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Mitigate The Cost of Not Hedging Fuel Prices

I bet if the Board of Directors tied long-term CEO compensation to how effectively the C-suite hedged basis risk, it would become a focus overnight. They certainly put enough effort into making sure they hit their quarterly earnings number…

In order to better afford hedging operations, when there is employee attrition, the firm might consider not replacing the employee and using their salary for hedger margin. This will likely result in a handful of fewer jobs, but I think it’s in the best interest in the overall firm. Don’t risk the entire operation by not hedging.

If the operation is large enough, an employer can look to see where computer hardware or software can create efficiencies, or reassign some tasks. Everyone will eventually benefit by having a firm that can be more competitive in the marketplace.

If you remember Peak Oil, Southwest Airlines did not have to pass along higher fuel costs nor add fuel surcharges thanks to its hedging operations. [Note to hedgers: call a recruiter and hire the best energy traders you can. The life you save may be your own.]

From the WSJ:

“Volatile oil prices have forced many businesses to walk a fine line between passing along costs to customers and finding other ways to mitigate fuel’s impact on earnings,” began the article Firms in Mitigation Mode as Oil Prices Jack Up Costs.

This is especially true where there are price wars for beverages such as beer and soda distributors. The article also mentions car dealerships.

From an academic and historical standpoint, commodity futures markets exist for the hedgers. Although there is no such thing as a “perfect hedge,” all the rules are skewed to benefit hedgers over investors. Kudos to the CEOs named in the article who hedged their risk. They are forward thinkers.

I find it hard to believe that the smaller players cannot utilize options to hedge and keep the cost of the insurance finite. I’m not saying that it doesn’t take a little planning, but with options you can define your potential losses before you pay for the insurance. Some of the insurance costs can be passed on to the end user.

“Deutsche Lufthansa AG says fuel is the largest cost on the company’s balance sheet, and it expects to spend €6.8 billion ($9.6 billion) on fuel in 2011, topping last year’s €5.2 billion, says spokesman Martin Riecken. The company is hedging about 74% if its fuel exposure for 2011, says Mr. Riecken, in line with what it has hedged in previous years.

Norwegian Cruise Line, meanwhile, has 60% of its fuel hedged for 2011, a move that CEO Kevin Sheehan says will make the rise of oil prices manageable for the cruise operator.

In 2008, Norwegian had a very small percentage of its fuel hedged, and had to levy fuel surcharges on its passengers. The company began hedging more aggressively after that experience, and isn’t currently considering fuel surcharges, says Mr. Sheehan.”

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