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Airline Fuel Hedging Programs

Summary Overview

The three airline companies in the articles face challenges concerning the logistics of fuel; thus, they focus on the use of fuel hedging programs. It is documented that Southwest Airlines has been posting impressive results. Fuel contract issues made the firm record losses in its third and quarter results of 2008 after oil prices decreased. China Eastern Airlines suffered huge losses to the tune of about $1 billion in 2014 after its fuel hedging strategy backfired. Analysts expected the company to continue suffering from the losses since a significant portion of its derivative contracts would expire in 2011 (Liu & Jones, 2016). Delta Air Lines has reacted to the challenges of sourcing for fuel by purchasing an oil refinery plant, which is intended to enable the company to realize remarkable savings as well as huge profits in the long run. Since this is the first firm to utilize the approach, observers are unclear about the economic sense of the acquisition. Many analysts state that lower fuel prices might negatively impact Delta Air Lines, and it would have been a better idea for the business to pursue a hedging method (Manuela Jr, Rhoades, & Curtis, 2016).

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Procurement Methods and Evaluation

Although Delta Air Lines posted a relatively lower adjusted fuel price in comparison to American Airlines, fuel costs were estimated to be higher because of increased rates of consumption and fuel hedging program losses. It is important to note that its fuel price was the same as the pre-refinery cost. Besides, the refinery is not equipped to handle renewable fuels; thus, the business buys renewable energy credits, a scenario that adds more expenses to the strategy. Increased rates of fuel consumption were critical internal considerations relevant for fuel hedging by the firm.

The contracts that China Eastern Airlines has signed with an international financial institution put it into a position that has more risks than benefits. The hedging strategy does not establish a balance between cost decreases and anticipated obligation; thus, putting the business into a scenario that could have remarkable risks. It appears that the corporation’s management did not pay attention to the chances of price variations, a purely internal consideration, and their consequences (Liu & Jones, 2016).

Although the hedging program adopted by Southwest Airlines exposed the firm to significant risk during economic upheavals, the program was the most successful among the three since it enabled the corporation to post remarkable profits for several years before there was a global economic slump. Regarding its success, these factors were most notable: prudent management, generally high global fuel prices, and firm optimism. However, risk factors could negatively impact the company to a substantial level if the market takes an unexpected direction. That notwithstanding, the view of achieving fuel cost advantage is biased for loss prevention purposes, and the predisposition is perceived in the assumption that the hedged price would be relatively low in comparison to the market price, which is a factor that requires external consideration (Liu & Jones, 2016).

Lessons

A few lessons can be taken from the three case studies. First, senior management teams of airline companies face the challenge of rapidly changing fuel prices, which they should handle to realize impressive commercial results in the short and long runs. Second, from a technical perspective, the Southwest and China Eastern Airlines case studies show that flexibility is an important factor for any successful implementation of hedging. Third, in a strategic sense, although risk management may result in value addition, a biased view concerning risk management might lead to harmful results. Airlines will most probably continue to use fuel hedging programs in the coming months and years because some have proved beneficial in the past as described in the three case studies. After Southwest Airlines and China Eastern Airlines implemented their fuel hedging strategies, the two firms recorded remarkable fuel savings as well as profits. That notwithstanding, the programs also backfired at some point in time, and the management teams of the two companies could do little to change the situation (Liu & Jones, 2016).

References

  1. Liu, C. Y. A., & Jones, K. J. (2016). Integrated risk management on fuel hedging program: A case study on Southwest and China Eastern Airlines. Academy of Business Research Journal, 2(3) 74-85.
  2. Manuela Jr, W. S., Rhoades, D. L., & Curtis, T. (2016). An analysis of Delta Air Lines’ oil refinery acquisition. Research in Transportation Economics, 56(1), 50-63.

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