An airline plans to buy aviation fuel in December 2022 and decides to hedge using crude oil futures contracts. Based on their forecast of ticket sales, it is expected that 3,000 barrels is needed. Each futures contract is for the delivery of 1,000 barrels. The nearest delivery dates available are: December 2022, and January 2023. The current futures price for December 2022 is $110 and for January 2023 it is $120 per barrel. The current spot price of oil is $100 per barrel. The airline does not wish to take delivery of crude oil, and the forecast of sales is very uncertain due to impacts of COVID on travel. Some of its competitors do not hedge.
Explain the strategy the airline should use to hedge its oil cost using futures contracts (i.e. transactions to open the hedge and transactions to close the hedge).
Assume the futures price in January 2023 is $95 and the spot price is $90. What is the purchase cost in dollars with, and without, the hedge?
Discuss whether, in your opinion, the hedge removes all financial risk.
Discuss the advantages and disadvantages of hedging for this company.