Airline Volcano Losses

[robcaro]

News says that Airlines have losses of 1 Billion Dollars. But, it doesn't say anything about Gains from not using fuel. What say ye about that?

[Machine Elf]

? The airlines don't gain anything from not using fuel.

[wmfellows]

News says that Airlines have losses of 1 Billion Dollars. But, it doesn't say anything about Gains from not using fuel. What say ye about that?

I'd say that the observation is irrelevant as losses announced are doubtless net losses, and the minor gains relative to fuel non-use are clearly going to be swamped by fixed costs such as maintenance, salaries, interest and principal payments on equipment, etc. etc. etc.

[ivan astikov]

Yes, but in a spot of good news on the cloudy horizon, boat fares have doubled.

[IAmNotSpartacus]

? The airlines don't gain anything from not using fuel.

Sure they do, they gain the benefit of not having to spend the money.

For example, it's been said that here in LA County, if the bus drivers went on strike, that it would save the County $20 million a day. Of course, that's American public transit, where the concept of "profit" through "farebox recovery" is a pipe dream, but since none of the major airlines have made much money in the last couple years, I think the point stands.

[Sailboat]

Of course, that's American public transit, where the concept of "profit" through "farebox recovery" is a pipe dream

Does any public transit operate entirely through fares, without government subsidy?

[Si Amigo]

One main benifit may be that people in the States will most likely want to vaction closer to home this summer rather than risk making plans to go to Europe, providing a boom for local routes.

[wmfellows]

Sure they do, they gain the benefit of not having to spend the money.

The benefit is not spending money on ONE variable factor. There are a good bloody number of fixed costs (and to an extent variable costs not easily change in near term if one wishes to be ready to start up in short term) that definitely counter-weigh fuel savings. And of course no revenues.

A public transport system is not a good analogy at all.

[IAmNotSpartacus]

Does any public transit operate entirely through fares, without government subsidy?

What airlines operate without government subsidies? Especially here in the US? Are you under the impression that the airlines pay for traffic control, airports, etc? Are we forgetting the handouts the airlines got a few years ago when they pretty much all went bankrupt (again)?

[JoelUpchurch]

Does any public transit operate entirely through fares, without government subsidy?

There are some profitable systems in Japan, Hong Kong and India, but I don't know of any in North America or Europe.

http://www.demographia.com/db-htld-rail.htm

[IAmNotSpartacus]

Does any public transit operate entirely through fares, without government subsidy?

Yes, see this thread for more info: http://boards.straightdope.com/sdmb/showthread.php?t=551561&highlight=farebox+recovery

ETA: Just not in the US...

[JoelUpchurch]

What airlines operate without government subsidies? Especially here in the US? Are you under the impression that the airlines pay for traffic control, airports, etc? Are we forgetting the handouts the airlines got a few years ago when they pretty much all went bankrupt (again)?

Technically speaking the passengers pay for these things with the fees added on to their tickets. Ultimately all the costs come from passengers, since their fares also pay the landings fees and fuel taxes. They buy the over priced food and merchandise and parking from the airport concessions.

Airlines aren't being heavily subsidized by the non-flying public in the United States. It may be different in other countries where the government owns the airline.

[crazyjoe]

News says that Airlines have losses of 1 Billion Dollars. But, it doesn't say anything about Gains from not using fuel. What say ye about that?

I'd say any airline worth flying on is probably not buying fuel on the spot market, but instead buys fuel futures at a reduced (usually) rate, and is thus locked in to a certain minimum fuel purchase. I'd hazard a guess that they aren't really gaining anything by having a bunch fo fuel inventory they are unable to use.

[Triskadecamus]

If they are sophisticated enough to buy their needed fuel on the futures market, they are probably sophisticated enough to sell their surplus fuel on the spot market, and make a profit at it.

Tris

[drachillix]

Sure they do, they gain the benefit of not having to spend the money.

