Making Fuel Hedging a Meaningful Strategy - The Case of Airlines

Abstract

Financial risk management, particularly fuel hedging plays a vital role in the corporate strategy of firms that heavily rely on oil/jet fuel as an input. This paper aims to re-examine risk management theories and managerial practice for airlines and investigate if hedging is indeed a meaningful strategy for enhanced profitability whilst being exposed to volatile market environments. A sample of 90 international airlines over five fiscal years was used to inspect the impact of hedging on airlines’ profit margin, profit margin volatility, operating costs, leverage and change in capacity. Our results show that fuel hedging was significant in decreasing profit margin volatility but insignificant in changing profitability and operating costs. This suggests that fuel hedging is an efficient strategy to mitigate the risk of volatility; however, it cannot be used as a speculation mean to generate profits. In contrast, Passenger Load Factor is significant in increasing profit margins and reducing operating costs, which suggests that operational hedging is an important integral part of profitable strategy. We conclude that the combination of financial and operational hedging can be used for gaining/maintaining a competitive advantage and enables airline management practice to achieve sustained financial performance.