Fuel Hedging a Strategy for Air Carriers to Combat Fuel Hike

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Fuel Hedging
A Strategy for Air Carriers to Combat Fuel Hike


Jet Fuel – The Nemesis of Airlines

In the year 2008, the growth of global aviation industry received a major bolt from the fear of global economic slowdown and the rise in crude oil prices. Though the global economic uncertainties impacted the business of airlines, but the steep surge in crude prices has changed the financial equations of the airline across the world, with India being no exception.

In fact over the previous ten months crude prices have increased over 80 percent, from nearly $80 per barrel in October, 2007 to $147 per barrel in June, 2008. A similar increase was seen in the case of Arabian Gulf Jet prices. As per the figures released by IATA (International Air Transport Association), fig. 1, the price of Jet Fuel, as on 1st Aug’07, has increased by 314.5% since 2000, and almost 70% since August last year. IATA has forecast the loss in aviation sector to be nearly USD 2.3 billion (more than 9500 crores) in 2008.

|1-Aug-08 |

Fig. 1

Aviation Turbine Fuel more popularly known as ATF or Jet Fuel, continues to be the single largest cost factor for airlines constituting nearly 40 per cent of the total operating costs. Hence as ATF prices start to increase, airlines typically respond by raising fuel surcharges. Only Rs. 225 of the surcharge is payable to AAI (Airports Authority of India); the balance goes to the airlines.

In the past six months alone, fuel surcharge has increased from nearly Rs 950 to Rs 2,350. That’s nearly an increase of 150%. Considering a basic fare of Rs 1,000(say) and other charges being constant, cost of flying has nearly doubled. That is deterring the low and middle income group travelers who were beginning to switch to air travel mode from traveling by railways.

The rise in crude prices is hurting both high end carriers and low cost carriers as the decline in the number of passengers has affected the load factor. The load factor for Indian carriers has come down during June-July period. Further increase in ticket prices, which is inevitable if the fuel prices rise further, can devastate the future plans of airlines.

Reasons for Rise in Fuel Prices

Demand Outstrips Supply

According to the experts, the demand for crude oil is directly related to the world GDP growth. During the last few years, the developing countries like India and China have seen tremendous growth, and hence accelerated the demand for crude oil. Though the developed countries have also seen growth, but the increase in the buying power of people is higher in developing countries. Although the demand has surged but the supply side has not seen much change. The oil reserves are more or less same and producing same amount of oil. This mismatch in demand and supply has been the most prominent factor behind the crude prices rally.

OPEC Control

The Organization of Petroleum Exporting Countries (OPEC) is an organization of eleven developing countries that are the major exporter of crude oil across the globe. OPEC controls almost 40% of the world’s crude oil. It accounts for almost 75% of the world proven oil reserves. OPEC yields power to disturb the supply-demand equation by squeezing the supply side, and it has even been observed in the past that OPEC countries have reduced the supply of oil to increase the prices.

Speculative Buying and Selling

A lot has been debated over the trading of oil futures in the commodity exchanges around the world. The OPEC countries, to shift the blame, criticize that speculation causes the prices of commodities like fuel to rise beyond expectation. Cartelization and hoarding of oil are said to be responsible for such irrational increase in the crude prices.

Possible Measures

The factors that control the prices of crude oil are all external to aviation...
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