239 replies to this topic

[WorldTraveler]

Callaway,
at times there is the opportunity to truly get to know people on this forum... and it is always a great privilege when it happens.
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thanks for sharing your story - your views make alot of sense in light of your story.

[CallawayGolf]

WorldTraveler, on 20 February 2012 - 04:50 PM, said:

Callaway,
at times there is the opportunity to truly get to know people on this forum... and it is always a great privilege when it happens.
.
thanks for sharing your story - your views make alot of sense in light of your story.

Thanks WT. I welcome your feedback in the spirit in which it was given. Not sure what about my views may not have made sense until now, but I'm glad it helped to bring some clarity.

[Jester]

WorldTraveler, on 17 February 2012 - 05:47 AM, said:

Unlike true insurance, hedges cost very little to implement other than tying up some cash and credit lines - but it does provide a level of stability which analysts look for.

As I understand hedging, while it cost very little to implement (assuming the airline has the credit) it has the very real potential of expensive losses if the bet goes wrong. Hedging locks in the price for the airline to buy, but it also locks in the price for the supplier to sell. If passengers bought several months, in advance, with a locked-in price for their fare, then locking in the price of fuel would be wise, but most tickets are not bought that far out. The hedge might provide some stability to the cost structure, but that's not a good thing when that cost structure is much higher than that of the competition.

More of a true "insurance" which would limit the exposure to rapid increases in oil prices in the short term would be in the use of a proxy asset lilke West Texas Intermediate crude options which has an R-square of around .98 relative to the price of aviation fuel historically speaking. An airline could buy calls with the right to buy WTI crude (but not the requirement to buy) at some future date, as not to take delivery, but to sell the option if the price of WTI exceeds the strike price. That money from the sale would be used to purchase the more expensive aviation fuel, and offset the increased costs.

Options are relatively cheap in the short-term with strike prices well above of the market, but obviously a high degree of risk insofar, that even cheap options run the risk of being worthless with 100% of the "investment" lost. (Much like most car insurance paid annually provides no returns to the "investment" as no claim was made by the policy holder.) With as many options which would be required given the large amounts of fuel burned daily, I think the costs would be excessive. In an industry which seems to live on pennies of CASM, the costs of bushels in relatively cheap options would probably be too expensive, otherwise most airlines would be in the options market for WTI crude.

However, I think a more prudent approach would be to consider call options on WTI crude for some "Black Swan" event where the price of oil soars to $300 a barrel over some exogenous shock to oil supplies, and an option a year out with a strike price of $200 should be relatively cheap.

So Recommends Jester.

[WorldTraveler]

CallawayGolf, on 20 February 2012 - 04:58 PM, said:

Thanks WT. I welcome your feedback in the spirit in which it was given. Not sure what about my views may not have made sense until now, but I'm glad it helped to bring some clarity.

I wasn't saying that your views didn't make sense... but having pulled yourself up by your bootstraps, so to speak, your desire to see market forces really work make more sense.... your politics reflects your own personal experiences.
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thanks for your insights, Jester.
Fuel hedging as with currencies is highly complex for airlines and it is risky... the cost comes in getting it wrong either way.
US' aversion to hedging directly comes from its bad experience with hedging a couple years ago. As FWAAA notes, I'm not sure why US has had less success and been more preoccupied with a process that alot of airlines refine but they still know they have to do - and occassionally like WN earlier in the 2000s, you strike the motherlode.
But there is alot about any hedging that involves credit qualtiy and on that basis, US will likely be at a disadvantage because their smaller size in a pond with larger fish makes it harder and harder for them to compete on the same basis.. it's not just revenue for which they fight an uphill battle.
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Carriers do have to make commitments to the amount of capacity they fly several months out, even if many of the passengers haven't bought tickets yet... every airline uses a host of advance booking and revenue models to determine if they are where they need to be based on the time from departure... and some of the airlines that have turned their finances around the best have been very aggressive in changing their schedules up until the latest period allowed by their own planning processes... factor in the change in fuel prices which airlines can use to model profitbility and there is alot more predictability to planning for profitability than has ever been possible in the past. Thus if fuel prices soar and it is known that fare increases are necessary to cover those costs - and with those two comes reduced demand - there is little reason why carriers should be operating flights at losses after the "table has been set" two to three months in advance. Even if you can't get labor and other costs out quickly, it makes little sense to operate flights that can't make money given that fuel is now 1/3 or more of the cost of operating a flight.

