Risk Management of Airline Companies

Negative occurrences happen but their impact is minimized. Hedging techniques minimize airline risks, but in financial markets, it is not as simple as insurance, as instruments in the market are used to set off the risks of negative price tendencies.Hedging, in technical terms, is investing in two securities with negative correlations. Of course, it comes by paying in some form or the other. We can not save ourselves from risk-return tradeoff, as hedging is not a technique of making money but a way of minimizing future losses. Mostly, hedging techniques require the usage of complicated financial instruments, known as derivatives. options and futures are the most commonly used derivatives. With these instruments, trading strategies are developed whereby a loss in one investment is compensated by profits in another.Taking the example of Southwest Airline’s hedging techniques in mid-2005 when oil prices rose to more than $60 per barrel, giving huge profits to the company because it had entered into a contract of commodity hedging for 85% of its oil needs at the rate of $26 per barrel. Had the company not entered into commodity hedging, it would have incurred heavy losses. Southwest Airlines saved $34 per barrel and not only covered the risks involved in the scenario of $60 per barrel but solidified its market position. Other American airlines like Delta had no long term contract and in the year 2004 had to sell its supply contracts to arrange cash for paying debts. It shows how difficult it is to survive in the volatile oil market without practicing some risk minimizing techniques. Similarly, another airline – United Airlines – had filed for bankruptcy protection in December 2002 — could hedge 30% of its fuel requirements in 2005 at the cost of $45 per barrel. One can understand the compulsions behind different strategies adopted by these airlines, as their financial standings are also different.