Almost no business that is unable to operate at full capacity is making money, the fixed costs for loans, buildings, ancillary personell, etc still exist and they depend on the income from customers to cost justify their existence.

For comparison, on a more personal level, its kind of like saying its like getting suspended from work without pay, and someone pointing out how you are saving on gas and wear & tear on your brand new car from not going to work, the car you still have to make payments on.

[Xema]

Are you under the impression that the airlines pay for traffic control, airports, etc?
I'm definitely under the impression that they pay significantly for airports, through landing and terminal-use fees, taxes on fuel, etc.

[Xema]

since none of the major airlines have made much money in the last couple years, I think the point stands.
As others have noted, for this to be the case, their fixed costs would somehow have to shrink during this volcanic ash no-fly period. Since these continue, and to them are in some cases added such things as paying for the accommodations of stranded passengers, the point fails to stand.

[Machine Elf]

If they are sophisticated enough to buy their needed fuel on the futures market, they are probably sophisticated enough to sell their surplus fuel on the spot market, and make a profit at it.

To whom?

[butler1850]

If they are sophisticated enough to buy their needed fuel on the futures market, they are probably sophisticated enough to sell their surplus fuel on the spot market, and make a profit at it.

Tris


I'm going to suspect that you've never worked in a futures driven industry. I once worked for a natural gas supplier, who purchased based on weather trends. The biggest fear they had was a warm day, where their loaded pipeline supply would be in excess. If their customers didn't need the gas, other potential buyers would also be using less, leading to a surplus on the spot market, driving prices lower. Often MUCH lower than they had purchased it. They had no choice but to sell it, at whatever price they could get.

In this case, the other consumers of jet fuel, are also experiencing problems, and are unable to fly to Northern Europe, and have the same problem. They aren't using fuel, so don't need what they have scheduled for delivery, and won't buy your surplus. I think the only one who could make out is someone with very empty tanks, or excess storage capacity... something that is generally lacking, due to the costs of maintaining excess capacity in the first place.

[Broomstick]

What airlines operate without government subsidies? Especially here in the US? Are you under the impression that the airlines pay for traffic control, airports, etc? Are we forgetting the handouts the airlines got a few years ago when they pretty much all went bankrupt (again)?

Technically speaking the passengers pay for these things with the fees added on to their tickets. Ultimately all the costs come from passengers, since their fares also pay the landings fees and fuel taxes. They buy the over priced food and merchandise and parking from the airport concessions.

Airlines aren't being heavily subsidized by the non-flying public in the United States. It may be different in other countries where the government owns the airline.
The US government does not directly subsidize airliners any more than it directly subsidizes trucking companies. However, the government (on levels from local to Federal) does subsidize quite a bit of the infrastructure required for the airlines to operate. Fees added to tickets do cover some costs of air commerce, but by no means all of them.

In the US the Federal government (by and large) pays for air traffic control (there are some private ATC towers, but I don't want to get bogged down in minutiae). The funds for that come from everyone's taxes, so in that sense yes, the non-flying public DOES "subsidize" the airlines. However, virtually everyone benefits from air commerce. Even if you don't fly personally, if anything you use travels by air freight you do benefit. That's the same reasoning why road maintenance comes out of a general fund, because even if you don't drive yourself you benefit from the existence of roads.

Not all airports have landing fees. That is a local decision. Local municipalities may choose to support an airport and not charge such fees in hopes of attracting more business.

As for the handouts "a few years ago" - that was in reaction to the post-9/11 airspace shutdown. If it had not been down major carriers would have ceased operation, further disrupting air commerce. The rational was that, overall, it would be cheaper to bail out the airlines than to deal with the economic hit that would occur if those airlines were permitted to go under for an event entirely out of their control. That same rationale is being used by European airlines right now, asking governments to help them weather this business disruption.

