The Airline Oil Spin

While airlines rail against the negative impact of speculating commodity traders on oil prices, it is often overlooked that airlines themselves engage in a form of oil speculation that has been vital to their survival: fuel hedging.

By speculating on the future cost of jet fuel, some airlines have managed to save billions of dollars in potential fuel costs. It seems that airlines are now trying to have it both ways, by condemning the “bad” speculators (the commodity traders) and ignoring the “good” speculators (themselves).

Fuel hedging is a strategy that airlines employ in order to insulate themselves from an anticipated rise in the price of jet fuel. Most commonly, airlines trade oil futures contracts and use the profits derived from those trades in order to offset the high price of fuel. According to MSNBC, “hedging has been described as everything from gambling to buying insurance.” U.S. businesses have begun to more aggressively speculate in commodities markets through fuel hedging in hopes of protecting themselves from high oil prices. According to the Wall Street Journal:

And who are these “speculators” driving up prices? The futures market operator Intercontinental Exchange says that an increasing share of its customers are not financial houses but commercial firms that need to manage oil-price risks – refiners, airlines, and other major energy consumers. Another term for these “speculators” would be “American business.”

As a result of its aggressive fuel hedging strategy, Southwest Airlines has hedged 70 % of this year’s fuel needs at $51 per barrel instead of the current price of more than $140 per barrel. Since 1999, hedging has saved Southwest an estimated $3.5 billion. Unlike Southwest, other domestic carriers have been less aggressive at hedging and are paying higher jet fuel prices because of it. Delta hedged only 27% of its first-quarter fuel consumption, while United hedged 30%, and Continental hedged just 22%, leaving them particularly exposed to the higher prices of jet fuel. As a result, Southwest was paying $1.98 a gallon for jet fuel during the first quarter of this year, while United was pay $3.02 a gallon during the same period.

As a form of speculation, fuel hedging bears inherent and potentially severe risks for airlines that rely on it. According to Jon Najarian, co-founder of Optionsmonster.com, a derivatives strategy firm, “if oil goes down too fast you get caught locking in prices ridiculously high, and then you carry that on to the consumer for a considerable period of time.” In 2006, Delta reported a loss of $108 from fuel hedging, while in 2007 Continental reported a first quarter loss of $18 million from hedging.