Monday, March 14, 2016

Why Airlines Are Kicking the Oil Betting Habit: Attempts to take advantage of low oil prices aren’t so simple

The Wall Street Journal
By Charley Grant
March 14, 2016 11:16 a.m. ET

U.S. airlines are trying to harness low fuel prices to power their bottom lines. That might not be as simple as it sounds.

Low oil prices mean that major airlines are less interested in using derivatives to hedge their exposure to fuel-cost fluctuations.

Delta Air Lines said last week it has closed its hedges altogether, while United Continental Holdings and Southwest Airlines have scaled back their use of such contracts. In this regard they are catching up to American Airlines, which has eschewed the use of such safeguards since 2014.

Certainly, there are valid reasons for airlines to pursue this strategy. Fuel is the largest expense for an airline, and low prices have provided an earnings tailwind.

And with passenger unit revenues on the decline after a long climb higher, management teams need to find new ways to keep the bottom line growing. Lowering expenses is a natural place to start. Furthermore, using derivatives has a cost and exposes the contract holder to certain risks as well.

Still, it is no secret that oil prices are volatile. The average U.S. front-month crude-oil futures contract price has gained 17% or more in eight years since 2000, according to the Energy Information Administration. Similar volatility can be observed over shorter time frames as well.

Fuel expense has varied widely as a result. Those costs averaged 18.7% of revenue for the four major carriers in 2015, when the airlines enjoyed record profits. That was down from 33% in 2011. The higher number would have put a significant dent in those windfalls.

The move by airlines to bet on the persistence of lower energy costs may indeed turn out to be the correct decision. But investors should keep in mind that companies are still taking a significant risk by doing so.

Original article can be found here:

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