Southwest Airlines is famous for its fuel hedging strategy. Aircraft fuel, i.e. Kerosene, is a derivative of crude oil and accounts for 30%-40% of the cost of flying an airplane and hence a significant expense. Southwest routinely uses forward contracts to lock in the price for aircraft fuel using Crude Oil futures.

a. Describe Southwest’s exposure to fuel prices and describe the position Southwest should take to hedge the price of fuel. Illustrate your answer using either a Table, a Graph, or Equations as a function of future fuel prices.

b. Kerosene is a different commodity compared to crude-oil. What are the challenges in hedging fuel costs using Crude Oil futures contracts?

c. Explain the pros-and-cons of hedging. Consider scenarios as of June 2019 and June 2020.

Answer rating: 100% (QA)

a Southwest Airlines is highly exposed to fuel prices as fuel accounts for a substantial proportion ... View the full answer