United Dumps Losing Fuel Hedges
January 11, 2015
United Airlines has paid a premium to dump old losing bets on higher oil prices, and is reviewing its strategy for insulating itself from oil market volatility, in a sign of how some airlines' efforts to hedge their fuel costs have backfired.
United reported that it has shrunk its hedge position to cover 22 percent of the fuel it consumes in 2015, down from the 24 percent it had anticipated when oil prices were higher.
The airline said it did so at a cost, raising its average fuel expenses last quarter to USD$2.83 per gallon from up to UD$2.76 per gallon, the price it had estimated on December 8.
This move represents just one step of a broader effort parent company United Continental has taken to evaluate its fuel hedges, a United spokesman said.
At stake for United and its rivals are potentially billions of dollars in gains or losses that could flow from what amount to sophisticated bets on the future of oil and jet fuel prices. Guessing wrong could hurt profits and leave an airline vulnerable to competitive pressure from rivals.
Oil is the largest variable cost for airlines, often representing a third or more of their operating costs. Falling oil prices, down more than 55 percent since June, have buoyed airline profits and sent their shares up.
But the oil price drop caught many carriers off guard, as they had purchased financial instruments that protected against rising prices and that required them to pay hundreds of millions of dollars in collateral when prices fell.
United now must decide whether the cost of closing more of its existing hedges outweighs the risk of posting more collateral if prices continue to fall.
NEW HEDGES
Company officials have met to discuss whether United should unwind its hedges more than it announced on Friday.
They have also discussed whether prices have bottomed out enough for them to make new hedges that could cover multiple years of fuel consumption, although they have yet to make any decisions and are keeping all options on the table.
A multi-year bet by Southwest Airlines more than a decade ago protected the airline while oil costs for the industry soared.
"Southwest looked clairvoyant when they hedged at USD$30 (per barrel), and then the price shot up to USD$70 or USD$80," United's Chief Financial Officer John Rainey said in a recent memo to the carrier's pilots.
"We're mindful of this possibility and are closely evaluating our options."
Yet locking in prices long-term comes at a premium, with USD$50 call options nearly twice as expensive when they expire in December 2017 than those that last until December 2015, for example.
And losses from a bad bet would be significant, as a USD$1 change in the price of oil amounts to USD$100 million for United, according to the memo.
"It's prudent to be a little bit cautious here, and we'd like to see if there's a new trading band that forms," Rainey said.