Is jet fuel hedging in the airline industry valuable? A case study of Southwest Airlines and Deutsche Lufthansa

Gjest Andreas Breistein

Student thesis: Master thesis

Abstract

This thesis seeks to give an educated understanding of whether commercial airlines should hedge their jet fuel price exposure. The initial part gives a short overview of the jet fuel price hedging in the airline industry. This part briefly illustrates how and why jet fuel price hedging can be a value adding activity for airlines by explaining the theory of financial hedging and how energy prices together with the cyclicality of the industry effects the value of hedging. Further the performance of Southwest Airlines and Deutsche Lufthansa which both have extensive hedging programs have been investigated. Their operational and financial performance together with their financial risk management activities have been studied in order to determine how these different aspects influence each other. Even though these two companies are significantly different in most ways, they are both very well operated and they have incorporated risk management, both operational and financial, throughout the entire organization. But despite that both airlines have extensive financial risk management programs; their underlying motivation seems to be quite different. It appears that Southwest is more motivated by hedging gains that helps the airline maintain their low fares. Lufthansa’s jet fuel hedging is to a stronger degree founded on the positive effects of knowing what the airline has to pay for its jet fuel. Subsequent to the analysis of Southwest Airlines and Deutsche Lufthansa, the theoretical and practical incentives of financial risk management are explored. In this section the findings from previous research on financial risk management is compared with the risk management practices of the two airlines. It reveals that jet fuel price hedging not necessarily is a value adding activity disregarding whether or not the hedges contribute with positive or negative cash flows. How jet fuel prices correlates, positively or negatively, with the level of activity in the commercial aviation industry will have severe effects on the value of jet fuel price hedging. The next part is a brief introduction to the practice of hedging commodity prices with different types of derivatives. This is a concise follow-through of the different aspects one has to consider when hedging commodity prices. Airlines who want to utilize financial commodity markets while minimizing the probability of losses need thorough knowledge about these markets. To end with, the characteristics of the crude oil and jet fuel prices and their implications for the airline industry are examined. This chapter is an extension of the previous one and is supposed to provide additional knowledge about the challenges of jet fuel price hedging. The two last sections give the reader an educated understanding of how some airlines have been able to utilize the commodity markets better than others.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2009
Number of pages73