7 ms·

I imagine that, just like airlines use futures to hedge the price risk of jet fuel, they do the same for their vast logistics operation. They can lock in prices

by phdp 7y ago

I imagine that, just like airlines use futures to hedge the price risk of jet fuel, they do the same for their vast logistics operation. They can lock in prices so they aren’t suddenly facing a massive bill if gas goes way up.

sbolt 7y ago
That makes a lot of sense, their logistics operation is massive!
formercoder 7y ago
Interestingly airlines are divided on hedging and not all participate in it https://www.eurofinance.com/news/airlines-divided-on-hedge-benefits-as-oil-volatility-surges/ https://www.eurofinance.com/news/airlines-divided-on-hedge-b...
- selectodude 7y ago
  You can make an indirect bet on oil futures by trading airline stocks. Southwest Airlines (LUV) if it's going up, American Airlines (AAL) if it's going down.
- refurb 7y ago
  Fascinating article! To hedge or not to hedge basically comes down to US versus EU accounting rules.
- joosters 7y ago
  Hedging is extremely odd in that while it is thought of as a way to lock in 'certainty' on the price of something, it really is just another way of gambling on a price. In the case of airlines, they are effectively 'short' oil, in that they profit if the price of oil falls, and lose if the price rises. So the usual story is that it makes sense to hedge their oil costs. They can do this in three main ways: 1) Buy oil forward. They get to lock in the price of oil at a future time. If oil prices rise, they win. But if oil prices fall, they lose out, since competitors can now buy oil more cheaply. 2) Buy a call option on oil. They get the right to buy oil at a fixed price at a future time. If oil prices rise, they can exercise the option, and win. If oil prices fall, they can just take the cheaper price => another win. But the option itself has a cost, so if oil prices don't change much, they lose out since they had to eat the cost of buying the option. 3) Sell a put option on oil. This is the airline being paid by someone for the option to sell them oil at a fixed price at a future time. In this case, the airline wins if oil prices don't move too much in any direction (since they get paid for the put option). If oil falls in price, they will have to buy it at the higher price => they lose. If the oil price rises, they also lose since the costs have risen. Yet, in all cases, after hedging, the airline will still either win or lose depending upon the change in oil price. No certainty has been gained. The choice whether to hedge or not is really down to game theory. What matters is not just whether/how your airline hedges, but what your competitors do.
  - elemeno 7y ago
    > Yet, in all cases, after hedging, the airline will still either win or lose depending upon the change in oil price. No certainty has been gained. That’s not really true. You’re locking in the price that you’re going to pay - that’s the certainty. You might however not be getting the best price at that point in time. From a financial forecasting perspective it probably worthwhile trade off though as you’re fixing one of your costs for that time period and that’s useful even when sub optimal.
    - joosters 7y ago
      There's still no certainty. For an airline, your prices have to be competitive. If you've locked in an oil price, and it turns out to be a high one, then your fares will be more expensive than your competitors (assuming that they didn't hedge in the same way). So the only certainty there is failure. In all situations, hedging and non hedging, the oil price will determine whether you win or lose. There is no magical combination of derivatives that will ensure success. In fact, for every financial product you buy, you're paying a cost due to the margin that the bank/market charged you. Hedging might make sense for some accounting/tax situations, but that's another issue entirely.
      - fennecfoxen 7y ago
        "If you've locked in an oil price, and it turns out to be a high one, then your fares will be more expensive than your competitors." No. Your fares will remain competitive. It's just a hit to your profits.
        joosters 7y ago
        You are free to lose money by keeping the prices competitive, or lose money by raising your prices and losing business. Either way, it's the same result.
      - 1998v2 7y ago
        Airlines sell tickets in advance, so hedging will allow them to match their near-future fuel prices to the ticket prices they're selling now. They consume fuel but don't produce it, so I don't think they can fully balance things out over time internally. edit: I see this was mentioned already in the thread.
namdnay 7y ago
I think the difference is that by the time an airline is buying fuel, they have already sold the tickets at a certain price. So hedging makes sense. That’s not the case with Walmart for produce - if tomatoes are more expensive to buy they can just sell them for more. The only things for which it makes sense are those that aren’t sold back, eg the fuel for their fleet of trucks etc
- refurb 7y ago
  Grocery prices are highly elastic. Yes, if gas prices doubled, Walmart could increase the price of their products, but consumers would likely buy a lot less, and Walmart sales would suffer. Walmart’s focus is on “low, everyday prices”, and future can help maintain those.
  - ikeboy 7y ago
    There is absolutely no more reason to keep prices low if you've made a profit independently on futures than if you haven't. Your marginal cost goes up in both cases. If you're optimising profits, you should make the same decision in both cases regardless of if you bought futures.
    - refurb 7y ago
      Your marginal costs don't go up in both cases. If you have futures to buy diesel at $2.50/gal and the diesel price skyrockets to $4.00/gal, you can keep your prices the same. If you didn't have futures you couldn't without taking a loss.
      - ikeboy 7y ago
        This is incorrect. If you have futures, your marginal cost is still $4, since now you're using an additional gallon instead of selling it at market price at $4.
        refurb 7y ago
xerox13ster 7y ago
Not just fuel for their logistics, but also selling gasoline in their Wal-Mart brand gas stations near their stores, Neighborhood markets, and Sam's Club. They ditched Murphy USA a few years back for much of this fuel and began sourcing it themselves. It's a way to ensure those prices are the lowest they can reasonably offer and still turn a profit.

