An Open Letter to All Airlines - Quit Whining and Hedge Your Fuel Costs 29 comments
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I received an email from United Airlines (UAUA) today, "An open letter to all airline customers" was the subject line. In it, they bemoan the fact that speculators are a larger percentage of traded contracts than years before and that they believe the speculators are responsible for driving up the price of oil, and thus their fuel costs. Look in your junk email box and you probably received it as well.
There has been a lot of debate over this recently, but as outlined in the WSJ a couple days ago, commodities speculators aren't dealing in the underlying, just the cash settlement difference of the futures contracts. Unless there has been significant hoarding or some other tangible change in the supply or demand for the commodity, speculators, and hedgers for that matter, don't materially affect the underlying price. If prices are getting too disconnected from fundamentals, then other speculators will come in and short contracts, driving the price to equilibrium.
In futures markets, there are only 2 types of participants - hedgers and speculators. Another category might be called "investors", since many have noted that a lot of institutional money has moved into the market, to capture asset class exposure, but that begs the question whether commodities are truly assets, since they don't pay any dividends, interest or generate earnings. In a sense, these institutions are speculating that the commodities will generate a real return over time, which is debateable.
Typically speculators buy from hedgers, or other speculators betting against them. The airlines missed the boat by not buying oil futures and thus hedging their fuel costs. Of course Southwest famously did and has reaped tremendous benefits for it. Few other industries have such an overwhelming exposure to a potentially hedgeable cost as the airlines and oil. The admonitions should be towards the airlines who didn't manage their businesses prudently, and we're all paying for that - not from what the speculators are doing.
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This article has 29 comments:
Also, who wants to hedge at $147/barrel. I'm sure SWA isn't hedging here either.
Each company has its model to make money and each model is not necessarily similar of it's peers (sometimes completely different of it’s . If companies don’t understand very, very well the impacts of costs/income during periods of time, they are speculating in things they are not specialized in….when you play hard ball with a pro….i prefer to bet on pros and short your incapacity.
When management fails to decide about hedging variable cost or variable income policies, leaving extreme important decisions to god, invisible hands or simply leaving decisions to a one on one situation without treating the matter uncovered (by the management, board and important investor pre-tested/decided approach), it´s legitimate specs to short this companies as they know (good bets) they will suffer and suffering is blood smell for specs.
Incapacity of developing hedging strategies to defend the interest of investors against market oscillations is one of major threats of capitalism.
Models are designed to mitigate risk not directly related to the core businesses of companies.
Good controvertial subject Dan. Cheers from Brazil!!!
A solid company with a very bright future as the others drop by the wayside.....
I sometimes believe the public thinks they should be able to get on a plane and fly 800 miles and pay almost nothing. A typical 2 engine jet will burn approx 4700 gallons of fuel to make that trip, thats right 4700 gallons. So do the math when you have 400-500 airplanes in your fleet and in the air on average about 8hrs a day that fuel bill adds up. I don't know who is to blame but it amazes me that if somebody hiccups in the Mideast the oil price per bbl will spike.
I believe southwest Airlines glory days are number due to this problem and by the way Airtran Airlines is taking action now by cutting employees wages by 10% and deferring delivery of aircraft and they are also a low cost carrier like Southwest. Its obvious this is affecting all airlines.
On July 15, esw wrote:
Can anyone point to a reputable economist (other than the Air Transport Association's) who will credit speculation for a substantial share of the current per bbl price of oil?
Speculators are the "life blood" of any derivative market, providing liquidity, price discovery, and viability for hedgers. Sure, sometimes in markets speculators drive prices up, but other speculators come in, as I mentioned in the post, and sell to the buyers believing the fundamentals don't justify current prices. Remember, someone has been selling to the speculators all the way up - who will be crying for their heads when they make big profits when (if) oil prices decline?
Again, the bogey man isn't functioning markets, with speculators and hedgers, it’s the underlying supply/demand fundamentals and myriad other economic dynamics that affect the price of oil (and all commodities). If I was to concede any restrictions to the marketplace, I would consider raising the margin requirements on contracts, to reduce some of the leverage involved, which we've seen to be the essence of the troubles in the housing market.
I can't reply to all, but in general, I thank you for posting your replies and spurring discussion. Let's all hope for lower oil prices, and perhaps lower airline fares as well.
1) Welcome to Seeking Alpha, Vice President Quayle.
2) Please offer proof of, or otherwise make a reasonable case for, the speculative element you allege.
You may have missed the fact that the "open letter to passengers" was signed by ALL of the U.S. airlines including your beloved Southwest, who in particular will cease to exist if these oil/fuel prices don't come down soon. Southwest's gamble on fuel hedging is now quickly expiring and when these "new" fuel costs kick in, Southwest's budget fliers will not be able to afford the "luxury" of flying. This is critical for ALL the airlines as well as this country. This isn't whining, this is very, very real. You should be very, very afraid for what Wall Street and this Administration are doing to this country and it's "blue collar" citizens.
Hindsight or foresight, It takes plenty of garbanzoes to hedge!!!!
On Jul 14 09:00 PM DanK wrote:
> Wow - what an onslaught of replies from all ends of the spectrum.
> First, I want to make it clear that my post was not as much an indictment
> on the airlines for not hedging their fuel costs (which in hindsight
> or foresight would be a wise business decision - oil prices have
> been volatile for years), but to chastise the industry for blaming
> "speculators"... for their ills and the recent run up in oil prices.
>
>
> Speculators are the "life blood" of any derivative market, providing
> liquidity, price discovery, and viability for hedgers. Sure, sometimes
> in markets speculators drive prices up, but other speculators come
> in, as I mentioned in the post, and sell to the buyers believing
> the fundamentals don't justify current prices. Remember, someone
> has been selling to the speculators all the way up - who will be
> crying for their heads when they make big profits when (if) oil prices
> decline?
>
> Again, the bogey man isn't functioning markets, with speculators
> and hedgers, it’s the underlying supply/demand fundamentals and myriad
> other economic dynamics that affect the price of oil (and all commodities).
> If I was to concede any restrictions to the marketplace, I would
> consider raising the margin requirements on contracts, to reduce
> some of the leverage involved, which we've seen to be the essence
> of the troubles in the housing market.
>
> I can't reply to all, but in general, I thank you for posting your
> replies and spurring discussion. Let's all hope for lower oil prices,
> and perhaps lower airline fares as well.