[IAmNotSpartacus]

Technically speaking the passengers pay for these things with the fees added on to their tickets. Ultimately all the costs come from passengers, since their fares also pay the landings fees and fuel taxes. They buy the over priced food and merchandise and parking from the airport concessions.
Technically speaking? I don't think you quite understand how 90% federal matches work, or that gate fees don't pay for air traffic control.

Airlines aren't being heavily subsidized by the non-flying public in the United States. It may be different in other countries where the government owns the airline.
You have absolutely no idea what you are talking about. Let me break it down for you.

Direct cash handouts (http://www.dot.gov/affairs/carrierpayments.htm).

Airports are generally built by municipal agencies. They are generally exempt from property tax. I'm not aware of any municipal airports paying property taxes, but they may be out there. People who do not use the airport are paying for its free ride.

Small airports are heavily subsidized so as to bring "air travel to the small guy." Did you know the DOT actually pays airlines to fly between rural airports, making the route profitable when the average passenger load is only 1/3 of the plane's capacity (or less)? This is called Essential Air Service (http://ostpxweb.dot.gov/aviation/x-50%20role_files/essentialairservice.htm). Feel free to peruse (http://en.wikipedia.org/wiki/Essential_Air_Service#Subsidized_routes) the list of routes and their annual handout. $170,000,000+ last year, I'd say that's a fair chunk of change, wouldn't you?


Civil Reserve Air Fleet (http://en.wikipedia.org/wiki/Civil_Reserve_Air_Fleet). Airlines are paid for having these aircraft "at the ready" (which they would have at the ready anyway, since they are in active service) whether or not they actually ever get used.

Federal exemption from anti-trust law.

Most importantly, federal protection from foreign competition. Surely you realize there's a reason that foreign airlines don't fly domestic routes, right? Do you think this lack of competition somehow benefits consumers with lower prices or something?

[IAmNotSpartacus]

The US government does not directly subsidize airliners any more than it directly subsidizes trucking companies. However, the government (on levels from local to Federal) does subsidize quite a bit of the infrastructure required for the airlines to operate. Fees added to tickets do cover some costs of air commerce, but by no means all of them.

Really? Can you find me some trucking companies that receive direct cash payments from the government? Or loan guarantees?

[IAmNotSpartacus]

As others have noted, for this to be the case, their fixed costs would somehow have to shrink during this volcanic ash no-fly period. Since these continue, and to them are in some cases added such things as paying for the accommodations of stranded passengers, the point fails to stand.
Let's look at American Airlines income statement from last year, you will need to review the latest 10-K report filed with the SEC and then view the income statement.

~$20 billion in revenue.

~$6 billion in wages.

~$5.5 billion in fuel.

~$.5 billion in food expenses.

By my math, 60% of the gross income went to non-fixed expenses, and that's only with a 3 minute review of the income statement.

So if you want an explanation of how the fixes costs shrink, I'll tell you.

They are not paying flight attendants or pilots when the planes on affected routes are not in the air.

Obviously they are not buying the fuel for those routes, either.

They are not serving food to the passengers that are not in the planes because the planes are not flying.

Planes are not having as many flight hours put on them, that means less maintenance (both regular inspections based on flight hours and anomalous failures requiring immediate attention).

They do need to make debt payments. They do need to pay for terminal rental and the like. Unless, of course, they get some more government subsidies, because of the "massive losses" they are suffering (again).

[wmfellows]

What pray tell does any of this US stuff have to do with European airline losses? If you all want to debate questions relative to subsidies in airlines, wouldn't a proper thread be the place?

[IAmNotSpartacus]

What pray tell does any of this US stuff have to do with European airline losses? If you all want to debate questions relative to subsidies in airlines, wouldn't a proper thread be the place?

Well, just so you're up to speed, US airlines do fly to and from Europe.

[wmfellows]

Well, just so you're up to speed, US airlines do fly to and from Europe.

Quite aware of that mate, when I want to fly a crappy flight, I fly American over the Atlantic. Hardly a reason to hijack the question with reams of purely American wanking.

