Fuel price risk management using futures

Abstract

The primary objective of this study is to investigate whether an ongoing policy of hedging jet fuel price risk using heating oil futures contracts reduces the volatility of quarterly pretax income of an average major airline in the US. The results indicate that, after controlling for trend, seasonality, and persistence of shocks, hedging has the potential to reduce the unexplained volatility of the average airline’s quarterly income by over 20%. Thus, the results suggest that the usefulness of hedging is not restricted to protecting weak airlines incapable of withstanding an increase in fuel prices. Also, airlines should not eschew hedging merely because of the possibility of incurring opportunity costs if fuel prices go down rather than up; hedging appears to pay off in the long run by providing a more stable earnings stream. Further, the results also point to the importance of selecting an appropriate futures contract and timing the hedging transactions properly.