US Airlines Rethink Hedges As Oil Price Drops

While US carriers saved hundreds of millions of dollars from oil prices halving since June, they forfeited a large chunk of that gain because of fuel hedges they bought as protection against oil rising.

The bulk of those hedges are set at levels that force airlines to pay more for fuel than current market prices, turning them into a hindrance rather than a help.

As a result, three of the four biggest carriers - Delta, Southwest and United - said this week they were rethinking their hedging tactics. Meanwhile American, which does not hedge fuel costs at all, is reaping the biggest savings.

Southwest said on Thursday its outstanding hedges represented a loss of USD$1.8 billion until 2018, at January 15 prices. However, it still expects a fuel bill that is more than 30 cents per gallon lower this year compared to 2015, or a roughly half-billion dollar net benefit.

Southwest has exited some contracts so that 30 to 35 percent of its fuel consumption in the second half of 2016 is covered by fuel hedges, down from 60 to 70 percent.

"While our hedging philosophy has not changed, our tactics have in this environment," chief financial officer Tammy Romo said. "We will focus on catastrophic protection with no downside risk," she added, referring to more expensive hedges that cap the price an airline will end up paying for fuel.

Delta said on Tuesday it has exited hedge contracts for 2016 at a cost of between USD$100 million and $200 million per quarter in order to save each dollar that fuel prices decline. It forecast savings at USD$3 billion this year.

"You could have made this call a while ago. The pain wouldn't have been so bad," aviation industry consultant Robert Mann said, noting oil oversupply is expected to continue as sanctions on Iran lift and the country pumps extra crude into the market.

United has not added new hedges since July and is evaluating its hedging structure, acting chief financial officer Gerry Laderman said on on Thursday.

At the same time, United said the oil price drop has hurt sales to energy clients near the airline's Houston hub.

To make matters worse, lower fuel costs have given big carriers room to reduce fares so that smaller, low-cost rivals do not undercut them, leading to revenue-draining price wars.

The big winner is American Airlines. It said its fuel cost was between USD$1.48 and USD$1.53 per gallon in the fourth quarter because it had not hedged fuel at all - better than Delta, United and Southwest by some 30 cents or more.