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Airlines bet on long oil slump after millions lost to hedging

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Two of the world's biggest airlines are betting that oil prices won't rally any time soon, growing more cautious after losing hundreds of millions of dollars on hedges.

[CALGARY] Two of the world's biggest airlines are betting that oil prices won't rally any time soon, growing more cautious after losing hundreds of millions of dollars on hedges.

United Continental Holdings and Delta Air Lines have reduced fuel hedging as oil plunged close to a six-year low. They've become more like American Airlines Group, the biggest global carrier, which closed its last hedging position in 2014.

"There is a growing realisation that American's approach was the smarter one," Bob Mann, president of airline consultant RW Mann & Co, said in a phone interview.

"These programmes have not met expectations, costs are very high and the results have underperformed." 

Getting it wrong has been costly. Hedging losses over the past three quarters totalled US$1.95 billion for Delta, the world's third-largest airline; US$650 million for United, the second largest; and US$326 million for Southwest Airlines Co, the fourth-biggest US airline, according to data compiled by Bloomberg.

The companies locked in fuel prices before the price of crude collapsed over the past 17 months. Losses were calculated by totaling the settled hedging results for each quarter as provided on company releases and conference calls. The hedging figures were confirmed by spokesmen at all three airlines. The airlines, all US based, are ranked by their passenger traffic.

Reducing Hedges Delta said last month that it hedged 5 per cent of its fuel for next year, down from 20 to 25 per cent announced in May and 30 to 40 per cent announced last year for 2015. United is 17 per cent hedged for next year, Gerald Laderman, acting chief financial officer, said last month on an earnings call. In October 2014, the company said it was 35 per cent hedged for the following 12 months.

Airlines commonly hedge using swaps, call options or so- called costless collars, which involve buying calls and selling puts to create a floor and ceiling on price. Companies hedge off jet fuel as well as West Texas Intermediate and Brent crude oils and other refined products such as gasoline.

While hedging can protect against price surges, they pay for the benefit. Alaska Air Group Inc, for instance, paid an average of US$3 a barrel for call options that gave it the right to buy oil for delivery in the first quarter at US$76, the company has said.

"You look at how much our competitors have lost this year on that so-called safe insurance policy," Scott Kirby, American's president, said in July on the company's second-quarter earnings call.

"There is no free lunch. You can't go off and protect against the downside and pretend it doesn't cost you a lot of money." West Texas Intermediate (WTI), the US benchmark, has dropped as low as US$38.24 a barrel this year from US$107.26 in June 2014 amid a glut of supply that the International Energy Agency estimates will persist until at least mid-2016. US crude futures will average US$54.23 a barrel next year, according to the mean estimate of 26 analysts, data compiled by Bloomberg show.

Aviation fuel is down 43 per cent in the past year to about US$1.40 a gallon in New York, according to data compiled by Bloomberg. WTI has fallen 42 per cent over the period to about US$43 a barrel on the New York Mercantile Exchange.

With fuel accounting for as much as 30 per cent of their costs, airlines operate sophisticated oil forecasting models, George Ferguson, senior aerospace and airline analyst at Bloomberg Intelligence, said in a phone interview. Some have hired oil traders from investment banks and, three years ago Delta bought the Trainer refinery in Pennsylvania.

"The bigger picture is they feel oil is going to be lower for longer," Mr Ferguson said.

Delta spokesman Trebor Banstetter said the carrier had no comment on its strategy beyond what was said on earnings calls and investor updates. We are "pretty cautious", Delta's chief financial officer Paul Jacobson said on an earnings call last month.

United spokeswoman Megan McCarthy referred to a Nov 9 statement at a conference by acting CFO Laderman, who said the airline's hedging strategy has changed because there isn't as big a risk today that a short-term event will cause "a shock to oil prices" as there was in the past.

This isn't a bad time to buy a "lottery ticket" should prices surge, Carl Larry, head of oil and gas for Frost & Sullivan LP, said by phone. Yet "airlines are seeing the big picture here - oil prices, especially US oil prices, are going to stay stable for the next year or so", he said.

Southwest has taken a different course. It's increased its hedging again after cutting it earlier in the year. The carrier raised coverage to 35 per cent for next year, up from 10 per cent announced in February. That amount was down from 40 per cent covered last year.

"We view our hedging program as catastrophic insurance," Chris Mainz, a Southwest spokesman, said in an e-mail. "We will continue to actively manage our hedging position to protect from the impact of rising fuel costs."

BLOOMBERG