by phdp 7y ago

sbolt 7y ago

That makes a lot of sense, their logistics operation is massive!

formercoder 7y ago

Interestingly airlines are divided on hedging and not all participate in it https://www.eurofinance.com/news/airlines-divided-on-hedge-benefits-as-oil-volatility-surges/ https://www.eurofinance.com/news/airlines-divided-on-hedge-b...

selectodude 7y ago
You can make an indirect bet on oil futures by trading airline stocks. Southwest Airlines (LUV) if it's going up, American Airlines (AAL) if it's going down.
refurb 7y ago
Fascinating article! To hedge or not to hedge basically comes down to US versus EU accounting rules.
joosters 7y ago
Hedging is extremely odd in that while it is thought of as a way to lock in 'certainty' on the price of something, it really is just another way of gambling on a price. In the case of airlines, they are effectively 'short' oil, in that they profit if the price of oil falls, and lose if the price rises. So the usual story is that it makes sense to hedge their oil costs. They can do this in three main ways: 1) Buy oil forward. They get to lock in the price of oil at a future time. If oil prices rise, they win. But if oil prices fall, they lose out, since competitors can now buy oil more cheaply. 2) Buy a call option on oil. They get the right to buy oil at a fixed price at a future time. If oil prices rise, they can exercise the option, and win. If oil prices fall, they can just take the cheaper price => another win. But the option itself has a cost, so if oil prices don't change much, they lose out since they had to eat the cost of buying the option. 3) Sell a put option on oil. This is the airline being paid by someone for the option to sell them oil at a fixed price at a future time. In this case, the airline wins if oil prices don't move too much in any direction (since they get paid for the put option). If oil falls in price, they will have to buy it at the higher price => they lose. If the oil price rises, they also lose since the costs have risen. Yet, in all cases, after hedging, the airline will still either win or lose depending upon the change in oil price. No certainty has been gained. The choice whether to hedge or not is really down to game theory. What matters is not just whether/how your airline hedges, but what your competitors do.
- elemeno 7y ago
  > Yet, in all cases, after hedging, the airline will still either win or lose depending upon the change in oil price. No certainty has been gained. That’s not really true. You’re locking in the price that you’re going to pay - that’s the certainty. You might however not be getting the best price at that point in time. From a financial forecasting perspective it probably worthwhile trade off though as you’re fixing one of your costs for that time period and that’s useful even when sub optimal.
  - joosters 7y ago
    There's still no certainty. For an airline, your prices have to be competitive. If you've locked in an oil price, and it turns out to be a high one, then your fares will be more expensive than your competitors (assuming that they didn't hedge in the same way). So the only certainty there is failure. In all situations, hedging and non hedging, the oil price will determine whether you win or lose. There is no magical combination of derivatives that will ensure success. In fact, for every financial product you buy, you're paying a cost due to the margin that the bank/market charged you. Hedging might make sense for some accounting/tax situations, but that's another issue entirely.
    - fennecfoxen 7y ago
      "If you've locked in an oil price, and it turns out to be a high one, then your fares will be more expensive than your competitors." No. Your fares will remain competitive. It's just a hit to your profits.
      - joosters 7y ago
        You are free to lose money by keeping the prices competitive, or lose money by raising your prices and losing business. Either way, it's the same result.
    - 1998v2 7y ago
      Airlines sell tickets in advance, so hedging will allow them to match their near-future fuel prices to the ticket prices they're selling now. They consume fuel but don't produce it, so I don't think they can fully balance things out over time internally. edit: I see this was mentioned already in the thread.

namdnay 7y ago

I think the difference is that by the time an airline is buying fuel, they have already sold the tickets at a certain price. So hedging makes sense. That’s not the case with Walmart for produce - if tomatoes are more expensive to buy they can just sell them for more. The only things for which it makes sense are those that aren’t sold back, eg the fuel for their fleet of trucks etc

refurb 7y ago
Grocery prices are highly elastic. Yes, if gas prices doubled, Walmart could increase the price of their products, but consumers would likely buy a lot less, and Walmart sales would suffer. Walmart’s focus is on “low, everyday prices”, and future can help maintain those.
- ikeboy 7y ago
  There is absolutely no more reason to keep prices low if you've made a profit independently on futures than if you haven't. Your marginal cost goes up in both cases. If you're optimising profits, you should make the same decision in both cases regardless of if you bought futures.
  - refurb 7y ago
    Your marginal costs don't go up in both cases. If you have futures to buy diesel at $2.50/gal and the diesel price skyrockets to $4.00/gal, you can keep your prices the same. If you didn't have futures you couldn't without taking a loss.
    - ikeboy 7y ago
      This is incorrect. If you have futures, your marginal cost is still $4, since now you're using an additional gallon instead of selling it at market price at $4.
      - refurb 7y ago

xerox13ster 7y ago

Not just fuel for their logistics, but also selling gasoline in their Wal-Mart brand gas stations near their stores, Neighborhood markets, and Sam's Club. They ditched Murphy USA a few years back for much of this fuel and began sourcing it themselves. It's a way to ensure those prices are the lowest they can reasonably offer and still turn a profit.