Wednesday, August 04, 2004

Hedging: It’s good for you and good for your company

European Airlines Review Hedging As Oil Prices Rise: "Already grappling with stiff competition and deep cost cuts following a slump in global travel, rising fuel costs are the latest blow to the beleaguered industry"

Oil prices are at all time highs (in nominal terms) on both supply (OPEC said they could not pump much more at present) and demand (higher than expected) concerns. Now I am guessing you have heard that from a zillion places. And moreover, I would wager that you probably expected oil prices to fluctuate. So is it just me who is angry every time airlines (this time it was American Airlines) complain about the price of fuel.

Why? They can easily be hedging this risk.

While hopefully their CFOs are all subscribers to the FinanceProfessor Newsletter and read all about the good aspects of hedging when we reviewed the Simkins, Carter, and Rogers paper on airline industry hedging practices. The paper is so interesting we reviewed it a twice. First in 2001 and then again this past spring-the latter review is listed below. But maybe the executives missed those issues (spam filters being what they are and all).

So if they did miss that, and are still not reading this, maybe these constantly complaining executives may happen to have heard of a firm called Southwest Airlines ;) The low cost airline from Texas recently named Gary Kelly as their new CEO. Kelly, an accountant who was formerly the CFO, is probably most famous for his hedging of jet fuel. How well did he hedge? The firm is reported to have locked in oil at $24 and $25 a barrel for much of the next two years. Remember current market price is over $44 a barrel! Gee, I bet that helped his reputation 
It is interesting to see the how other airlines (both in the US and abroad) are dealing with the high jet fuel prices. For instance, Ryanair had hedged much of their fuel only through October. When this fact was admitted, the stock price fell about 3% on volume that was twice its average. “Scandinavian airline SAS plans to announce next week it has decided to resume hedging after being left exposed since the first quarter, while Swiss International Air Lines faces more potential losses after selling hedges to boost cash reserves.”

I will concede that there is truth to the claims that hedging long term risks is more expensive for firms with high financial risks, but the added cost is not a good excuse! So get out there and hedge! You too may end up as CEO.


Articles on Southwest’s hedging,1,6498775.story?coll=hc-headlines-business

Article on other airlines hedging —VERY GOOD!

For complaints on high jet fuel prices:
From Reuters on July 31, 2004:
“``Record-high fuel prices and an intensely competitive domestic revenue environment have made the need for further cost-cutting all the more clear,'' Gerard Arpey, chief executive of American parent AMR Corp. (AMR), said earlier this month.
Continental Airlines (CAL) has said in recent months that fuel prices would add an extra $700 million in operating expenses this year, and it might have to lay off workers as a result.
``The current revenue and fuel environment have overwhelmed our efforts to return to profitability, and we now must achieve significant additional cost reductions,'' Continental CEO Gordon Bethune said when the airline released its quarterly earning in July.


From the January 13, 2004 FinanceProfessor newsletter:

My chairman Jeff Peterson complained recently that academic publications travel at "glacial speed". The paper is by Simkins, Carter, and Rogers and looks at hedging in the US Airline industry is one such paper. It really is one of my favorites. I saw it presented a few years ago and I thought it was close to publication then, but I guess the glacier has not yet completed its journey as the paper was presented at this year's AFAs. Their findings? Hedging does create value. Using regression analysis, they report that hedging increases firm value by over 10%! How? One hypothesis is that hedgers can better afford to maintain capital spending when jet fuel prices climb. This view is supported by their finding that there is a "positive relation between hedging and…increases in capital investment."

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