How to manage jet fuel volatility, profitably

Next generation credit risk, could have managed Thomas Cook credit risk exposure

The holiday industry has evolved considerably.  Savvy customers are putting together their own packages online, and competition is growing from low-cost airlines like Jet2 and Ryanair. In addition, political changes such as Brexit are causing many holidaymakers to spend their time off in the UK while a weakening GBP/USD increases fuel costs for airlines. 

All these changes are adding pressures to profit margins. Two holiday giants, Monarch and Thomas Cook have already folded. So, what went wrong?   

While holiday companies cannot control the evolution of consumer habits and preferences, they can have better control over expenditure.  Transforming services and looking at ways to reduce and manage costs helps to remain competitive, but could they also look to traditional commodity and energy trading markets for more robust software solutions?   

Credit Risk

One of the largest costs to an airline is fuel, making price volatility of jet fuel is a key risk to profitability.  Creating certainty in the price of fuel is a clear need and airlines can, and do, take steps to hedge their jet fuel exposure. Traditionally this risk was hedged with trading Brent crude but more frequently we see this with ultra-low sulphur diesel/gasoil and jet fuel swaps. Moreover, they are rarely 100% hedged. Thomas Cook would typically be around 80% hedged heading into the next season (summer or winter) and 50% hedged for the season after. Wizz Air, like other airlines making use of lower jet fuel swap prices, recently announced it has increased its 2020 hedging to nearly 80% of predicted need. This is against a policy level of 50% for a 12-month window and 40% for an 18-month window.  

 Irrespective of the strategy used, hedging anticipated fuel demand with derivatives is not perfect and there are a limited number of priced delivery locations available. With airlines operating (and thus fuelling) from multiple locations around the globe, they are subjected to a number of other factors impacting their final fuel costs including refining costs, demand and costs of the pipeline operator and the “basis” risk.      

Jet fuel is priced in USD therefore non-USD denominated airlines have the added challenge of managing USD risk to their base currency as was the case for Thomas Cook. The strengthening of the GBP against the USD struggled to materialise next to a backdrop of BREXIT, preventing any respite to increased fuel costs.  

The impact on costs for Thomas Cook was significant; the difference between their 2017 fuel costs and 2019 costs was well in excess of £100m. These extra costs needed to be either passed on to the customer in rate increases, potentially making them less competitive, and/or absorbed by the business.  

The energy sector is exposed to similar risks as jet fuel trading and manages these challenges using sophisticated energy trading and risk management software. In addition, the energy sector contends with the unpredictable and intermittent nature of renewable energy generation. Therefore, it is essential for successful energy retailers to implement robust and flexible solutions, like Brady’s energy software suite to mitigate these risks, support their custom hedging strategies and manage costs.

Airlines may believe they have robust trading strategies and credit risk policies in place, but do they have the best tools to manage these? Can they proactively and confidently foresee and mitigate market risks? Holiday companies with poor systems to support credit control and hedging practises may find themselves significantly exposed and should look to implement robust trading and risk management software such as Brady’s solutions.  

Brady’s software solutions are designed to manage and  optimize  credit risk and hedging strategies increasing security and protecting profit margins. They can be used by airlines and holiday companies to help mitigate additional risks, manage costs and prevent further loss to profits. 

Each year, enterprises s around the world depend on Brady systems to transact billions of USD worth of trades. With 30 years of expertise in multi-commodity markets and more than 10,000 users worldwide, Brady’s  software solutions are relied upon to deliver mission critical business transactions across global operations. 

Contact us now to learn more.

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How to manage jet fuel volatility, profitably