And re variable costs, in Europe you can bloody well expect that the airlines do have to pay salary when grounded. Not an easily compressible cost that.

[OldGuy]

What pray tell does any of this US stuff have to do with European airline losses? If you all want to debate questions relative to subsidies in airlines, wouldn't a proper thread be the place?

The OP didn't, at least directly, mention European airline losses. Now it may be that the figure cited is just for European airlines rather than all airlines, but you can't tell that from the post.

[IAmNotSpartacus]

And re variable costs, in Europe you can bloody well expect that the airlines do have to pay salary when grounded. Not an easily compressible cost that.
Do you have a cite for this?

[Xema]

Let's look at American Airlines income statement from last year...
~$20 billion in revenue.
~$6 billion in wages.
~$5.5 billion in fuel.
~$.5 billion in food expenses.
By my math, 60% of the gross income went to non-fixed expenses
Is it your theory that the moment planes are grounded by volcanic ash, wages cease?

[Fake Tales of San Francisco]

Do you have a cite for this?

No idea what the official sites would be for this, but this (http://www.jobsite.co.uk/insider/volcano-ash-4513/) is the best I can find and corresponds with what I already thought I knew about wages law in UK/Europe. As the article says, you generally have to get paid since you're capable of working, but there may be a clause in your contract relieving your employer of this responsibility in the case of freak occurrences such as this.

[t-bonham@scc.net]

News says that Airlines have losses of 1 Billion Dollars. I generally distrust such figures, since they are usually computed by just calculating the value of ticket sales on canceled flights.

But this does not take into consideration the fact that most of these lost ticket sales are made up when the planes start flying again. After all, the stranded passengers aren't going to stay there forever -- they will buy tickets home as soon as they can. Some of them may be lost within Europe, as they take trains or buses rather than wait for the planes to fly again, but not very many. Especially the international passengers -- very few will switch to a week-long voyage on a trans-Atlantic liner to get home.

[Candyman74]

News says that Airlines have losses of 1 Billion Dollars. But, it doesn't say anything about Gains from not using fuel. What say ye about that?

If there was a net gain from saving fuel by not flying planes, all the airlines would maintain fleets of grounded planes instead of flying passengers.

They don't. They fly passengers. Why do you think that is?

Why on earth would anyone maintain a working airline if not doing so made them more money?

What a bizarre question.

[IAmNotSpartacus]

Is it your theory that the moment planes are grounded by volcanic ash, wages cease?

Since flight attendants and pilots are only paid when the planes are in the air, and grounded planes don't need cleaning or fixing.. yeah, I am.

Are you suggesting airline work rules have changed in the last month?

[IAmNotSpartacus]

No idea what the official sites would be for this, but this (http://www.jobsite.co.uk/insider/volcano-ash-4513/) is the best I can find and corresponds with what I already thought I knew about wages law in UK/Europe. As the article says, you generally have to get paid since you're capable of working, but there may be a clause in your contract relieving your employer of this responsibility in the case of freak occurrences such as this.

I am not aware of any major airlines that do not have a contractual agreement with their major trade employees. Certainly not here in the US, Europe may be different.

[Richard Pearse]

Since flight attendants and pilots are only paid when the planes are in the air, and grounded planes don't need cleaning or fixing.. yeah, I am.

Are you suggesting airline work rules have changed in the last month?

That's not true. Pilots are often paid per hour but they are guaranteed a certain number of hours per month. They get paid for these hours regardless of whether or not they actualy fly them. Any additional hours flown are extra. They are essentially paying salaries plus overtime.

Australian airlines dispense with the hourly pay farce altogether and pay a salary plus overtime.

Also don't forget that all of the crews stranded overseas are getting hundreds of dollars a day in allowances and the airline is paying for hotels.

[alphaboi867]

...Especially the international passengers -- very few will switch to a week-long voyage on a trans-Atlantic liner to get home.

