Market Insight: What an airline's oil trading strategy reveals about ticket prices

Operating an airline in a way that shareholders can enjoy is a notoriously difficult undertaking. Over a five-year period, Lufthansa shares are up around 20 percent - not a particularly impressive performance. The Dax, for example, has gained around 60 percent in value since autumn 2021.

One reason for the poor performance of many airlines lies in their business model. An important cost factor has been very volatile in recent years and is beyond management's control: the price of fuel, kerosene.

The strategies airlines use to hedge against fluctuating commodity prices are therefore among the industry's best-kept secrets. Until now.

Kang was head of finance at Qatar Airways from 2011 to 2013. A look at the oil price chart reveals that the period is certainly comparable to today's market environment. At that time, the oil price was trading at more than $100 for a long period of time. Kang found a situation in which Qatar Airways was burning millions using classic hedging strategies, as he also recently described on the Bloomberg podcast “Odd Lots.”

Such classic hedging strategies involved airlines buying derivatives or other financial instruments that increase in value when oil prices rise. The idea: Profits from derivatives can be used to offset costs caused by increased purchasing prices for kerosene.

However, this simple hedging strategy ignores the correlation of oil prices with demand for airline tickets. Both depend on the economic cycle. Kang sums it up this way: “When oil is expensive, the global economy tends to be strong – and passengers fly.” Airlines could make money with clever hedging. But: “The protection takes effect exactly in the case in which the airline least needs the help.”

The situation is different if oil prices collapse as a result of a recession: an airline that hedges against high prices is then threatened with high losses in the hedging business. At the same time, bookings and sales are also collapsing in this environment. “Although cheaper fuel prices provide cost relief, this is more than outweighed by the double deficit of declining booking numbers and realized hedging losses,” explains Kang.

The surprising finding: declines in the price of kerosene can sometimes hit an airline harder than high kerosene prices. Since demand for airline tickets is often robust in times of high oil prices, the additional costs can be passed on to passengers.

Qatar Airways therefore introduced a fuel surcharge on tickets in 2011. Lufthansa also uses such fees. Kang's analysis shows that with a kerosene price surcharge, an airline can largely protect itself against rising prices. It is enough to hedge only very high and very low prices with complex financial instruments.

Using this strategy, Kang says Qatar Airways made $130 million in profit within just five months. This is good news for airline shareholders – less so for customers. When an airline CEO says the company is protected against high prices, what he really means is that passengers bear the additional costs.