to 18 per cent of
> operating costs, second only to labor expense.  Fuel
> costs nearly doubled in 2004 and unlike other
> industries, the airline industry was unable to pass
> the expense to the consumer.  Cargo airlines such as
> FedEx and UPS tacked on fuel surcharges to customer
> invoices and consumers accepted the price increases
> for services.  When Contential and United airlines
> tried to add fuel surchages to ticket prices, airline
> passengers sought other carriers without the
> surcharges and both airlines quickly recinded the
> charges.  The US passenger market remains extremely
> price sensitive and fuel surchages of as little as $10
> per ticket have led to mass defection of travelers to
> other carriers.  Purchasing jet fuel at the lowest
> cost has become one of the most important factors to
> remaining competitive.
>
> FUEL HEDGING AT SOUTHWEST VERSUS OTHER CARRIERS
>
> SouthWest Airlines locked in 80% of their 2004 fuel
> costs based on a $26 per barrel of crude oil while
> other carriers paid as much as $55 per barrel on the
> spot market.  Southwest has already hedged much of
> their 2005 fuel costs at $32 per barrel and 45% of
> their 2006 fuel deliveries at $28 per barrel.  United
> and US Airways are prevented by law from hedging
> because they are operating under bankruptcy court
> supervision.  Delta had hedged nearly 40% of their
> 2004 fuel costs but were forced to sell their hedge
> positions for $82 million because they were strapped
> for cash.  This short- sighted strategy forced them to
> buy fuel on the spot market.  Other carriers hedged
> fuel costs to a much smaller degree than Southwest but
> were unprepared when oil prices peaked in mid-year
> 2004.  While hedging has proven extremely successful
> for Southwest, it is not without its risks.  Hedging
> requires substantial up-front cash and few airlines
> have sufficient cash post 9/11 to take hedge
> positions.  Most of the surviving legacy carriers have
> needed all available cash to avoid bankruptcy.  By not
> hedging, airlines are taking on the risk of rising
> commodity prices into their business model.  This
> would be acceptable if no airlines hedged.  But when
> carriers such as Southwest are successful at keeping
> fuel costs (at times nearly half of their competiters)
> so much lower than their rivals, other competiters
> must match fares and absorb the rising fuel expense.
> Were crude oil prices to fall in the $20 per barrel
> range, Southwest would be at a decided disadvantage.
> Few in the oil industry or the airline industry expect
> oil prices to retreat to that range in the near
> future.  It's not that Southwest was better than
> rivals at predicting where fuel prices were headed.
> Instead, with its rock-solid credit rating and strong
> cash position, it could afford to buy hedges in the
> past few years when the financially ailing carriers
> couldn't.  With their weak credit ratings, they faced
> not only higher costs but demands for cash collateral
> in some cases.  The weak position of rival airlines
> was summed up by Continential Airlines CEO Gordon
> Bethune, "you can't get enough money to buy hedges,
> and you can't find anybody dumb enough to get on the
> other side of it".  American Airlines CEO Gerard Arpy
> stated much the same sentiment, "we couldn't enter
> into swaps, which were our traditional mechanism for
> hedging fuel, so as a consequence, we're not as hedged
> as we've been historically, its's frustrating".  Fuel
> costs will be the deciding factor for many airlines in
> 2005 as to whether they can postpone bankruptcy.
>
> Southwest uses a combination of hedging instruments,
> including call options, collars, and fixed-rate swaps.
> Some are more expensive than others but less risky,
> while others give the airline a bigger advantage if
> oil prices fall.  These instruments work in different
> ways, but Southwest essentially pays for the right to
> lock in fuel at a particular price or price range in a
> future period.
