Background On Jet Fuel Volatility
The average cost of a barrel of jet fuel fell 6.6pc last week to $179, but that was still $80 (£60) more than a barrel of crude, according to IBA Insight. In normal times, the so-called oil crack spread is below $20. The catch is that the recent surge in jet fuel prices has already pushed some airlines over the edge, with two folding in the past fortnight alone. On closer reading, it becomes clear that the key to survival lies in the use of financial hedging instruments and risk management strategies.
How Financial Hedging Instruments Work
Carriers lacking the financial clout to invest in fuel hedges – financial instruments used by the industry to guard against soaring kerosene prices – are most at risk from the squeeze. But even major operators are feeling the pinch as the annual slump in revenue coincides with the unwinding of hedges taken out before the start of the Iran war. Dan Taylor, IBA’s head of consulting, said that even with crude oil prices easing, the figure was “probably a best-case scenario”. Follow the money, and it becomes clear that hedging is a crucial tool for airlines to manage their fuel costs.
The Numbers Behind Crude Oil Versus Jet Fuel
The numbers behind the surge in jet fuel prices are telling. The average cost of a barrel of jet fuel is $80 (£60) more than a barrel of crude. In normal times, the oil crack spread is below $20. But with jet fuel prices hovering close to record highs, the oil crack spread has blown out to $80 (£60). This has a direct impact on airline operating margins, with fuel costs accounting for around 40-50% of their operating costs, according to estimates cited in industry reports.
What Current Price Environments Mean For Airline Operating Margins
The current price environment is particularly challenging for airlines. With fuel costs accounting for around 40-50% of their operating costs, the surge in jet fuel prices has put a significant squeeze on operating margins. The extension of the 7% VAT rate on jet fuel in Maharashtra until April 2027, for example, is a welcome relief for airlines operating in the state. But for European carriers, the key to survival lies in their ability to hedge against volatile commodity price swings. As the annual fuel bill reaches €9.3bn (£7.9bn) for German giant Lufthansa, it is clear that hedging is a crucial tool for managing fuel costs.
As airlines continue to grapple with the challenges of surging fuel costs, the ability to hedge against price volatility will be crucial to their survival. The mechanics of hedging are complex, but the outcome is clear: for European carriers, hedging is a vital tool for managing fuel costs and protecting operating margins.
Sources
- The £12bn fuel bill threatening to down Europe’s airlines
- Jet fuel
- Montco jet fuel spill: Air monitors have not detected elevated toxins
- Europe risks running short of jet fuel in a major war, NATO study says
- Aviation Fuel Prices: National Averages
- Maharashtra extends 7% VAT on jet fuel until April 2027, offers airlines more cost relief – CNBC TV18
Photo: NOAA / Unsplash (Unsplash License)
