Jet Fuel Hedging and Firm Value: Evidence from publicly-traded airlines in Europe and Russia

Abstract

Jet fuel costs have historically been between 10 and 20 percent of commercial airlines’ total operating costs. In recent times the fuel costs have increased and surpassed labour costs as the largest operating cost item. Volatile jet fuel prices have generally forced airlines to embrace two different approaches to manage their jet fuel price exposure: transfer higher fuel costs to their passenger customers by increasing ticket fares or use different hedging practices. Of these, the former is less desirable since the industry is highly competitive and passengers tend to be very sensitive to changes in air fare. Competitive market conditions together with volatile fuel prices have therefore resulted in increased operational and financial hedging mechanisms in most European airlines.

The purpose of this thesis is to study whether there is a similar positive relationship of jet fuel derivatives hedging and firm market value in European and Russian airlines as reported in previous studies that have focused primarily on the US and North American airline industry. The natural logarithm of the simplified approximation of Tobin’s Q ratio is used to represent airline firm value. That has been a common practice in previous value effect studies. In addition to value effect, the focus is on estimating whether sample airlines’ stock returns are exposed to fluctuating jet fuel prices and also on identifying the determinants that drive jet fuel derivatives usage. The data sample consists of 15 publicly-traded airlines in Europe and Russia over the period from 2009 to 2016. Both univariate and multivariate approaches are applied to examine aforementioned relationships.

The results provided no consistent evidence to support the positive relation between the usage of jet fuel hedges and airline market value. In fact, some of the results indicated that jet fuel derivatives users experience a statistically significant decrease in airline value. The results regarding to jet fuel price risk exposure were somewhat in line with previous research and partly supported the hypothesis that airline stock returns are negatively correlated with jet fuel prices. Finally, analyses on the determinants of jet fuel hedging usage suggested that fuel hedging activity is more common in larger airlines, in airlines that utilize foreign currency derivatives and in airlines that have high management ownership.