>
> OTHER ADVANTAGES OF HEDGING
>
> The financial results of the US Airline industry for
> 2004 and the positive gains achieved by Southwest
> Airlines aggressive fuel hedging strategy have
> demonstrated the benefits of hedging. Those airlines
> that have chosen a non-hedging strategy because of
> bankruptcy or policy have paid dearly.  John Armbrust,
> a jet fuel contract consultant, talking about the
> majority of the airline industry, other than Southwest
> and JetBlue, states "don't underestimate the ability
> of the airlines to walk off a cliff together.  Almost
> all of them are pretty vulnerable right now".  This
> herd mentality exists primarily among the legacy
> carriers.  The low-cost carriers such as Southwest
> have departed from this line of thinking, and by doing
> so have achieved financial success while the rest of
> the industry is on the verge of bankruptcy. But other
> financial issues facing airlines benefit from hedging
> as well.  There are two major ways in which hedging
> can assist in an airlines ability to invest.  First,
> new aircraft purchases must be planned years in
> advance, and purchase orders submitted to the aircraft
> manufacturer.  Hedging preserves internal cash flow to
> meet future commitments to purchase aircraft.  Second,
> during periods of economic downturn, weak airlines
> often have to sell assets to survive.  Financially
> stronger airlines may be in a position to buy these
> assets at prices below fair market value.  If hedging
> improves a carriers cash position during economic
> downturns, the hedged airline may rely less on
> external sources of funds to make capital
> expenditures.  External finance is increasingly
> expensive when the hedgeable risk factor (jet fuel)
> negatively affects cash flow.  By hedging its fuel
> costs, Southwest has been able to meet financial
> objectives and has taken advantage of its superior
> cash position to buy gates from other financially
> troubled airlines.  Even though hedging requires
> substantial up-front cash, Southwest can predict its
> budgetary needs and avoid unexpected rises in
> operating costs that have forced others into
> bankruptcy and "fire sales" of assets.  High jet fuel
> prices coincide with low industry cash flows, and
> industry investment is directly related to the level
> of jet fuel cost.  Studies have shown investors are
> willing to pay a "hedging premium" for companies that
> reduce their exposure to commodity risk.  The hedging
> premium can be attributed to the benefits an airline
> reaps by generating more consistent, stable cash
> flows.  Hedging airlines are able to better predict
> future cash flows, and earnings, and make investments
> during the high stages of the price cycle, both of
> which are positively valued by investors.  Investors
> in general do not trust airlines' earnings consistency
> and heavily discount the sector's stock.  Airline P/E
> ratios are generally half or a third of the market
> average, a fact often lamented by airline CEO's.  By
> hedging jet fuel purchases, airlines are better able
> to predict future expensed and earnings, which would
> help increase the confidence of financial markets.
>
> HEDGING STRATEGIES AVAILABLE
>
> A properly designed hedging strategy should optimize
> the use of an airlines' capital and minimize the
> volatility of earnings.  Hedging may occasionally lose
> money, but the carrier as a whole benefits.
> Well-designed hedging programs secure or limits the
> loss on key financial ratios by allowing the carrier
> to spend capital on core activities.  One of the
> reasons hedging activities have historically come
> under so much scrutiny is that all hedging
> transactions have a "loser".  Warren Buffet described
> derivitive contracts (related to hedging strategies)
> as "weapons of financial mass destruction".  If
> airlines entered into hedging contracts solely as
> speculative investments, Mr. Buffet's observation
> would perhaps be correct.  But airlines must purchase
> vast quantities of fuel to operate and hedging allows
> them to smooth out expenditures, keep costs within a
> certain range, and avoid suffering from sudden and
> swift rises in operating expenses.  Derivitave
> contract operations are a very specialized field and
> most airlines that utilize hedging operations use a
> combination of internal employees and outside
> consulting firms.  Southwest for example, has three
> full time fuel risk management employees who handle
> fuel risk operations.
