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Should airlines rethink fuel hedges?

jonjuan

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http://articles.philly.com/2011-02-06/business/27104421_1_fuel-hedges-jet-fuel-fuel-surcharges

Should carriers rethink fuel hedges?
February 06, 2011|By Linda Loyd, Inquirer Staff Writer

Fuel prices are the No. 1 worry of airlines, with crude near $90 a barrel and unrest in Egypt heightening uncertainty over where oil prices may head.

Like other industries that depend on fuel, most airlines hedge a portion of their fuel needs to reduce the effect of volatile crude prices. But hedging - paying to cap or lock in prices - is risky, and it is expensive.

US Airways Group Inc. does not hedge, a strategy that recently paid off. Philadelphia's dominant airline - with no fuel hedges - had the lowest fuel cost last year of any major U.S. carrier.

Even though jet-fuel prices jumped 29 percent year over year, the most effective hedging strategy in 2010 was not to hedge at all, US Airways president Scott Kirby said in an interview.

"We don't hedge fuel," Kirby said, "because it's just too expensive." Hedging for a year's worth of jet fuel would have cost the Tempe, Ariz., carrier about $335 million.

Without fuel hedges, US Airways posted a $447 million profit, the second-highest annual profit in the company's history.

Hedges work as insurance against unexpected swings or large increases in commodity prices - oil, oranges, wheat, gold, steel - by capping a price, or locking in a range of prices, months in advance.

These futures contracts can take several forms - called options, swaps, and collars. Jet fuel is airlines' biggest cost after labor.

Most airline observers say they think hedging some fuel is a good idea. On the other hand, airlines can and do lose money on hedges.

"It's important to know that fuel hedges are very expensive," said analyst Helane Becker with Dahlman Rose & Co. L.L.C. "If you are going to hedge, you have to have a really strong balance sheet with a lot of cash and be prepared to be right and wrong. The reality is you wind up in some cases having higher fuel costs than you would otherwise have."

At an airline conference Thursday in New York, Delta Air Lines Inc. president Edward Bastion said that, even with 36 percent of its 2011 fuel hedged, Delta would have to raise fares and lower growth plans to offset higher fuel.

Airlines have increased fares four times in the last 45 days, as well as added fuel surcharges on international routes to offset higher oil.

"The cost of hedging is very damaging, not only for airlines, but for any large commodity user," Virgin America Inc. chief executive officer David Cush said in an interview last week.

"It's not a transparent market. It costs $6 to $8 per barrel to hedge a barrel of fuel, regardless of the price. It is an outrageous cost," Cush said. "You have a handful of players, primarily the big banks, and it's in their best interest to keep the cost of hedging very high."

Still, the San Francisco low-fare carrier partly owned by British billionaire Richard Branson has about 80 percent of this quarter's fuel use hedged and 60 percent in the second quarter.

"We just want to know what our fuel prices are going to be six to eight months out," Cush said. Hedging is standard practice in industries that use a lot of raw materials. "It's the best way to plan a business going forward," he said.

I see fuel hedges as a form of insurance," said airline analyst James Higgins with Soleil Securities. "Insurance costs money, but it also helps to overcome catastrophic situations. Unfortunately, it looks as though Virgin America may survive another year."

US Airways' decision not to hedge lowered its fuel expense the last several quarters. But if oil stays where it is, or goes higher, the airline will "see a significantly larger year-over-year increase" in 2011 fuel costs compared with competitors, Higgins said.

US Airways' Kirby said the industry would be more profitable if it did not hedge. "Even if oil goes up another 29 percent again, not hedging will be the best policy in 2011," he said. "We are an industry that has fuel-price risk, and we cannot solve it through fuel hedging."

If all airlines stopped hedging, "they all would have the same problem, and be equally incentivized to pass through fuel surcharges," said airline analyst Hunter Keay with Stifel, Nicolaus & Co. Inc.

"Right now, their hedge books are not providing much of a benefit," he said.

Freight carriers UPS Inc. and FedEx Corp. do not hedge, but instead pass on fuel increases in surcharges to customers. However, it is easier to pass through a fuel surcharge on freight than on passengers who are sensitive about ticket increases.

Southwest Airlines Co. traditionally hedged much of its fuel needs, but incurred losses when crude spiked at $147 a barrel in July 2008 and then plunged to $33.87 a barrel by year's end.

Southwest had to account on its books for millions in fuel contracts that were priced higher than the market. Jet fuel generally follows crude prices.

On Southwest's earnings call last month, airline analyst Glenn Engel of Bank of America Merrill Lynch remarked about the trade-off benefit of hedges, which had a "big impact" on Southwest earnings, causing a 24-cent-per-share hit to 2010 profit, and which will result in a 15-cent-per-share impact on 2011 earnings.

"It's costing your market cap $1.5 billion, and it doesn't seem like your hedges really give you that much benefit until oil is well over $110 a barrel," Engel said.

