How do you manage fuel and currency risks?

Keeping to the risk appetite of the business is imperative so as not to be lured by the economic gains that can be realized through speculative use of financial derivatives designed for hedging purposes. The implications of all price variations of the underlying instrument (jet fuel) on the business' financial performance should be analyzed thoroughly when using any hedging instrument.

Fuel and currency risks are two of the biggest challenges facing airlines today. Fuel costs can fluctuate wildly, and currency fluctuations can erode margins. Fuel hedging is one of the most common ways for airlines to manage fuel costs. Fuel hedging involves contracting to buy fuel at a predetermined price in the future. This can help airlines to lock in a price for fuel, even if prices go up in the future. Currency hedging is another way for airlines to manage their risk. Currency hedging involves using financial instruments to offset the risk of currency fluctuations. For example, an airline might buy currency forwards to lock in a price for fuel that is denominated in a foreign currency.

In 2008, the global financial crisis led to a substantial surge in oil prices, causing severe repercussions for numerous airlines. However, Southwest Airlines successfully navigated this turbulent period due to its astute fuel hedging approach. Southwest had secured a substantial portion of its fuel supply for 2008 at rates that were below prevailing market prices. Remarkably, Southwest not only weathered the storm but also recorded a profit in 2008, a remarkable feat, while many other carriers were compelled to raise ticket prices or implement cost-cutting measures. Southwest's judicious fuel hedging strategy saved the company billions of dollars and enabled it to sustain its competitive edge in the aviation industry.

In 2016, the Nigerian naira fell sharply against the US dollar. This significantly impacted Dangote Cement, as it made its exports more expensive and its imports cheaper. To mitigate this risk, Dangote Cement implemented a currency hedging strategy. The company hedged a portion of its foreign currency exposure using forward contracts. This allowed Dangote Cement to lock in a fixed exchange rate for the naira against the US dollar for a specific time. As a result of its currency hedging strategy, Dangote Cement was able to protect its profits from the devaluation of the naira. Despite the challenging economic conditions, the company reported a profit of ₦171.2 billion in 2016.

The 2004 scandal of China Aviation Oil Corporation Limited (CAO) provides us with an example of the need for top-down properly defined risk management policies within this space. Such strategic objectives and policies should be emanate from the Board of Directors and incorporated into the daily operations of the business by senior management. Additionally, the required resources to implement a robust risk management framework cannot be overemphasized.