>
> There is no specific market that trades in jet fuel
> hedging contracts so airlines use contracts in
> existing markets for products that are closely related
> in kind or whose price is closely correlated to jet
> fuel prices.  Crude oil is actively traded on several
> markets with the New York Merchantile Exchange (NYMEX)
> being the most active.  Jet fuel is a direct product
> of crude oil but does not precisely follow the price
> trends in crude.  Home heating oil is very simular to
> jet fuel and is actively traded on several markets
> including futures markets.  Additionally, home heating
> oil demand is seasonal and competes with jet fuel
> refining capacity so it correlates well with jet fuel
> spot market prices.  Successful jet fuel hedging
> operations spread risk over different time frames and
> several crude oil related product markets.  Some
> contracts extend as far as eight years in advance but
> the bulk of hedging operations are for contracts of
> one year or less.  Generally, the farther in advance
> an airline hedges the more expensive the up-front
> costs while shorter range hedging, though cheaper,
> exposes fuel expenditures to more risk.  Successful
> strategies use a variety of products over a variable
> time frame.  Derivatives are traded directly between
> airlines and investment banks and are usually traded
> with several different banks and investment firms to
> diversify risks and to get the best pricing.
>
> Hedging instruments are either over-the-counter (OTC)
> products or exchange-traded futures.  The most
> commonly used hedges in the airline industry are are
> OTC swaps, collars, futures and forward contracts.
> Collectively these are known as symmetric hedges.
> While reducing earnings volatility by eliminating the
> exposure to downside risks, they give away all or part
> of the carriers participation in the upside (falling
> oil prices).  A symmetric hedge is nothing more than a
> portfolio of an option purchased (a long position) and
> an option sold (a short position).  The long-option
> position insures the operator against the downside,
> but the short-option position gives away the upside
> participation.  The premium from the short-option
> position finances the creation of a long-option
> position.
>
> Swaps, also known as Contracts-for-Differences
> (CFD's) are used to lock in a fixed price for a
> predetermined but not necessairly constant quantity.
> The first airline swap contract was traded in 1986
> when Chase Manhattan Bank acted as counterparty to
> Cathay Pacific Airways and Kock Industries in an
> oil-indexed price swap.  Swaps are further delineated
> into vanilla swaps, variable volume swaps,
> differential swaps, margin or crack swaps,
> participation swaps, double-up swaps, and extendable
> swaps.   The vanilla swap is an agreement in which the
> counterparties exchange a floating energy price for a
> fixed energy price, that is, one party pays a fixed
> price and recieves the floating price either by
> receiving the cash value of the spot energy or the
> spot energy itself.  The other party, the swap
> provider recieves the fixed prices and either supplies
> the spot energy or its cash equivilent.  The contract
> defines the fixed volume or quantity over a specified
> period of time.  The variable volume swap contract is
> identical to a vanilla swap except that the quantity
> is not known in advance.  A differential swap is
> simular to a vanilla swap except that the
> counterparties exchange the difference between two
> different floating prices for a fixed price
> differential.  The crack spread or margin is the price
> differenetial between crude oil and jet fuel.  Because
> jet fuel competes with other refined products, crack
> spread swaps can protect against rising fuel costs due
> to refinery capacity swings.  Participation swaps are
> simular to vanilla swaps except the airline may
> participate in a certain percentage of the savings if
> prices fall.  Double-up swaps allow the airline to get
> a better swap price but the provider has the option of
> doubling the volume of product delivered.  Extendable
> swaps are simular to double-up swaps except the swap
> provider has the option to extend the period of the
> swap for a predetermined period.
>
> Caps, floors, and collars are also CFD's used in
> hedging.  Caps provide price protection for the buyer
> above a predetermined level, the cap price, for a
> specified period of time.  A floor guarantees the
> minimum price that will be paid or received at a
> predetermined level.  A collar is a combination of a
> long position in a cap and a short position in a
> floor.  Caps, floors and collars are for predetermined
> quantities and are usually settled at regular
> intervals over the period of the contract.
>
> Exchang-traded futures are also use by airlines to
> hedge fuel costs.  Jet fuel futures contracts do not
> exist in the United States, so futures on crude or
> heating oil is used instead to hedge jet fuel purches.
> Because these futures contracts are based on an
> underlying commodity other than jet fuel, they
> introduce basis risk because they are not perfectly
> correlated.  Basis is generally defined as:
>     Basis = spot price of hedged item - futures of
> selected contract.
