Posts Tagged ‘hedging’

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Southwest Airlines’s hedges

May 2, 2012

Michael Giberson

“We don’t know where the price of crude is going to be,” says [Southwest Airlines's Chris] Monroe. But, he adds, “I think we have to be generally bullish just because we’re trying to protect against an increase … So we have a little bit of a bias that prices may go higher.”

He chuckles that he and [former SW treasurer Scott] Topping, longtime colleagues and friends, used to describe themselves as the “most conflicted” managers in the building — although low fuel prices would benefit Southwest overall, it would mean their carefully crafted hedging strategy wouldn’t pay off as well….

Still, “In my heart, I would love lower prices,” says Monroe. “Lower prices are good for everybody in our country, and especially good for an airline.”

From, “The ‘Fixer’ at Southwest Airlines,” CNBC.

Notice that Southwest trades crude oil options and other derivatives even though they are not in the physical crude oil market. Proposals that aim to limit trading to parties with “true” commercial interests in the underlying commodity could inadvertently trip up quite reasonable hedging strategies such as pursued by Southwest. (Presumably they find the liquidity available in the much more heavily traded crude oil markets attractive compared to trading in the less liquid jet fuel markets even though the crude oil price is an inexact proxy for the price of jet fuel.)

In related news, Delta Air Lines is buying a refineryfrom the Phillips 66 unit being spun off of ConocoPhillips. According to Dana Blankenhorn at SeekingAlpha, “Delta Refinery Deal All About Southwest.”

(I’m still with the skeptics on this deal. Is is really going to be cheaper for Delta to own a refinery and make jet fuel than just buy jet fuel in a reasonably competitive market? Another way of asking the question, why does Delta think it can do a better job of running the refinery than ConocoPhillips did? Surely contract-based cost management as practiced by Southwest will be more flexible and adaptable to changing conditions than Delta’s ownership of an aging refinery near Philadelphia.)

Posted in Energy markets, Transportation | Tagged , , | 6 Comments »

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Keeping some speculators out of the oil market may lead to higher oil prices

August 4, 2009

Michael Giberson

From Fortune-Investor Daily:

If Congress or the CFTC forces through stiff curbs on futures trading by so-called “speculators” — i.e. investors who use futures to bet on future price movements but don’t buy actual oil — it may lead to higher, not lower, oil prices over the long term.

Why? Imagine you’re an oil company CEO thinking about drilling a new oil well that won’t produce until 2011. Given the high upfront costs of drilling, you’re going to be more likely to undertake the project if you can use the futures market to lock in oil prices in 2011 that will justify your drilling costs. The buyer on the other end of your futures trade is probably an investor — someone who will commit to paying you $75 a barrel for oil in 2011 because he believes actual price in 2011 will be even higher.

However, if fewer investors are allowed to take the other side of your trade, you will have a harder time locking in a good price for your 2011 oil. That could make it harder for you to justify the upfront cost of building the new well. Less investment in new oil wells means less future supply, and less supply means higher oil prices.

Posted in Economics, Energy markets, Politics | Tagged , , | 2 Comments »

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Crude oil price volatility

July 6, 2009

Michael Giberson

The New York Times observes that crude oil price volatility has been exceptionally high for the last eighteen months.

Daily changes in the spot price of crude oil, 1983-2009

New York Times graphic: Daily changes in the spot price of crude oil, 1983-2009

(Hmmm. Eighteen months ago … January 2008 … the Iowa caucuses … the U.S. presidential primary season gets underway in earnest … nahhh, couldn’t be all due to presidential politics.)  Actually, eyeballing the chart that accompanies the article, it looks like volatility didn’t really take off until the macroeconomic slide later in 2008. From the story:

“To call this extreme volatility might be an understatement,” said Laura Wright, the chief financial officer at Southwest Airlines, a company that has sought to insure itself against volatile prices by buying long-term oil contracts. “Over the past 15 to 18 months, this has been unprecedented. I don’t think it can be easily rationalized.”

Volatility in the oil markets in the last year has reached levels not recorded since the energy shocks of the late 1970s and early 1980s, according to Costanza Jacazio, an energy analyst at Barclays Capital in New York.

Energy price volatility may have implications for various energy policy proposals seeking to dramatically reshape the industry.  Research published in the Energy Journal (“Does oil price uncertainty affect energy use?” Gerard Kuper and Daan van Soest, 2006. Link to abstract.) reported that oil price volatility discourages investment in new energy-using technology:

Volatility clustering implies that high levels of volatility today give rise to the expectation that volatility will remain high in the foreseeable future, and hence the probability of price change reversals is expected to remain high as well. Volatility itself induces firms to respond sluggishly to energy price changes, and this effect is exacerbated if volatility is clustered over time as higher volatility today implies that tomorrow volatility is likely to be high too….

Our results thus give support to the theoretical prediction that energy price volatility renders energy-saving technologies less attractive. The policy implications are that in uncertain times, energy taxes are not expected to be very effective in reducing energy use, and that reducing and managing uncertainty should be high up on the policy agenda.

AN ASIDE: Between when I first read the NYT story yesterday and posting about it this morning, the title of the article morphed from “Volatile swings in price of oil stir fears on recovery” to “Swings in price of oil hobble forecasting.” I wonder if that change is a editorial judgment to minimize negative tone toward the economy, or just an effort to make headlines into statements of the obvious?

ANOTHER COMMENT: The Energy Journal doesn’t make it easy for web-based researchers to locate and link to articles in the journal (as compared to, say, the Electricity Journal or Energy Policy). As research has become increasingly web-based, that is probably not the best long-term approach.

