SINGAPORE - Jet fuel prices have slid by about 20 per cent in recent months but air travellers are unlikely to see a corresponding fall in ticket prices. A key reason for this is what the industry refers to as fuel hedging. Here is a quick look at what fuel hedging is:
1. Fuel hedging is a tool used by airlines, to reduce their exposure to volatile and potentially rising fuel costs. A fuel hedge contract allows an airline to lock in a guaranteed amount of fuel for future consumption at a fixed price.
The actual amount of fuel that is hedged varies from airline to airline and depends on internal risk assessment and projections of where the market could go. Singapore Airlines for example, has hedged about 65 per cent of its needs until the end of March.
2. When fuel prices increase, airlines benefit from hedging. But on the flip side, when prices fall as they have in recent months, carriers end up paying more than the current market price.
3. Despite the risk, many airlines still prefer to hedge given volatile oil prices. This is because it gives them certainty on their fuel expenditure. The cost of fuel accounts for as much as 40 per cent of airlines' operating costs. Fuel hedging is also common in other industries such as shipping and, transport and logistics.
4. There are many reasons why oil prices fluctuate. Production levels is a major one. A large part of the world's crude oil share is produced by OPEC (Organisation of Petroleum Exporting Countries) nations and decisions they make to raise prices or reduce production has an immediate impact on the global commodity markets.
5. Oil prices are also tied up to demand which has risen significantly in recent years due to high growth and demand from the emerging economies. On the supply side however, the jump has not been as great, hence the higher prices.