> Basis risk is a result of the relationship between the
> spot price and futures price not remaining constant
> throughout the life of the hedge, thus generating
> ineffectiveness.  At the onset of the hedging
> relationship, the optimal hedge ratio will take into
> account the current basis, as well as the difference
> in volatilities of and the correlation between the
> spot commodity and the futures contract.  In the case
> of the airline industry, they are always short jet
> fuel and must go long futures.
>
> To implement a dynamic hedging strategy, an airline
> needs to vary the hedging products over the oil price
> cycle.  When oil is at the low point in the cycle,
> receive-fixed swaps are used because the likelihood of
> further price declines is not considered as probable
> as price increases, and the swap contract allows the
> airline to lock in the relatively low price.  In the
> mid-range of the cycle, collars are used to lock in a
> specified range of prices, giving up potential savings
> from price depreciation while hedging against further
> increases.  When oil prices are at the top of the
> price cycle, caps are used to prevent losses from
> further appreaciation while allowing the company to
> take advantage of price decreases.  This sophisticated
> strategy requires a substantial amount of monitoring,
> but it has been rather successful for Southwest
> Airlines: their fuel costs are currently locked in at
> prices well below their competition.  Southwest
> prefers OTC derivatives to exchange traded futures
> because they are more customizable.  The ability to
> customize these contracts greatly facilitates the
> implementation of a dynamic hedging strategy.  This
> strategy is based on the presumption that the oil
> price cycle is a mean-reverting process, or that it
> moves in cycles rather than consistently in one
> direction.  Given this characteristic, it is possible
> to implement a hedging strategy that enables airlines
> to lock in prices at the low point in the cycle while
> capping prices at the high end to take advantage of
> eventual price declines.  To implement a dynamic
> hedging strategy, a firm needs to vary the products
> over the oil price cycle.  When oil is at the low
> point in the cycle, receive-fixed swaps are used
> because the likelihood of further price declines is
> not considered as probable as price increases, and the
> swap contract allows the airline to lock in the
> relatively low price.  In the mid-range of the cycle,
> collars are used to lock in a specified range of
> prices, giving up potential savings from price
> depreciation while hedging against further increases.
> When oil prices are at the top of the price cycle,
> caps are used to prevent losses from further
> appreciation while allowing the company to take
> advantage of price decreases.
>
> ACCOUNTING ISSUES ASSOCIATED WITH HEDGING
> Accounting for jet fuel hedges is an important issue
> for airline managers because poorly structured hedging
> strategies can adversely affect earnings statements.
> Some airline CEO's and managers are reluctant to enter
> into hedging agreements that they don't completely
> understand and accounting rules can sometimes make
> losses on hedging appear as a management failure when
> if fact, hedging makes sense for the airline.  It is
> essential that trades are structured and tested in a
> way that will enable the firm to receive the
> preferable accounting treatment, otherwise earnings
> volatility will be increased rather than decreased.
> Trading desks play a crucial role in ensuring that
> both the internal and external accountants have the
> information they need, so an intimate knowledge of the
> relevant accounting standards is necessary by all
> parties involved.
> Jet fuel consumers are short jet fuel and must
> purchase the commodity in the future as it is needed
> for consumption.  This type of hedging strategy is
> defined as a "cash flow hedge of a forcasted
> transaction" by the Statement of Financial Accounting
> Standards Number 133.  The accounting guidance for
> such a transaction specifies that the derivative must
> be marked-to-market on the balance sheet.  The
> offsetting journal entry, however, is not booked to
> earnings but rather to Other Comprehensive Income
> (OCI).  Entries to the OCI account are booked directly
> to Retained Earnings, bypassing the income statement.
> Then, when the forcasted transaction impacts the
> income statement, the amounts booked to OCI are
> "released" to the income statement, offsetting the
> earnings fluctuations from the price of jet fuel.  The
> net result is that the derivatives are carried at the
> market value on the balance sheet, but there is no
> volatility introduced to the income statement.
