Airlines have long used fuel hedging (buying in bulk at a committed price) to give themselves an advantage for their largest expense. How are those hedges performing now?
What Is Fuel Hedging?
Jet fuel is typically the largest single expense for an airline (depending on the price) but can make running the business unpredictable. Commodities like oil that have yet to be produced and delivered can vary in price significantly from month to month. Because they have yet to be produced and delivered, bulk purchasers can buy oil at a locked-in price for a future date. Fuel hedging is the act of making those advance purchase commitments at a locked-in price and quantity for future delivery.
For example, Southwest Airlines was famous for hedging a low fuel price for years into the future and it fueled their growth from LCC to the largest domestic carrier in the largest single air market in the world. Southwest’s strategy became a case study on the topic and they’ve produced a page discussing it. Here’s an example of just how effective the strategy became:
“With OPEC struggling to preserve market share and unwilling to trim production in step with falling demand, oil prices cratered. At one point, crude hit $11 a barrel and jet fuel was quoted at just 35 cents a gallon. Southwest loaded up on crude oil futures contracts, which yielded huge profits when oil prices rebounded to $26 a barrel in December 1999 and then $34 in November 2000.” – Southwest Airlines
In that example, Southwest had its highest expense at a 70% cheaper price than competitors. Coupled with a newer, fuel-efficient fleet, it was the single biggest driver in its growth over other carriers that grappled with the fluctuations.
Airline Fuel Hedging Positions
Not every airline hedges fuel, but it’s incredibly important at the current moment amid all-time high prices for oil. American, Delta, and United Airlines do not use fuel hedging, opting to pay market rates for oil rising and falling with the market cost as and when they need it. The thought process is that by not hedging they are more or less even with the competition on fuel; as it becomes cheaper or more expensive, the advantage and disadvantage is the same.
Here are some of the airlines that have currently hedged their fuel and at what prices if stated:
- Air France/KLM – 72% Q1 2022, 63% Q2 2022 @ $90/bbl
- Cathay Pacific – 100% Q1/Q2 2022, 50% Q3/Q4 2022 (no price disclosed); additional hedging in 2023
- EasyJet – 60% Q1/Q2/Q3 2022 @ $72/bbl
- IAG – 70% Q1 2022, 65% Q2 2022 @ about $60-70/bbl
- Lufthansa – 63% all of 2022 @ $74/bbl
- Qantas – 90% Q1/Q2 of 2022, 50% Q3/Q4 of 2022 (no price disclosed)
Reuters had additional details.
The Problem With Hedging
Right now, hedging part of an airline’s supply is a very attractive business model. An airline doesn’t have to hedge its entire supply, for example, if Stewart Airlines uses a million barrels (bbls) of fuel a month (during the pandemic in 2021, US carriers only used 328 million bbls combined) they may choose to hedge half of that and pay the “float” price of the remaining quantity needed.
The problem with hedging is that locking into the wrong price can handcuff an airline as happened with Cathay Pacific in 2017.
“Bloomberg reports that Cathay Pacific is struggling to take off as it reports its fourth consecutive year of deficits amidst massive fuel-hedging [losses] worth $6.45b in 2017 with analysts expecting a turnaround by 2019.
Even though the airline has reduced the proportion of fuel it hedges, the effects still weigh on the company’s financials as the futures contracts were locked in years ago.”
That would have been a tough time for a turnaround given the pandemic around the corner and global lockdowns.
Similarly, no airline wants to hedge when prices are already high ($120/bbl) but should they reconsider that strategy as forecasts suggest oil could reach $175/bbl by year-end? If the Russian-Ukrainian conflict were to cease tomorrow and a recession took full effect, dropping demand, the airline that locks in today at $120 out of fear of $175/bbl later could find themselves in the next Cathay Pacific position.
It’s always a gamble and like gambling, there are always winners and losers.
It’s a precarious time to run an airline and even harder when facing the fuel costs that they encounter today. My gut leans toward a partial hedge, and reluctant optimism that prices will drop not rise. That said, there are real-world consequences for airlines that don’t hedge at all vs those who do, and those who hedge incorrectly vs those that hedge at the perfect time. Despite forecasts for higher fuel costs in the future, I’d be inclined to hedge light in this environment.
What do you think? Should airlines hedge now in fears of fuel costs rising? Is it time to just let it play out and wait for some calm from the storm?