To what extent are commodity futures used by airlines?

Discussion in 'Archived Threads 2001-2004' started by Brian Perry, Mar 25, 2003.

  1. Brian Perry

    Brian Perry Cinematographer

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    As I dabble in the futures business, I'm a bit embarrassed not to know the answer to this question, but how much do airlines use commodity futures to lock in fuel costs? None? A little? Extensively?

    A little background for commodity futures novices...

    A futures contract is an agreement to buy or sell a predetermined amount of a particular commodity at a future date (hence the name). For example, at the Chicago Board of Trade, agricultural commodities such as wheat, corn, oats, and soybeans are traded in increments of 5,000 bushels per contract. If a farmer sells one September corn futures contract, he is entering into an obligation to sell 5,000 bushels of corn in September at a certain price. Farmers use futures to lock in current prices for their crop (which hasn't been harvested yet) and to prevent huge price swings. While the price of corn could go up before September delivery, the farmer who sells the futures contract today is giving up those potential gains for the peace of mind of not having to worry about falling prices. He's locked in. The main reason your Corn Flakes don't cost $2 per box one week and $6 the next is due to the futures markets.

    In addition to agricultural commodities, there are futures contracts traded in almost every conceivable product: currencies, gold, pork bellies, orange juice (remember Trading Places? [​IMG]), etc. Which brings us to a popular contract, crude oil.

    Right before the current "situation" in Iraq, crude oil futures reached almost $40 per barrel. The airlines did their usual crying about how the higher prices would hurt their already precarious financials. However, in recent weeks, the price of crude oil futures has gone done to the low 20s, and that's including contracts with delivery going all the way out to 2004 and beyond.

    Of course, you don't hear United or American saying how they will save many tens of millions based on these lower prices. My question is, do airlines (and to a lesser extent, companies with high fuel costs, such as UPS) buy crude oil futures to mitigate some of the volatility in the oil markets? It would seem that the prudent thing to do is lock in lower prices via the futures market and insulate yourself from some uncertainty. However, I can also see how in a competitive marketplace it may not be in United's best interest to have overall smooth pricing. If other carriers buy their fuel on a more short-term basis and the price is very low, they would be able to offer better prices than United. (Of course, this strategy would backfire if something happened to spike the price of oil.)

    I believe some companies have experimented with having a base price and then adding a fuel surcharge based on the current price of oil, but I was wondering to what extent airlines use commodity futures to smooth out their fuel costs.
     
  2. ken thompson

    ken thompson Second Unit

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    I'm sure the airlines use futures extensively. And, by the way, "dabbling" in futures is not a smart thing to do.
     
  3. Philip_G

    Philip_G Producer

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    airlines future quite extensively in fuel. The larger airlines make quite a lot of money selling their futured fuel to other airlines for profit. I can't remember the specifics (it's been over 2 years since I took the class) but in a lot of cases they make more off fuel and cargo than they do revenue passengers. The class I was in we had to decide to contract for fuel at a set price, or to go market value and pray the price goes down. With this extended up turn in pricing that wouldn't be terribly effective, I know it's quite a lot more complicated in the real world however.
     
  4. Chris Lockwood

    Chris Lockwood Producer

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    Funny how they use futures to control their cost, yet it seems every time the price of oil goes up, they raise fares right away.
     
  5. Seth_S

    Seth_S Second Unit

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    I remember reading that airlines have to sell something like 80% of the seats on a flight just to break even, and that's why they are always over booking flights.
     
  6. CameronJ

    CameronJ Stunt Coordinator

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    Brian,

    I know with relative certainty that United is not currently, and has not been recently, hedged.

    I've heard some folks chalk it up to the bankruptcy situation, but I'm not sure of the real reason.

    I'm pretty sure that Continental and American are currently hedging, but I'm not sure to what extent.

    The WSJ had an article about 2 - 3 weeks ago on this subject.
     
  7. Philip_G

    Philip_G Producer

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    seth-
    no, I would consider a 75% load factor a fantastic average, if it could be maintained.
    Flights are overbooked simply because a calculated percentage of people miss flights, an empty seat is revenue lost. You have to also consider that an airline seat is the most complicated product in the world to price, it is perishable, but interchangeable with anyone else, to most people a seat that goes from A to B is the same regardless of the airline. An efficient airline can take off with 10 passengers, but at max gross weight with cargo, and make money. Any payload not taken by pax's should be used for cargo (which pays more anywho, as they say, boxes dont bitch [​IMG] )

    cameron- AFAIK NWA is the big dog in hedging. But again it's been a few years..
     
  8. Seth_S

    Seth_S Second Unit

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    That's my point.
     
  9. Philip_G

    Philip_G Producer

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    but you stated the "have to sell %80" that isn't the case. Even during the boom a few years ago, a mid 70% load factor would have been considered pretty good. The can certainly be profitable on much less. 0% if it happens to be an EAS contract hehe.
     

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