Ever wondered how airlines remain profitable despite India's high fuel costs? Fuel prices have a greater role to play in the overall operational costs of any airline company in India. In the total of any airline�s operational costs, it constitutes an average of 30%-40% costs of oils.
These airline firms use various fuel hedging strategies to cope with the high fuel price in India and lower their fuel risks. Let�s understand what fuel hedging is and how airlines incorporate various hedging strategies into their business model.
What Does Fuel Hedging Mean for Airlines?
Fuel hedging is a technique that allows you to predict the future price of fuel and buy the fuel at that current price but opt for delivery in the future.
Technically, you�re buying the fuel for the future predicted price and if the predicted price does touch the mark at the time of delivery, you�ll get the profit. This price predicted can be either higher or lower than the current market price.
Fuel Hedging: Securing Future Fuel Prices and Managing Financial Risks for Airlines
Some of the aspects of fuel hedging are
Airlines use fuel hedging to protect themselves from paying higher fuel prices in the future.
Fuel hedging requires analysis and strategic planning, but there is a risk of paying more if fuel prices decrease.
Hedging helps airlines manage the fluctuating and rising oil costs, which can impact their operations and financial strategies.
Hedging plays a crucial role in determining future fuel prices and acts as a fuel risk management tool in India.
Fuel hedging does not guarantee profits as it depends on the market, so airlines do not hedge all their fuel contracts.
Airlines should be aware of the potential consequences if the market behaves differently than anticipated.
Hedging Techniques Used By Airlines
Multiple ways in which airlines hedge fuel prices to reduce their costs are:
Futures - Buying Fuel Contracts At the Current Market Price for Future
Most airlines use this hedging strategy to combat rising fuel prices in India in the future. The airlines believe that the fuel price in India will rise and thus enter into a buying contract with another party in the opposition.
The company purchases bulk current oil contracts for the future to eliminate the risk of paying higher prices for the same quantity of oil in the future.
Options - Buying Call Options for Set Fuel Prices
Buying a call option enables the airlines to buy the fuel at a specific price before a specific date. This means the airlines have the right but not a compulsion to purchase the fuel at set prices.
If the prices rise, the airlines have the right to buy the fuel in the future but at a price agreed upon on the date of buying the call options and hedging the position. It is considered less risky since in case the future fuel price in India drops, the airlines only lose their premium amount and won�t have to bear other losses.
Swaps - Right and Obligation to Purchase Fuel at Set Prices
Similar to call options, swap contracts are the ones that allow the airlines to enter a contract with sellers to purchase fuel at set prices on a specific date.
Upon entering swap contracts, the airlines attain the right and must buy the fuel at agreed-upon prices. If the fuel price in India goes opposite the prediction, the company will have to bear all the applicable losses.
Various other hedging strategies are implemented by airlines across India to combat the rising oil prices and maintain their financial graph.
Over-the-Counter (OTC) Derivatives - Privately Negotiated Financial Contracts to Mitigate Fuel Price Fluctuation Risk.
Airlines may negotiate customised derivative contracts with financial institutions or counterparties. Compared to conventional exchange-traded instruments, these OTC derivatives offer more flexibility and customisation since they may be tailored to meet the specific risk management needs of the airline.
It's crucial to remember that different airlines have different hedging strategies, and their levels of fuel price hedging can vary. Some airlines may hedge a significant portion of their fuel consumption, while others may hedge only a portion or not.
The decision to hedge fuel prices is based on several factors, including the airline's willingness to take risks, the condition of the market, and their perspective on fuel price fluctuations.
Rising fuel price in India has been a concern for everyone, including the airlines that bear the maximum fuel costs when we talk about their operational stats. The daily fluctuations in fuel prices can be frustrating, and there�s nothing much that can be done about it.
But the hedging strategies act as a profit protection tool and help them reduce their fuel risks if used wisely or can also turn the game around in some cases.
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