[BoeingBoy]

Jester, on 20 February 2012 - 06:30 PM, said:

As I understand hedging...

Hedging is, or can be pretty complex. Most carriers that do it use not just call options but a combination of options, swaps, straddles, collars, and one or two others. You can protect against both increases and decreases in price beyond a certain range resulting in losses but it's more expensive to do so. The hedged product fluctuates also. Few use pure crude or WTI because there are fluctuations in the so-called "crack spread" or difference between the price of the crude and the price of the final product. For example, the "crack spread" has been generally increasing the last couple of years so even if WTI remained constant the price of diesel, heating oil, or other hedging commodities would increase.

US' problems with hedging in 2008 stem from not just one factor. First, they dealt almost exclusively with call options so there was no protection when prices dropped so much. Second, they hedged short term while aiming to be 50% hedged entering a quarter. So to be 50% hedged in the 3rd quarter of 2008, they were only about 10% hedged for the 3rd quarter at the start of 2008 and maybe 30% hedged at the start of the 2nd quarter. They added a lot of call options at prices up to $140/bbl then the price collapsed, creating high loses. Contrast that with WN - at the end of 2011, they were 10% hedged for 2015 and 25% hedged for 2014. They look for hedging opportunities and don't have that "OMG, we've got to hedge a lot before the start of next quarter" impulse and hedge at any cost. Plus, with the losses after the price of crude plummeted in 2008, US didn't have the spare cash to hedge - they had to get relief from the credit card processor hold back requirement to keep from defaulting.

Jim

[Jester]

BoeingBoy, on 21 February 2012 - 12:45 AM, said:

Few use pure crude or WTI because there are fluctuations in the so-called "crack spread" or difference between the price of the crude and the price of the final product. For example, the "crack spread" has been generally increasing the last couple of years so even if WTI remained constant the price of diesel, heating oil, or other hedging commodities would increase.

Jim,

And that's exactly what has happened in the past few years, after I stopped following the relationship between WTI and various other oil related products. For example, on the following graph: http://www.bloomberg...NYPR:IND/chart/
Shows the price of jet fuel in the spot market (and I do not know if the WTI comparison was inserted into the graph, but its symbol is "OIL"), and the relationship holds up very well more than 3 years ago, but the last few years the relationship completely fell apart. Curious as to know why it happened, but I am not an oil trader.

Thanks again for your insights on the matter.

Jester.

[BoeingBoy]

Part of it is that WTI Cushing spot price is the price at the Cushing, OK, pipeline terminal while distilled product spot prices are generally at the port or pipeline terminus (like NYC port), so transportation - crude from Cushing to refinery and product from refinery to port - plays a significant role in the spot price of the product - transportation cost goes up, the spot price of the refined product goes up. Then refineries, like planes, have periodic shut-downs for scheduled maintenance which reduces refining capacity and drives up the cost of the finished produce while crude may actually decline due to reduced refining capacity. Of course, there the unexpected shut-down too - remember Katrina and the damaged refineries?

Refining is itself an interesting process. It's not like a refinery can turn crude into gasoline one week and diesel the next - each barrel of crude produces so much of each of a range of products. So if a refinery wants to increase production of gasoline, like normally happens in the spring, it has to refine more crude and get more of each of the range of products. Some products are almost interchangeable at the refinery level though, like diesel/heating oil/fuel oil/jet fuel. So producing more heating oil in the winter means producing more gasoline, which may not be desirable at that time of year, OR cutting production of the other interchangeable products and the latter can drive up the cost of those other products that have relatively constant demand - like jet fuel.

Jim

[USA320Pilot]

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