US Airlines More Cautious On 2010 Fuel Hedges

February 25, 2010

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Major US airlines are taking a more cautious, though varied, approach to fuel hedging this year, after incurring blistering losses from hedges in 2008 when oil prices spiked then tumbled.

In 2008, many airlines, wary of rapidly rising oil prices, locked in their fuel prices at relatively high levels just before crude prices began to fall as the economic recession took hold and sent energy markets into freefall.

Losses for some airlines ran into the hundreds of millions of dollars on a quarterly basis, prompting a rethink in fuel hedging strategies, with some pulling back on positions.

"We know what can happen when market conditions change or market sentiments change. We still cast a very cautious eye on oil prices," Tom Horton, chief financial officer of American Airlines parent AMR, told the Reuters Travel and Leisure Summit this week.

At the beginning of this year, American Airlines had hedged 24 percent of its full-year fuel requirements, down from 35 percent at the same time last year for the whole of 2009. Currently for 2011 only a small percentage is hedged.

Oil prices fell from a record USD$147 a barrel in mid-2008 to around USD$40 by the end of the year, hitting the coffers of many airlines that had fuel hedging programmes.

NYMEX futures prices have since rebounded to around USD$80 a barrel, and despite a recent fall in volatility, airlines, with 2008 still fresh in their memory, are taking a more cautious approach.

Oil price volatility cost United Airlines parent company UAL USD$370 million in cash losses on fuel hedges that settled in the fourth quarter of 2008, which helped change its attitude toward hedging.

"In 2008, the hedge positions that we had were 100 percent at-risk positions. As crude prices turned around from USD$147, because we had a portfolio with all at-risk positions we really took it on the chin," Kathryn Mikells, chief financial officer of UAL, told the summit this week.

"We no longer use 100 percent collars. Buying some straight call options in our portfolio allows us to participate in the upside opportunity should prices fall," Mikells said.

For the first quarter of 2010, the company has hedged 70 percent of its fuel consumption at a crude equivalent price of USD$75 a barrel. So far for 2011, 5 percent is hedged.

While all airlines recognise the dangers of crude price volatility, there is no consensus strategy to avoid losses from future price crashes.

"As an industry we are highly fragmented. Everybody has taken a different position," said Mikells.

US Airways, which also took a hit in 2008, has not hedged at all since August 2008, and has no immediate plans to return to fuel hedging.

"This is not a prudent use of our shareholders' money right now... The volatility has been so great over the last year," US Airways CFO Derek Kerr said.

Even airlines whose bets paid off in 2008 are now treading more carefully. Southwest Airlines, which saved about USD$1.3 billion from its hedging programme in 2008, has tempered its involvement since then.

"Oil prices will continue to be volatile and they will continue to live through a lot of market swings as we have seen over the last year and a half," said Laura Wright, Southwest CFO.

"We lessened our hedging primarily because we felt energy prices were going to be under downward pressure between 2010 and 2011," she said, adding that longer term prices will likely rise with a recovering economy.

In 2010's first quarter, Southwest is hedged about 60 percent up to USD$100 a barrel, 27 percent for USD$100-USD$120 a barrel and about 47 percent above USD$120, Wright said.

(Reuters)