US airline fuel hedging Part 2: Alaska Air, JetBlue and Southwest try to crack the hedging code

Similar to the the US global network airlines Delta and United, Southwest, Alaska and JetBlue are greatly benefitting from lower oil prices. And like their larger rivals, the smaller airlines are attempting to manage their hedging portfolios effectively in light of lower oil prices.

Southwest, Alaska and JetBlue are each taking a different approach to managing their hedge programmes. Southwest seems to have been in and out of the market in 2015 while Alaska’s strategy remains unchanged. It continues using call options, and is willing to pay a bit more for its hedging insurance to protect against downside pricing. JetBlue does not appear to have made dramatic changes to its hedge book, but watches what its competitors do closely.

Those three airlines, and all carriers, are attempting to craft hedging strategies to effectively manage the fuel price volatility that has occurred in the market place during the last year. It is a formidable challenge, but the overall upside is a substantial decrease in one of their largest cost inputs.

Southwest's hedging moves in 2015 show the challenges of dealing with price volatility

As previously reported by CAPA, 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 forecast 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 forecast at USD59.42 per barrel.

This is Part 2 of a two part CAPA Report. For Part 1, please see:
US airline fuel hedging Part 1: United, Delta fight to reduce losses. American enjoys hedge-freedom

All airlines have benefitted from the sharp drop in fuel prices, but like many airlines Southwest is attempting to navigate the complexities of hedging when fuel pricing is unpredictable. The airline definitely enjoyed a significant drop in fuel prices in 1H2015, and has attempted to manage its hedging programme in a sensible way, CEO Gary Kelly has recently stated.

Southwest fuel price per gallon: 1Q2015 vs 1Q2014 and 2Q2015 vs 2Q2014

1Q2015 1Q2014 2Q2015 2Q2014
USD2.00 USD3.08 USD2.02 USD3.02

In late 2014 Southwest stated that in response to the collapse in fuel prices it was effectively unhedging its 2015 fuel consumption. But during 2Q2015 the airline noted that energy prices started to trend upwards, and Southwest executives became concerned that market prices would continue to escalate. As a result the airline opted to add some hedge positions in 2H2015. Prices then fell, and as a result Southwest estimates that for 3Q2015 the losses from its hedge book would reach USD0.40, which was baked into its fuel cost per gallon estimate of USD2.20. The airline’s fuel cost per gallon in 3Q2014 was USD2.94.

With the unwinding of previous hedges, and the losses from adding some hedging back in the latter half of 2015, Southwest is estimating a USD0.25 fuel hedge penalty for the full year of 2015. But the airline is still forecasting an overall USD1.3 billion decrease in economic fuel cost for 2015.

At the end of 2Q2015 Mr Kelly explained, “we’re currently participating in a large percentage of the downside here in the third quarter [of 2015]. It is not as quick as we where, but it’s still substantial and it is producing fuel prices well below a year ago”.

Southwest CFO Tammy Romo remarked the company was still working on its hedge book for 2016 and 2017. “Our bias at this point is to lower jet fuel prices. So we’re working to balance that as best we can.”

Alaska Air is willing to pay higher prices for insurance against fuel volatility

At the beginning of 2015, Alaska Air Group opted to address the issue of falling oil prices and its fuel hedging strategy head on. The company described its hedging strategy as simple and straightforward. “We buy call options that act as an insurance policy against sudden spikes and allow us to fully participate in fuel price declines with no risk of collateral calls.”

Subsequently, Alaska’s management was queried as to whether it would change the way it was building its hedge positions since the price of call options were likely pricier given the decline in fuel prices. Alaska responded that “we are very systematic in it”, noting it takes the approach that hedging is insurance, and “when insurance rates go up slightly you continue to buy insurance”.

At the end 1Q2015 Alaska highlighted its year-on-year decline in fuel cost per gallon in the quarter from USD3.32 to USD1.98. And again, it reiterated its systematic approach to fuel hedging.

“Although different airlines use different techniques to manage fuel price risk, we remain committed to our simple, low-risk, low-volatility programme that uses only call options as a form of insurance, and as a result we fully benefit from lower oil prices,” the airline concluded.

Alaska Air Group fuel cost per gallon: 1Q2015 vs 1Q2014 and 2Q2015 vs 2Q2014

1Q2015 1Q2014 2Q2015 2Q2014
USD1.98 USD3.32 USD2.12 USD3.20

Alaska executives further explained that its hedging programme performed well during the run-up in fuel prices in 2008 and when prices fell after hitting historic highs in 2008-2009. The hedge portfolio also performed well as fuel prices increased from 2010 to 2013, Alaska stated. Alaska also noted it was fully participating in the current collapse of fuel prices.

Alaska’s strategy is a “little more expensive,” the company admitted. To further illustrate its logic, the company explained that if hedging costs rise from roughly USD10 million per year to “possibly USD19 million or USD20 million...that’s about USD0.04 a gallon. We think that’s insurance money well spent”.

Alaska’s decision to spend more for the insurance that hedging brings has not resulted in the airline paying substantially more than other airlines. Its all-in fuel price during 1Q2015 was lower than Southwest’s and below JetBlue’s per gallon costs for both 1Q2015 and 2Q2015.

JetBlue enjoys the upside of lower prices while not drastically altering its hedging strategy

JetBlue hedged 21% of its fuel requirements in 1Q2015, and its price per gallon in 1Q2015 fell 34% year-on-year to USD2.06. The airline also recorded USD35 million in losses on hedges that settled in the quarter. For 2Q2015, the airline hedged roughly 19% of its consumption, and paid USD2.13 per gallon, which was a 31% decrease year-on-year. During 2Q2015, the airline recorded USD30 million in hedge losses that settled during that quarter.

JetBlue Airways fuel cost per gallon: 1Q2015 vs 1Q2014 and 2Q2015 vs 2Q2014

1Q2015 1Q2014 2Q2015 2Q2014
USD2.06 USD3.14 USD2.13 USD3.09

The airline has hedged 14% of its estimated 25 million gallons of fuel consumption for 3Q2015 and projects an average price per gallon of USD1.95 including the impacts of its hedges. It has hedged 15% of its projected 25 million gallon fuel consumption for 4Q2015, but has not provided an estimate of price per gallon.

JetBlue generally uses swaps and caps for its fuel hedging, and has stated it did not add to its hedge book in 1Q2015. Generally, the airline says it pays attention to the hedging strategy of its competitors. It has not drastically altered the percentages of consumption it planned to hedge in 2015 (based on guidance issued in late 2014), and has still enjoyed significant decreases in its fuel costs.

Few airlines have shown they can crack the difficult hedging puzzle

The hedging strategies adopted by US airlines during the past year when fuel prices have decreased significantly vary widely, and show that no one airline has masterfully crafted a plan to avoid posting hedge losses or paying higher premiums for its hedging insurance.

Arguably, the huge savings that most airlines are enjoying in fuel outweigh the challenges in solving the hedging puzzle. Projections of fuel costs per barrel in the USD50 range for the next year are no doubt a welcome development for airlines worldwide.

But the challenge of managing a hedging programme in a volatile fuel environment is not something that most airlines have mastered, and attempting to craft effective hedges in 2016 and beyond may prove to be vexing.

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