The management of financial risk exposure of fuel price changes in the Airline Industry: the case of African Airlines

Abstract

Hedging fuel costs is 'Widely practiced by most international airlines. Similarly in Africa major carriers have adopted hedging of fuel costs using derivatives. However, theoretical justification of hedging using derivative is still weak. This study explores how African airlines have managed financial risk exposure caused by fuel price changes and whether there is value in hedging of fuel costs using derivatives. The study is anchored on the underinvestment theory of risk management which asserts that risk management programs that break the dependence of investment on external cash flow can maximize firm value.

The theory suggests that firms 'With key planned investment programs and costly external financing would be inclined to use risk management to avert the need to access costly external financing to continue these programs. This study examines the relationship between fuel price movement, cash flow and capital expenditure in order to establish whether managing fuel costs through derivative hedging would guarantee cash flow certainty hence help solve the underinvestment problem.

Fuel price fluctuation has a direct impact on fuel cost hence investigating the value of fuel price risk management using derivative hedging in the airline industry in Africa is no doubt interesting considering the immense contribution of airline industry to national economies. It is important to note that the study is carried out against a back drop of myriad of challenges facing the global airline industry ranging from a volatile operating environment as well as the ever changing global financial environment. A better understanding of fuel costs management through derivative hedging IS therefore important to airlines industry stakeholders in general.