>
> The accounting rules have an important implication for
> hedging strategy.  If, for example, an airline
> forcasts that it will burn 100,000 gallons of jet fuel
> in a given month, hedges 100% of this usage, and then
> uses only 80,000 gallons, the portion of the
> derivative hedging the other 20,000 forcasted gallons
> must be released from OCI to the income statement
> immediately upon the determination that it is no
> longer probabable that the full 100,000 gallons will
> be used.  This will increase income statement
> volatility and also call into question the company's
> ability to forcast.  If the company repeatedly
> demonstrates an inability to forcast their usage and
> thus overhedges, that may be precluded from using cash
> flow hedging strategies in the future.  Therefore, it
> is a common practice for firms to hedge up to the
> level they are certain to use, and remain unhedged for
> any additional consumption.
>
> OIL COMPANY HEDGING OPERATIONS
> Airlines are naturally short on fuel while oil
> production companies are naturally long on crude oil.
> It is useful to monitor oil company hedging operations
> as a predictor of the direction oil prices are
> heading.  The largest companies in the oil industry do
> not hedge because they have several large projects
> spread over numerous time frames and simply choose to
> ride out the price cycle.  Smaller companies with less
> diverse production and less vertical integration often
> hedge their production to smooth out earnings swings.
> The latest run-up in crude oil prices was not as
> lucrative for some mid-level producers as one would
> think because many companies hedged their production
> at price levels far below the eventual high mark of
> $55 per barrel. This should encourage airlines in the
> short run because oil producers do not think the
> current prices will remain at their present level.
> The longer-term forcast is not as comforting. Oil
> price forcasting is a tricky and often an elusive
> pursuit, however, observing how oil companies have
> responded to the most recent upturn in prices should
> give airline managers some insight to how the
> suppliers of the second most expensive input to
> airline operations think the market will behave.
> While oil companies are currently enjoying substantial
> profits from the rise in crude oil prices, few have
> stepped up discovery budgets far beyond what was
> previously budgeted.  This would indicate that they
> think the current situation is temporary and prices
> will return to "normal" in the near future. The bulk
> of both large and small production companies have used
> the excess cash from earnings associated with high oil
> prices to pay down debt, buy back stock, and reward
> shareholders with increased dividends rather than step
> up exploration.  While this should encourage airline
> managers that fuel prices are falling, the longer-
> term outlook in the oil industry should be cause for
> alarm.
>
> The concept of  "peak oil", that is the eventual high
> point of worldwide oil production, has been discussed
> since Colonial Drake's first oil well.  A Shell Oil
> geologist and later professor emeritis of geology at
> Princeton University, L. King Hubbert, wrote a
> scientific paper in 1956 which was derided by his
> employer and peers and became known as "Hubberts
> Peak".  Hubbert theorized that oil production lags oil
> discovery by roughly forty years.  Since discovery
> peaked in the US in the thirties, he predicted that
> production would peak in the early 1970's. US domestic
> oil production did in fact peak in 1970.  His later
> prediction was that since world oil discovery peaked
> in the sixties, world oil production would peak
> shortly after the turn of the century.  While it is
> still too early to tell with certainty, there is much
> evidence to indicate that his second prediction is
> eerily accurate as well.  As production peaks, crude
> oil prices will rise with a constant demand.  With the
> rapid modernization of China, and to a lesser degree
> India, world oil demand is rising rapidly at the same
> time production capacity is falling.  The history of
> oil prices has been one of a fairly stable trend line
> with wild but short lived swings away from the mean.
> If Hubbert's Peak prediction holds true, we may see a
> shift away from the fundamental futures forcasting
> models and a substantial rise in the baseline price
> range for crude oil.  This should give pause to
> airline executives and further encourage them to adopt
> hedging operations to smooth fuel cost fluctuations
> and earnings swings.  A majority of oil industry
> analysts believe that there is a fundamental paradigm
> shift in oil price trends.  Where in the past,
> volatility was due primarily to geo-politics; future
> price swings will be more a function of geology.  This
> new paradigm can be seen by looking at the reserve
> life index (RLI) of global oil reserves, a
> simple-to-calculate metric: total reserves divided by
> total production.  Simply put, the higher the RLI, the
> greater the oil market's long-term growth potential.
