The Wall Street Journal
By Susan Carey
March 20, 2016 7:01 p.m. ET
After decades of spending billions of dollars to hedge against rising fuel costs, more airlines, including some of the world’s largest, are backing off after getting burned by low oil prices.
When oil prices were rising, hedging often paid off for the airlines, helping them reduce their exposure to higher fuel costs. But the speed of the 58% plunge in oil prices since mid-2014 caught the industry by surprise and turned some hedges into big money losers.
Last year, Delta Air Lines Inc., the nation’s No. 2 airline by traffic, racked up hedging losses of $2.3 billion, while United Continental Holdings Inc., the No. 3 carrier, lost $960 million on its bets.
Meanwhile, No. 1-ranked American Airlines Group Inc., which abandoned hedging in 2014, enjoyed cheaper fuel costs than many of its rivals as a result. “Hedging is a rigged game that enriches Wall Street,” said Scott Kirby, the airline’s president, said in an interview.
Now, much of the rest of the industry is rethinking the costly strategy of using complex derivatives to lock in fuel costs, airlines’ second-largest expense after labor.
Somes airlines have decided that, with oil prices weak, the potential benefits from hedging may no longer justify the risks. Delta and United said they have no hedges in place for next year.
Smaller U.S. carriers, including JetBlue Airways Corp. and Spirit Airlines Inc., have been minimizing their hedges, according to their public filings. Even in Europe, where carriers have been big advocates of hedging, some airlines are scaling back.
“We don’t need to hedge that risk like we used to,” said Gerry Laderman, acting chief financial officer of United. “That doesn’t mean that hedging is off the table. We are looking at formulating…a different way of thinking about it.”
In hedging, airlines enter into financial contracts that get more valuable as oil or fuel prices rise, offsetting the run-up in prices. But the reverse is also true. The value of these contracts fall when prices fall, creating trading losses—in some cases large ones—and canceling out the benefit of the cheaper fuel.
Oil prices, which peaked at $147 a barrel in 2008, are currently at around $41 a barrel, after rising from a 13-year low of $26 in mid-February. Some analysts and traders think the recent rally won’t hold amid a global oil glut, and that prices will remain weak for some time.
Another factor in the hedging pullback: a round of megamergers, capacity cuts and more fuel-efficient aircraft have fattened the industry’s profits, leaving carriers in better financial shape—and less vulnerable to a spike in fuel prices.
Airlines aren’t the only companies that have relied on hedging. Meat processors and other food manufactures might hedge to protect themselves from price swings of key raw materials like hogs or wheat. But airlines’ exposure to fuel costs can be more obvious to consumers, who often feel it in the form of higher ticket prices and international fuel surcharges when oil prices rise.
American swore off hedging after merging with US Airways Group. Most of its postmerger executives hail from US Airways, which abandoned the futures markets in 2008. Deep discounter Allegiant Air stopped hedging in 2007. Canada’s low-fare WestJet Airlines Ltd. gave it up a few years ago.
Delta, which bought its own refinery in 2012 to control some of its supply, recently closed its hedge book. It expects to book further losses of $100 million to $200 million in each of the final three quarters of this year.
While Delta said it remains committed to hedging, it hasn’t had a gain from the practice since the second quarter of 2014. But the company still expects the weaker oil market to pare this year’s fuel tab by $3 billion from 2015, Paul Jacobson, its chief financial officer, said in an interview.
United’s hedge position, which covers 17% of its fuel consumption this year, stood at a loss position of $225 million in January. Most of that deficit stems from hedges placed in 2014. United hasn’t added any new hedges since last July. “This is the least hedged we’ve been in quite a while,” said Mr. Laderman, the CFO.
Asian and European airlines have tended to rely more heavily on hedging because they must spend U.S. dollars to buy fuel but collect most of their revenue in other, and recent weaker, currencies. In Europe, after “huge” hedge losses last year, some of the largest carriers are hedging less of their future consumption, said Andrew Lobbenberg, an analyst for HSBC Bank PLC.
While a geopolitical crisis could quickly push up oil prices again, experts said airlines with good credit could easily jump back into the futures market, although it would be costly.
“It’s always possible we’d hedge in the future,” Bob Fornaro, chief executive of Spirit Airlines, which is unhedged for this year.
Southwest Airlines Co. ’s successful hedge strategy in the 2000s culminated in a $1.3 billion hedge gain in 2008. Over the next few years, however, Southwest routinely lost money on its hedges. It estimated in January that its 2016 hedge book—for 20% of its consumption—was $1 billion underwater, meaning the airline will pay 50 cents to 60 cents more per gallon for jet fuel than some rivals.
Even so, Chris Monroe, vice president and treasurer, estimates that hedging shaved $2 billion off Southwest’s fuel bill between 2001 and 2015. He said the carrier continues to see value in it. “It’s like having a teenage-boy driver living right in the middle of your income statement,” he said. “You need some insurance on him.”
Original article can be found here: http://www.wsj.com
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