Almost none will. The Queen Mary 2 is the only ocean liner in regular trans-Atlantic service. Getting a stateroom (even a cheapo inside one) at short notice is going to cost a small fortune. It's much easier to make ones way to Portugal or Spain and then fly across the Atlantic.

[IAmNotSpartacus]

That's not true. Pilots are often paid per hour but they are guaranteed a certain number of hours per month. They get paid for these hours regardless of whether or not they actualy fly them. Any additional hours flown are extra. They are essentially paying salaries plus overtime.
The guarantee will depend on the airline, here in the US it's around 60-70 hours for legacy carriers that fly internationally. From perusing airline pilot forums I get the idea that pilots tend to average 80-90 hours per month. I will assume that flight attendants do not enjoy the same work rules as pilots, but that information isn't as readily available as it is for pilots.

With planes back in the sky and passengers traveling, I'm sure now that the point is moot, the airlines will have the employees make up those hours in the next 10 days as they try to clear the backlog.


Australian airlines dispense with the hourly pay farce altogether and pay a salary plus overtime.
OK. Do many Australian airlines fly to Europe? Is the Australian model common in Europe? Because Australia is a pretty small market, relatively speaking.

Also don't forget that all of the crews stranded overseas are getting hundreds of dollars a day in allowances and the airline is paying for hotels.
According to http://www.airlinepilotcentral.com/airlines/legacy.html pilots get $2.20/hr per diem when they are overseas (less than $50 per day) and I'll suspect the airlines have negotiated sweetheart deals with the hotels. What are these hundreds of dollars per day supposed to cover? Something more than 3 meals and a bed?

Unsurprisingly, the airlines (http://news.yahoo.com/s/afp/20100422/wl_afp/icelandvolcanoaviation_20100422024940) are already pleading poverty and sticking their hand out.

They claim $1.7 billion in losses because of a week's worth of canceled flights. I don't know where they get that number from, but they've put a number on it and it seems pretty high.

[ShibbOleth]

But this does not take into consideration the fact that most of these lost ticket sales are made up when the planes start flying again. After all, the stranded passengers aren't going to stay there forever -- they will buy tickets home as soon as they can. Some of them may be lost within Europe, as they take trains or buses rather than wait for the planes to fly again, but not very many. Especially the international passengers -- very few will switch to a week-long voyage on a trans-Atlantic liner to get home.

Not some, many or most Europeans took trains, bus or hire cars to get somewhere else in Europe. Eurostar has been booked solid. DB trains have been packed. Hotels in the locations that people have been stranded have been jammed full.

Also, bear in mind, on any given flight, only half of the people are returning. So the other half can just not go in the first place.

I had a colleague fly Stuttgart - Milan yesterday on a plane that was less than 10% full. Demand for flight has been shunted to other transport modes. In Europe the main need for flights is into and off of the continent or the UK, where it's difficult to substitute.

For flights to Europe from North America, of course, it's impractical for most people to take a boat, but vacations have been canceled already. People who might have flown late in the year are reconsidering.

My suspicion is that once everyone is "home", net demand will dip for a while until memories fade, similar to what occurred post 9/11.

[Richard Pearse]

OK. Do many Australian airlines fly to Europe? Is the Australian model common in Europe? Because Australia is a pretty small market, relatively speaking.It doesn't matter. The "Australian model" is the same as the guaranteed hours model under a different name. The point is that the airlines are still paying wages for all of their stranded crews. Whether any of them end up flying fewer hours over their roster period will depend on the specific circumstances of each employee.


According to http://www.airlinepilotcentral.com/airlines/legacy.html pilots get $2.20/hr per diem when they are overseas (less than $50 per day) and I'll suspect the airlines have negotiated sweetheart deals with the hotels. What are these hundreds of dollars per day supposed to cover? Something more than 3 meals and a bed? Ok, "hundreds" was overstating the case. I based that on the assumption that it'd better than the $100 I get as a turbo-prop pilot per day away from base. The basic point stands that having crews stranded costs money, it doesn't save money.

