How do you hedge against fuel prices?

How do you hedge against fuel prices?

To protect themselves, and sometimes to even take advantage of the situation, airlines commonly hedge their fuel costs. They do this by buying or selling the expected future price of oil through a range of derivatives, thus protecting them from rising prices.

How does a fuel hedge work?

A fuel hedge contract is a futures contract that allows a fuel-consuming company to establish a fixed or capped cost, via a commodity swap or option. If such a company buys a fuel swap and the price of fuel declines, the company will effectively be forced to pay an above-market rate for fuel.

How is diesel traded?

Most diesel fuel moves by pipeline from refineries and ports to terminals near major consuming areas. Barges and trains also move diesel fuel to terminals. Trucks transport the diesel fuel from the terminals to retail service stations and to large volume consumers such as vehicle fleet operators.

What is a fuel swap?

A swap is an agreement whereby one party exchanges their exposure to a floating (often referred to as spot, index or market) fuel price for a fixed fuel price, over a specified period(s) of time.

Can you buy diesel futures?

As this example indicates, purchasing a ULSD futures contract provides you with the ability to hedge of fix your anticipated diesel fuel costs for a specific month(s), regardless of whether the price of ULSD futures increase or decreases between the date that you purchased the futures contract and the date the futures …

How do refineries hedge?

In order to mitigate their exposure to crack spread price volatility, many refiners hedge the crack spread by purchasing crude oil futures or swaps and simultaneously selling refined products futures or swaps as the results allows the refiner to lock-in or fix the refining margin.

Does fuel hedging make economic sense?

The results show that jet fuel hedging is positively related to airline firm value. The coefficients on hedging indicator variables in regression analysis suggest that the hedging premium constitutes approximately a 12-16% increase in firm value.

How do you hedge bunker fuel?

Traditionally, most bunker fuel consumers hedge with fixed price swaps, call options and costless collars. While all three instruments are generally acceptable hedging strategies, they each have their drawbacks. In the case of fixed price swaps, they present potential losses if prices decline.

What is diesel hedging?

In essence, it is an agreement whereby the buyer and seller of the swap exchange their floating price exposure for fixed price exposure and vice versa. The product is called a “swap” because the buyers and sellers of the swap are “swapping” their cash flow exposures.

Where is most diesel refined?

Most of the diesel fuel produced and consumed in the United States is refined from crude oil at petroleum refineries. U.S. petroleum refineries produce an average of 11 to 12 gallons of diesel fuel from each 42-gallon (U.S.) barrel of crude oil. The United States also produces and consumes biomass-based diesel fuels.

What is basis risk in hedging?

Basis risk is the potential risk that arises from mismatches in a hedged position. Basis risk occurs when a hedge is imperfect, so that losses in an investment are not exactly offset by the hedge. Certain investments do not have good hedging instruments, making basis risk more of a concern than with others assets.

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