Posted in Economics, Energy markets, Politics | Tagged , | 6 Comments »

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More on airline fuel cost hedging: Air New Zealand takes hit

January 23, 2009

Michael Giberson

As Lynne was saying yesterday with respect to Southwest Airlines losses of $117 million related to its fuel cost hedging operations, Air New Zealand is discovering with hedging that “sometimes you get the bear, sometimes the bear gets you.”

Platts reports Air New Zealand told the Australian stock exchange that “unbooked hedge positions for its 2009 financial year, which runs from April 2008 to March 2009, stood at $126.39 million.” That loss is up from the $81 million report of unbooked losses reported in October for 2009, and the air carrier’s hedging position for 2010 is also in the red.

Which doesn’t mean that the hedges were not a good idea at the time they were entered into, of course. The article also points out that “unbooked hedging losses can vary considerably from final booked losses, particularly if futures prices change significantly between the time mark-to-market is done and the contracts expire.”

The Platts story provides several details about Air New Zealand’s complex hedging strategy which relied on trading jet fuel options in Singapore and crude oil futures on the NYMEX.

Previously here: Does hedging against fuel price movements increase airline value?

Posted in Energy markets | Tagged , | 1 Comment »

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Fuel hedging: sometimes you get the bear, sometimes the bear gets you

January 22, 2009

Lynne Kiesling

One of my father’s default tag lines was “sometimes you get the bear, sometimes the bear gets you.” I use this phrase frequently when discussing hedging future price changes — if prices move in the direction you anticipated, you earn a profit, if they move in the opposite direction, you earn a loss.

Last quarter the bear got Southwest Airlines (hey, that’s a good pun too). Southwest reported a net loss last quarter, due in large part to their fuel price hedging position:

The loss included net charges of $117 million related to the falling value of its fuel-hedging positions. Without the charges, Southwest would have earned $61 million, or 8 cents per share, which beat expectations of analysts surveyed by Thomson Reuters, who forecast a gain of 5 cents per share excluding special items.

Recently, Southwest has cut back sharply on fuel hedging. It also said Thursday that it plans to reduce capacity this year by 4 percent and will rein in fleet-expansion plans.

In periods of uncertainty, you manage this risk by hedging your hedge, buy buying an instrument that in essence allows you to get out of buying the fuel at the price you contracted. I’m thinking of instruments like put options. Of course, you are unlikely to recoup all of your money by doing this, but you can mitigate your losses.

But, being the “glass is half full” person that I am, I focus on the fact that their net income before special items was higher than analyst expectations. I doubt that’s the case for other airlines in this market.

Posted in Economics, Energy markets | Tagged , , | 1 Comment »

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What fixed vs. flexible retail power rates in Texas tell us about wind power in the ERCOT market

January 13, 2009

Michael Giberson

Electric power consumers in (the ERCOT portion of) Texas have many choices when it comes to the electric power retailer they wish to enroll with, and typically each retailer offers a handful of different plans.  Historically speaking, this is a crazy cornucopia of consumer choice not seen anywhere else in the world. Or, seen from another point of view, a lot of data for economists interested in retail electric power not available anywhere else. This post dissects a few bits of that data and offers a preliminary conclusion.

One choice available to many Texas power consumers, but rare elsewhere, is between rates that are variable from month-to-month and rates that are fixed for a longer term.  Typical terms for fixed rate offers are six months and one year, but terms as long as five years are offered.

The primary difference between a variable rate and a fixed rate is whether the customer or the retailer is exposed to the risk of adverse price movements.  A little simple economics leads one to expect that if the retailer is to take on the risk of adverse price movements, the customer will have to pay the retailer to take on the risk. So we’d expect that fixed rate contracts would tend to be higher than variable rate contracts.

And that is just what we see in the offers listed at www.powertochoose.com, the State’s online list (just comparing average offered fixed rate deals to average offered variable rate deals). For example, in the Houston area the average rate for fixed price offers was 14.04 cents/kwh and the average rate for variable price offers was 13.60.  In Dallas, fixed price offers averaged 13.35 cents/kwh and variable price offers averaged 13.03.

But elsewhere in north Texas, specifically the AEP North Texas distribution service territory, the average rate for fixed price offers was 12.7 cents/kwh and the average rate for variable prices offers was 12.8 cents/kwh. So, apparently in parts of north Texas, electric retailers in effect are willing to pay consumers a little bit in exchange for taking on price risk.

Crazy, right?

Well, not exactly.  A fixed rate offer transfers the exposure to both adverse and beneficial price movements.  If a retailer expects prices to fall (relative to the current market expectations), then it would want to encourage customers to lock in at current rates; if the risk of a price movement down is larger than the risk of a price movement up, and retailers are less risk-averse than individual consumers, then retailers would be willing to pay consumers to take on the risk.

And why might retailers in certain parts of north Texas expect prices to fall? Might it be access to large quantities of wind power that sometimes can’t reach Dallas or Houston due to transmission limits – sometimes such large amounts of wind that prices in the ERCOT west region go negative?

I think so.

Admittedly, simple averages of offered fixed and variable rates provide only the coarsest of indicators of what is going on. Maybe more sophisticated analysis makes the anomaly disappear. But at first glance, it looks like another market indicator of the temporary excess supply of subsidized wind power in west Texas.

Posted in Electricity, Energy markets, Environmental policy | Tagged , , , | Comments Off

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