Some Airlines Turning to Fuel Hedging Again

High fuel prices have dealt a much milder blow to carriers that have used a practice known as fuel hedging.

Airlines that pay for their jet fuel when they fill up their planes have been forking well over $2 a gallon lately - nearly four times the average price they were paying just four years ago.

High fuel prices have dealt a much milder blow to carriers that have used a practice known as fuel hedging, which most often involves purchasing futures contracts that allow airlines to fix or cap the price they'll pay several months or years in advance.

Southwest Airlines Co. has led the pack, followed by Seattle-based Alaska Air Group Inc., the parent company of Alaska Airlines and Horizon Air.

Both companies are bracing to pay market rate for more of their fuel in the coming years after ramping down their hedging programs as persistently high oil prices sent the cost of those futures contracts soaring.

But now, with some experts predicting crude oil could creep up another $10, $20, even $30 a barrel, some airlines are taking cautious steps toward hedging again.

"The idea is to spend some money now to avoid the harm that would happen to our business if fuel went up by a significant amount," said Brad Tilden, Alaska Air's chief financial officer.

Some airlines hedge against jet fuel prices, which have averaged about $2.17 a gallon over the past three months - up from an average of about 55 cents a gallon in 2002, according to Energy Information Administration data on spot prices in three major U.S. markets.

Others base their contracts on the price of crude oil, which has been trading above $70 a barrel since spring, compared to an average of less than $15 a barrel in 1998.

Fuel hedging contracts have gotten proportionately more expensive because they're tied to the price of crude or jet fuel.

Though hedging is speculative by nature, companies view it more like an insurance policy than a risky gamble.

"You're basically buying a level of certainty," said John Heimlich, vice president and chief economist for the Air Transport Association. "The market price may be higher, it may be lower, but I know what I'm going to pay, and I can set my business plan accordingly."

In the last several years, Southwest has reaped sweeter rewards from fuel hedging than any other airline in the industry - nearly $1.8 billion in savings from 1999 to 2005.

Seven years ago, the Dallas-based low-fare carrier set a goal of having most of its projected fuel consumption hedged, said Laura Wright, the company's chief financial officer.

"We sleep better at night if we know what that cost is going to be," Wright said.

Southwest had a whopping 85 percent of its fuel hedged at a rate based on $26 a barrel for crude last year, when oil was often trading at twice that price. That shaved about $892 million off the company's 2005 fuel bill.

It's hedging almost three-quarters of its fuel at roughly half the going rate again this year. Even so, it expects to pay $800 million more on fuel this year than in 2005 because of the rising costs of both fuel and fuel hedging.

Unless oil prices plunge, its savings from advance fuel purchases will shrink in the coming years because it has smaller percentages of its fuel hedged each year through 2010, when it has advance purchases locked in for only 12 percent of its fuel.

One of the most common types of fuel hedging contract is known as a "call option," or "cap," which names the highest price an airline would have to pay for fuel, usually averaged over a future monthly or quarterly period.

Say, for example, oil is trading at $70 a barrel. An airline might pay a $5 premium to protect itself against fuel going past $75 a barrel.

"If fuel prices drop, well, we're out the premium we paid," said Steve Rock, manager of Alaska Air's fuel hedging program. "If prices go above the $75 barrel threshold, we would start getting compensated back for whatever quantity we purchased at that level."

Hedging became difficult, if not impossible, for some airlines during the industry-wide slump that followed the Sept. 11, 2001, terrorist attacks.

This content continues onto the next page...

We Recommend