US airline fuel hedging Part 1: United, Delta fight to reduce losses. American enjoys hedge-freedom


There is no doubt airlines worldwide are benefitting from drastically lower year-on-year fuel prices, with lower oil costs driving much of the profitability enjoyed by US airlines. But the sudden drop in fuel costs that began in the latter part of 2014 resulted in some airlines being bitten by their hedge portfolios as the rapid slide in prices resulted in ample losses from some airline hedging programmes.

Two of the large US global network airlines – Delta and United have recorded losses from their hedge books in 2015 and are attempting to mitigate further damage. American, which opts not to engage in fuel hedging, is enjoying the full benefit of lower fuel costs without the difficulty of attempting to adjust a complex hedge portfolio to stave off losses triggered by the drop in fuel prices.

No-one can predict how long fuel prices will stay at their current levels; but signs are prices will remain well below historic highs through 2016. Overall, that is good news for airlines, but designing hedging portfolios during the next couple of years to exploit the declines and stave off further volatility will offer challenges and opportunities.

This is Part 1 of a two part series on fuel hedging by US airlines.

Delta Air Lines restructures some of its hedges after suffering losses in early 2015

Data from the US Energy Information Administration (EIA) show that WTI crude oil prices per barrel were USD97.98 in 2013, USD93.17 in 2014 and forecasted at USD49.62 in 2015. Brent crude was priced at USD108.56 per barrel in 2013, USD98.89 in 2014 and projected at USD54.40 in 2015. Its projections for WTI in 2016 are USD54.42, with Brent forecasted at USD59.42 per barrel.

Obviously that is a boon for airlines since fuel is their single highest input cost. But the sharp and quick drop in fuel prices has created some headwinds for airlines whose hedge books were not set-up to completely reap the benefits of a sharp price decline.

Delta Air Lines posted USD1.1 billion in hedge losses during 1Q2015, and has worked to mitigate further losses from its hedge portfolio. During Feb-2015 the airline explained it took advantage of a 20% spike in forward curves to settle one-third of its 2H2015 hedges for USD300 million. It stated it extended a similar portion of its exposure out of 2H2015 to 2016. The rearrangement provides roughly USD300 million in cash receipts during 2H2015 and requires approximately USD300 million in cash payments in 2016. Delta’s logic is that by deferring settlement of a portion of its original derivative transactions, its restructured portfolio allows for additional time for the fuel market to stabilise while adding some hedge protection in 2016.

At the end of 1Q2015 the airline forecast USD650 million in hedge losses for 2Q2015, and stated for that quarter it was 40% hedged against a rise in prices and had 90% full downside participation to Brent prices of USD40 per barrel. At the end of 2Q2015, Delta projected a USD1 billion decline in 3Q2015 fuel expense, net of USD200 million in hedge losses.

After making adjustments to its hedge book, Delta in 2Q2015 estimated its fuel price per gallon of USD1.90 to USD1.98 for 2H2015, and its fuel costs in 2H2015 would be 28% lower than 1H2015. For 2H2015, Delta stated it was 15% hedged against a rise in oil prices, with 85% downside participation for Brent as low as USD40 per barrel. “Overall, we continue to expect fuel costs to be an enormous tailwind and provide a net benefit of more than USD2 billion for Delta this year, [2015]” said company CFO Paul Jacobson.

Delta Air Lines all in fuel cost per gallon: Year-on-year change, 1Q2015 vs 1Q2014 and 2Q2015 vs 1Q2014

1Q2015 1Q2014 2Q2015 2Q2014
USD2.93 USD3.03 USD2.40 USD2.93

Delta’s rival United has also faced some hedge portfolio headwinds in 2015; United posted a USD200 million hedge loss in 1Q2015, of which USD10 million stemmed from 2Q2015 positions the airline closed out in 1Q2015. United recorded a USD200 hedge loss in 2Q2015, and predicted a USD225 million loss for 4Q2015 while participating in 77% of a decline in fuel costs for the last quarter of 2015.  

United in 2Q2015 opted to create what it described as a small hedge position in 2016 “marking our first entry into the market since oil prices began to decline late last summer [2014],” said then CFO John Rainey. “We will continue to be opportunistic as we consider layering on additional hedge positions.” As of 30-Jun-2015 United had hedged 22% and 5%, respectively, of its projected fuel requirements for the remainder of 2015 and 2016.

Mr Rainey described United’s historic approach to fuel hedging as “more of a mechanistic structure, where it has sort of been on autopilot”, but admitted in periods of extreme volatility that is not necessarily the most prudent way to hedge.

Looking forward into 2016, Mr Rainey explained that having an ability to reduce volatility in one of United’s largest cost inputs allows United to accomplish other tasks such as recently outlining a USD3 billion share repurchase programme. “If we see a more stable environment with less volatility going forward, we might be able to get back to a hedge programme more like what you’ve seen in the past,” Mr Rainey stated. For the full year 2015 United is projecting all in fuel costs per gallon in a range of USD2.07 to USD2.12.

United Airlines all in fuel cost per gallon: Year-on-year change, 1Q2015 vs 1Q2014 and 2Q2015 vs 1Q2014

1Q2015 1Q2014 2Q2015 2Q2014
USD2.12 USD3.18 USD2.17 USD3.08

American Airlines has adopted the legacy US Airways approach (the two airlines are in the process of merging) of not hedging against sudden spikes or decreases in fuel costs. The policy is reflected in American’s consolidated cost per gallon falling lower than its rivals in 1Q2015 and 2Q2015.

American Airlines fuel costs per gallon: Year-on-year change, 1Q2015 vs 1Q2014 and 2Q2015 vs 1Q2014

1Q2015 1Q2014 2Q2015 2Q2014
USD1.83 USD3.10 USD1.90 USD3.03

American for now remains unconvinced that there is any upside to hedging. “It’s really expensive to buy that insurance,” company CFO Derek Kerr recently explained. “You look at how much our competitors have lost this year on that so-called safe insurance policy.”

The top executives of US Airways are now at the helm of American, and have held that view since 2008-2009 when US Airways opted to unravel its hedging programme.  US Airways posted annual profits in 2010, 2011, and 2012 when oil prices were markedly higher, and the company was unhedged.

Mr Kerr highlighted the correlation between fuel prices and airline revenues, both rise at the same time and fall at the same time. That has certainly been the case in 2015, but airlines are still remaining profitable since revenues have not fallen as fast as fuel costs. American continues to benefit from its decision to abandon hedging as its estimated fuel costs for the remainder of 2015 will fall below its large global network airline rivals Delta and United.

Price volatility makes hedging a challenging exercise for Delta and United

Full hedging is a complex exercise, and each airline shapes its portfolio based on its philosophy about seeking insurance against volatile fuel prices. Elements of a given portfolio can include swaps, options and futures contracts.

Airlines have faced oil price volatility since 2008, and arguably no US airline has crafted a hedging strategy that has created a comprehensive shield against price fluctuations. Perhaps American has charted the right course. In Europe, Ryanair used to do be hedge free, then changed tack just in time to suffer a little when prices dropped. The other US airlines still believe buying protection creates a certain level of upside to price volatility.

American does not appear to have any plans to change its clear cut strategy of not hedging in the near future, but United and Delta are attempting to create hedging portfolios to combat the volatility in oil prices, which now seems to be one of the more challenging tasks in airline operations.

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