As many questions have been globally thrown around, one specific question pertaining to the circumstances of these odd times I seem to question myself. How does the value of Oil affect the airline industry? One might think, supply and demand. However, I believe that with more refined research that the answer could be different than my original response. I hope to reach the true definitive answer to this question. I will be scouring academic sources to use in this research paper. I plan to research academic sources to explain facts and data that have not been exactly displayed in the spotlight. I hope by the end of this paper, more knowledge and insight of information will be gained by reading this.
Before viewing the upcoming paragraph, there is some basic information and terminology I must address to fully understand everything that is being discussed. Stock Cost, After an organization, opens up to the trade market and starts offering to exchange on the market, its cost is controlled by the interest for its offers in the market. Volatility, is a statistical measure of the dispersion of returns for a given security or market index. Hedging, means strategically using financial instruments or market strategies to offset the risk of any adverse price movements. Call options, are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. A collar hedge – is an options strategy implemented to protect against large losses, but it also limits large gains.
II. The Dependence of Oil for the Airline Industry
First, we must understand the terminology and language used by the airline and oil industry. Airline fuel is the organization’s largest cost, and those prices can be identified with the possession of the oil. At the point when oil costs are expanding in the worldwide economy, it’s certain that the stock costs of Airlines drop. At the point when oil costs decrease in the economy, it’s foreseeable that the company’s share price will go up. High Fuel costs are so detrimental to the prices of flights and costs of airlines so, that the fluctuating cost of oil is the primary cost of aircraft organizations. Since the cost of oil is very volatile, airline companies shield themselves from unpredictable oil expenses. Sometimes airline companies try to exploit the circumstance. Airlines commonly practice fuel hedging. They do this by purchasing or selling the future cost of oil through investment technology, protecting airline organizations from losing future pay.
III. How Important Fuel is to Maintaining Financial Stability
One of the two main ideas to take away from the previous paragraph is when oil prices go up the airline stock prices usually go down and vice versa. The other idea to take in is that airlines practice fuel hedging to limit their losses when there is high volatility in oil prices. They do this by purchasing options. Call options are basically the right to buy the underlying stock on the expiration date as long as the stock is above the strike price. For example, if the price of oil is $100.00 per barrel and you buy a call option with a strike price of $105.00 that expires in 6 months. Then in 6 months say oil is $200.00 per barrel then the company can save $95.00 on the barrel of oil. But if oil goes down the lose the premium they paid for the contract. This is the reason why airline businesses are very dependent on the price and availability of fuel.
High volatility in fuel costs, increased fuel prices or significant disruptions in the supply of aircraft fuel could negatively impact the operating costs and liquidity. Because airlines need so much fuel to operate all their aircraft even a small fluctuation in the price of aircraft fuel can affect profits that’s why airline flights are sometimes cheaper than others. Political wars, natural disasters, wars involving oil-producing countries or when government polices have fuel related changes.
IV. Different ways that Airline companies acquire Oil
There are several strategies that airline companies use to increase their profit margin. According to Evan Tarver, there are four common ways that these companies acquire oil. For starters, Buying Current Oil Contracts. In this situation, airline companies would need to accept that the costs of oil will ascend later on. To relieve these rising costs, these companies buy a lot of current oil contracts for their future needs. This is like an individual who realizes that the cost of gas around town will gradually go up throughout the following year and that he will require 100 gallons of gas for his vehicle over the course of the following year. Rather than purchasing gas monthly, weekly, or daily, he decides instead to buy every one of the 100 gallons at the current value, which he hopes to be lower than the gas costs later on.
Another common way that airplane companies try to save on fuel is, buying call options. At the point when an organization buys a call option, it permits the organization to buy a stock at a particular cost that includes a specific date. This implies that aircraft organizations can protect themselves against rising fuel costs by purchasing the option to buy oil later on at a value that is priced today. For instance, if the current cost per barrel is $100, yet an aircraft organization accepts that the costs will build, that carrier organization can buy a call option that costs $5. That gives it the option to buy a barrel of oil for $110 inside a 120-day time frame. On the off chance that the cost per barrel of oil increments to above $115 inside 120 days, the return rate increases even more.