Fuel hedging

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. Because crude oil is the source of jet fuel, the prices of crude oil and jet fuel are normally correlated. However, other factors, such as difficulties regarding refinery 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:

1. 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.
2. 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 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). 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).