Southwest chief financial officer Laura Wright replied that 2010 began with "locked-in losses" from hedges in late 2008, which continue to have a "net negative" hangover effect into 2011.

"We decided a long time ago as a company that we're willing to incur a certain amount of expenses premium for insurance to protect against the volatility that we have with energy prices," Wright said. "I think certainly over our history that has played out well."

It's a gamble either way. Airlines were profitable in 2010, but lost money on their hedges.

"What needs to be considered here is the cost of hedging," Keay said. "It costs Southwest $150 million a year to hedge. It costs Delta about $200 million a year to hedge. Their hedges need to save them $200 million for that entire transaction to start saving them money.

"Don't get me wrong, I understand why airlines hedge," he said. "2008 is still burned in their memories. If crude goes to $147 a barrel again, they are going to look very smart. I just think it would be a much more rational pricing environment if every airline got rid of their entire hedge book tomorrow."
 

RedDogC130

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enough
$119.79 as of 2/25/11


I did not think airlines look at Brent Crude for the "price". I thought it was the other crude...which right now is $97.15

Two vastly different prices depending what you are looking at
 

Tomct

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Or an even better idea. How about we drill for our own freaking oil here in the U.S. and stop being held hostage by OPEC??? Hmmm, that might help. You hear that you idiots in D.C.?
 

dicko

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Crash Pad

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Or an even better idea. How about we drill for our own freaking oil here in the U.S. and stop being held hostage by OPEC??? Hmmm, that might help. You hear that you idiots in D.C.?

What could go wrong?

For the sake of argument I'll play. Where? Where are these mountains of cheap oil that we aren't drilling? Last I checked they are sitting in the ocean going through a mile of water, then two miles of ground, in hopes of finding oil.

Come on do you believe everything Palin tells you. Exxon spends a lot of money looking for oil. The return on investment is decreasing. Meaning they are spending more and finding less.

Sorry. Why did I start. Drill baby drill! As soon as we find our own oil the price will go to 30 bucks.
 

Fubijaakr

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Or an even better idea. How about we drill for our own freaking oil here in the U.S. and stop being held hostage by OPEC??? Hmmm, that might help. You hear that you idiots in D.C.?

Get a clue, Ace. Do a little research. See if you can find out where our Alaska North Slope oil goes. Here's a hint...it isn't where you think it goes.
 

kf4amu

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IATA monitors jet fuel price weekly. If I'm reading it correctly the price per barrel for Jet fuel was $ 119.20 on 18 Feb.



http://www.iata.org/whatwedo/economics/fuel_monitor/Pages/index.aspx

This will include the crack spread between the price of crude and the price of jet fuel. Equates to about 20 dollars a barrel to the refinery.

To be more accurate, crack spread price should be included since it does vary...from what I understand its gone from 15 to 25 dollars a barrel for jet fuel refining.
 

SWA GUY

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When we talk about crude oil, and domestic pricing, WTI (West Texas Intermediate) is the baseline. Europe uses Brent as a baseline.
 

Ben Franklin

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Airline pilot mentality curse:

Whenever there is a chance that I might get screwed: I have thee smartest airline management in the world.

Whenever there is a chance that the airline might get screwed: I have thee dumbest airline management in the world.
 

Tomct

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Ok, take AK out of it...don't want to hurt Fubi's feelings....in the Gulf, they found 3 wells that were the biggest finds in history. They are deeper than any other, but they say we have the technology to go get it. The estimated barrel is over 100 Bill per well. Just passing on what the article said, we need to get out of ME oil plain and simple.
 

knowlimits

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http://www.popularmechanics.com/technology/engineering/4255407


Sorry, my quote was wrong, not 300 million barrels, it is an estimated 500 million barrels. I think this could help us out. It definitely has it's challenges, but this could really help us out with the price of oil. Fingers crossed. ;)

Dude, Saudi Arabia produces over 10 million barrels of oil a day. The US consumes almost 21 million barrels of oil a day. Domestic drilling is not the answer.

Turn off Fox News and go for a walk.
 
Last edited:

Tomct

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Dude, Saudi Arabia produces over 10 million barrels of oil a day. The US consumes almost 21 million barrels of oil a day. Domestic drilling is not the answer.

Turn off Fox News and go for a walk.


Uh, WHERE was Fox News in that article? Maybe you should turn off MSNBC and go for a walk you. :rolleyes:
 

dicko

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Tomct

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I'll take any kind of positive direction that is out there. ;)
 

ACL65PILOT

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Simple fact of the matter is this:
Airlines would love to have the cost of fuel be added as a surcharge after the base fair. Problem is that, in the domestic market, this is illegal. I do know that a few airline CEO's are pushing for the law to change and rightfully so. We are the only industry with this hindrance.

The reality is that a surcharge would take the competitive advantages away from hedging, and make fuel a pass through costs, as it should be, and as it is in every other industry in the country.
 
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