The task of controlling transportation costs

The task of controlling transportation costs

The task of controlling transportation costs has become one of the operational strategies that have significantly influenced and enhanced a company’s competitiveness in the airline market. Southwest and china eastern airlines have saved many million dollars in the cost of fuel through hedging but they have also incurred loss due to decline of the price of fuel in the past (Korkeamäki et al., 2016). Airlines purchase a certain amount of oil in the future at a pre determined price. The hedge fuel in a number of ways such as, purchasing current oil contracts, buying call options and purchasing swap contracts.

Southwest airline has a rapidly increasing advantage over other airlines because it loaded up years ago on hedges against higher fuel prices. With oil trading above ninety dollars per barrel, most of the airline industry is faced with a run up in costs while southwest is not (Liu & Jones, 2016). It owns longer contracts to buy most of its fuel at the equivalent of 51$ per barrel through 2009. The airline has a business model that is based on being a low cos provider and it has been successful in offering lowest fares in the industry.

This strategy has resulted effectively in a consistently increasing market share over the years. The most dominating factor of the airlines expense side is the cost of fuel (Liu & Jones, 2016). The second largest factor is the cost of labor. The rise in fuel prices has increased the importance of minimizing fuel costs and southwest consisted started by hedging its fuel usage and also wants to reevaluate the strategies it uses. while, delta has bought a refinery to hedge its exposure to the fuel market. The company does not plan to start hedging any time soon because of the jet fuel refinery that helps it insulate its operations from the gradually rising prices.

Hedging has allowed the airlines to take advantage of investment opportunities in times of high commodity prices which is explained by the significant distress costs in the industry. Airlines that are hedged against the higher prices have more resources at their disposal to invest in and they are therefore the only ones who are able to purchase the discounted assets (Manuela et al., 2016). This strengthens their competitive ability and grows value through a relatively more positive investment opportunities than their competitors. Southwest and delta airlines have benefited through this strategy, as the Delta airline has invested in an oil refinery that refines their jet fuel.

Diversification is the most effective hedging ways over a long-term situation. By holding uncorrelated assets and stock portfolio, overall volatility is minimized. Alternative assets typically lose less value during a beta market while diversified portfolio suffers lower average losses (Manuela et al., 2016). The southwest airline has used hedge using heating oil and plain vanilla swap for jet fuel, this strategy has a certain amount of floating price which would be exchanged for a fixed price. So, the southwest company is paying the fixed price and receiving the floating price.

There are various benefits that arise from hedging, and in addition, the financial distress costs, different hedging strategies also assist in the airline companies in reducing their cash flow variations. Delta and southwest airlines have hedged for two reasons, one of which is that they too conservative in the terms of risk taking and the other one is that, they want to avoid the future financial distress costs (Liu & Jones, 2016). by hedging, the two companies are able to focus on their core competencies and at the same time enabling the effectiveness of the operations in the company. Hedging reduces the price risk, avoids financial distress costs and maximizing the wealth of the stakeholders and the profitability of the company.

A company will have to hedge in order to survive the competition in the particular industry. The Delta and South-West airlines have hedged their positions in the market to save their companies from the future costs and reduce the risks of financial distresses (Korkeamäki et al., 2016). They are also able to exploit the high investment opportunities. Through hedging, an airline is able to buy the under prized assets in the market from other distressed airlines and competitors.

Airlines will continue hedging in the coming months and years. If oil futures have a negative beta, the value may appear as a premium in the future price over the expected value of oil. The expected loss will be the markets payment for the value of the negative beta risk (Korkeamäki et al., 2016). This may be the possible explanation for the six-year futures in 2005 being above the inflation adjusted cost of new long run alternative fuel sources.

Most modern minimum cost speeds for airplanes could be slightly higher than the minimum fuel burn speeds. This is because labor, maintenance and ownership costs vary with time. Tinkering fuel from low to higher cost airports may cost fuel bur and can be minimized with costs high everywhere. In some occasions, where fuel prices are quoted in the local currency, airlines can ask for the transport element in the fuel prices to be charged separately in the local currency.