To make money out of an airline you want to have as few crews and aeroplanes as possible flying as many hours as possible. By closing Europe the opposite is happening, there are a lot of crews and aeroplanes sitting on the ground. The lost revenue may be somewhat offset by the lower operating costs but it is still a big net loss and a big drop in cash flow.

[Johnny L.A.]

This came in an email today:

How One Airline Skirts the Ash Clouds (http://online.wsj.com/article/SB10001424052748704133804575198183757930998.html?KEYWORDS=airlines)

[ShibbOleth]

Cool article, thanks for sharing.

[Richard Pearse]

Qantas is claiming to have spent 700,000 on hotel accommodation for stranded passengers.

[Broomstick]

Excellent article - I've referenced it on other sites where I've been discussing this.

[Xema]

... flight attendants and pilots are only paid when the planes are in the air...
I spoke with several US pilots who were extremely skeptical that many European airlines have this sort of antiquated agreement with pilots and flight attendants. Do you believe a substantial proportion operate this way?

[JoelUpchurch]

This came in an email today:

How One Airline Skirts the Ash Clouds (http://online.wsj.com/article/SB10001424052748704133804575198183757930998.html?KEYWORDS=airlines)

I agree this is a good article. It looks like Alaska Airlines knows more about handling ash than the entire EU.

[ShibbOleth]

Also keep in mind that the entire EU is really a bunch of separate entities. There is not FAA that operates across the EU, so even if say, France wanted to open up, they'd be shut down by England and German airspace. EU needs to look at combining these AND learning something from others here.

On the topic of the European air losses, another problem faced here is that the EU does have strict traveler compensation laws that we don't have in the US, and must reimburse stranded travelers for some things that may be optional in the US.

Finally, I was checking flights for week after next, and the normal cost for a flight between Tampa and Germany has drastically dropped, from about $1000-1500 to below $1000 (easy to find at that price).

[atomicbadgerrace]

I spoke with several US pilots who were extremely skeptical that many European airlines have this sort of antiquated agreement with pilots and flight attendants. Do you believe a substantial proportion operate this way?

Antiquated? The "in the air" part doesn't hold for the US, but it's not far off. For the majors, pilots (and inflight crew) are being paid only when the aircraft is off the blocks. That is, from the time the aircraft is pushed back until the time it parks at the gate. There are a multitude of variances for things like reserve pay, etc., and as stated upthread, there is usually a minimum monthly guarantee around 80 hours. But if you're talking about when pilots are actually earning their hourly base rate, it's only after the doors are shut until the doors are open (loosely speaking).

On the topic of the European air losses, another problem faced here is that the EU does have strict traveler compensation laws that we don't have in the US, and must reimburse stranded travelers for some things that may be optional in the US.

Excellent point, and one that's going to hit the bank pretty roughly on several EU-based carriers. Ryanair has already indicated that, despite law, it isn't going to provide compensation to stranded customers (nor should they be forced to, aside from the "it's the law" angle, IMO).

[Xema]

But if you're talking about when pilots are actually earning their hourly base rate...
Actually, we were talking about whether airline's wage expenses cease when aircraft are grounded. The evidence strongly suggests that the answer in most cases is "Hell no." It's common that employees who fly (pilots and flight attendants) have minimum wage provisions of the type you allude to. And there are of course a host of non-flying employees as well.

[hibernicus]

I'd say any airline worth flying on is probably not buying fuel on the spot market, but instead buys fuel futures at a reduced (usually) rate,

I'm not sure what you mean by saying the rate at which they buy forward is usually reduced. If you mean it is usually less than the current price, that is not the case. The price at which a commodity is traded for future delivery is determined by market expectations and may at any time be more (contango) or less (backwardation) than the spot price. If you mean that their traders can achieve a small discount on the quoted forward price, by negotiation or shopping around, that may well be the case.