> The current situation does not look encouraging.  In
> the past 30 years, RLI has dropped from 119 years in
> 1970 to 47 years in 2004.  This trend is not reversing
> but in fact seems to be accelerating with some
> estimates that RLI will only be 20 years by 2020.
> This has a very ominous meaning for airline
> executives.  Where in the past oil prices have been
> determined by short-term political and economic
> factors, future prices will be a result of market
> recognition of the structural imbalance between demand
> and supply.  Detractors from this theory will point to
> "un-discovered" oil fields as the weakness in the
> Hubbert's Peak argument but the oil industry's
> reluctance to substantially increase discovery efforts
> during a period of high oil prices should give little
> comfort.  Most of the large and medium sized oil
> companies have chosen growth through merger and
> acquisition rather than the drill bit.
>
> The rising world demand for crude oil with a flat or
> declining supply of the raw product will have serious
> impacts across a broad spectrum of industries but
> perhaps none more so than airlines.  While many
> industries can switch to other sources of energy and
> raw materials, there is no substitute for crude oil
> derived jet fuel and no alternative fuels are expected
> for decades.  Prudent airline managers would be wise
> to closely follow investment and performance of oil
> companies to guage what direction long-term jet fuel
> prices are heading.  While no amount of hedging will
> stop this long term trend, the volitility of oil
> prices will most likely increase with more aggressive
> market speculation by traders as the spector of
> increasing demand along with falling supply develops.
>
> CONCLUSIONS
>
> The small number of airlines that produced stable
> earnings in 2004, including Southwest Airline,
> aggressively hedged their fuel budget.  Those airlines
> that chose to "ride the market" for fuel or were
> prevented from hedging by weak cash positions or
> bankruptcy saw their potential for profit decimated by
> the sudden run-up in crude oil prices.  Unless
> passenger airlines are able to pass fuel cost
> increases on to consumers, something no airline has
> been successful at to date, smoothing fuel price
> fluctuations through hedging would appear to be the
> industry "best practice".  Making the case against
> hedging, one foreign airline CEO, Rod Eddington, the
> CEO of British Airways, commented: "a lot is said
> about hedging strategy, most of it is well wide of the
> mark.  I don't think any sensible airline believes
> that by hedging it saves on its fuel bills.  You just
> flatten out the bumps and remove the spikes.  When you
> hedge all you do is bet against the experts of the oil
> market and pay the middle man, so you can't save
> yourself any money long term.  You can run from high
> fuel prices briefly through hedging but you can't run
> for very long".  Perhaps so, but the "bumps and
> spikes" of the 2004 crude oil market has nearly ruined
> several air carriers in the United States. The point
> that Eddington misses and the bulk of the US based
> legacy carriers missed in 2004, is this: hedging may
> not save money, in fact it may cost money, but it
> allows you to stay on budget and avoid suprises. At
> least two may face liquidation in 2005.  Investor's
> have shown a preference and are willing to pay a
> premium to purchase shares in airlines and other
> industries that protect earnings through hedging.
> Airline executives testified before members of the US
> Congressional House Transportation and Infrasturcture
> subcommittee in June 2004, outlining the airline
> industry's struggle for survival and pleaded for more
> government bailouts.  They were flatly denied any help
> and were heavily critisized by subcomittee members for
> their handling of fuel costs and the failure to hedge.
> It does not appear than any more government help is
> forthcoming. Those airlines that chose not to hedge
> have paid a terrible price and some may not survive
> because of their error in judgement.
>
>
>
>
>
>
>
> References
> Air Transport Association of America, Inc., 2003,
> "Airlines in Crisis: The Perfect Economic Storm",
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