However, in general the aim of hedging fuel prices is not to achieve a lower average fuel price; it is to stabilise gross margin by managing market risk. This has the effect of reducing the cost of borrowing.

[wmfellows]

Actually, we were talking about whether airline's wage expenses cease when aircraft are grounded. The evidence strongly suggests that the answer in most cases is "Hell no." It's common that employees who fly (pilots and flight attendants) have minimum wage provisions of the type you allude to. And there are of course a host of non-flying employees as well.

Yes, I could relative to continental Europe, find no exceptions to labour code there, and the American practice would be clearly illegal under EU labour standards, as I understand them.

[Richard Pearse]

Yes, I could relative to continental Europe, find no exceptions to labour code there, and the American practice would be clearly illegal under EU labour standards, as I understand them.

What would be the problem with it?

[crazyjoe]

I'm not sure what you mean by saying the rate at which they buy forward is usually reduced. If you mean it is usually less than the current price, that is not the case. The price at which a commodity is traded for future delivery is determined by market expectations and may at any time be more (contango) or less (backwardation) than the spot price. If you mean that their traders can achieve a small discount on the quoted forward price, by negotiation or shopping around, that may well be the case.

However, in general the aim of hedging fuel prices is not to achieve a lower average fuel price; it is to stabilise gross margin by managing market risk. This has the effect of reducing the cost of borrowing.

I'm sorry, but if the object of hedging fuel prices is not to achieve a lower overall average cost, then you're doing it wrong. While you are correct that the commodity future price might be higher than the current price, you are managing risk, as you say, in such a way as to avoid a catasrophic loss if the future price spikes astronomically. In some cases, this can result in an overall higher cost, but in general it results in lower cost and less volatility, or the airlines would not do it.

[hibernicus]

I'm sorry, but if the object of hedging fuel prices is not to achieve a lower overall average cost, then you're doing it wrong. While you are correct that the commodity future price might be higher than the current price, you are managing risk, as you say, in such a way as to avoid a catasrophic loss if the future price spikes astronomically. In some cases, this can result in an overall higher cost, but in general it results in lower cost and less volatility, or the airlines would not do it.

The object of hedging fuel prices is to reduce risk. It is as simple as that. I don't know of any evidence for your claim that "in general it results in lower cost".

If you could "in general" buy forward for less than the spot price on the delivery date, we would all be very, very rich. The reality is the opposite - the market is willing to pay a premium to reduce price risk, and this is reflected in the forward commodity price.

[crazyjoe]

The object of hedging fuel prices is to reduce risk. It is as simple as that. I don't know of any evidence for your claim that "in general it results in lower cost".

If you could "in general" buy forward for less than the spot price on the delivery date, we would all be very, very rich. The reality is the opposite - the market is willing to pay a premium to reduce price risk, and this is reflected in the forward commodity price.

And exactly what "risk" are they reducing? Why, the risk of drastic price fluctuations, which could result in a vast increase in costs. Right?

[hibernicus]

And exactly what "risk" are they reducing? Why, the risk of drastic price fluctuations, which could result in a vast increase in costs. Right?

Right, you've got it. It's a bit like insurance. Your business would be better off not paying for fire insurance, because on average your annual premium will exceed your annual claims (assuming the fire insurance business is profitable). But if there was a fire, it could wipe out the business, so you are willing to pay for insurance to spread the risk of a single event over many years.

Think of it another way: any time the airline gains a dollar by buying fuel forward instead of buying spot, their counter-party loses a dollar. Why would you expect airlines' commodity traders to be systematically cleverer than their counter-parties, or than the market? If they were, they could make a fortune on speculative trading, and forget the messy business of flying passengers around.

The expected contribution to gross margin of hedging activity is approximately zero. Probably slightly negative if you take account of transaction costs, etc. But it yields real benefits in terms of reduced volatility, which in turn reduces the cost of raising capital.