U.S. airlines eye oil prices to set fuel hedges

www.forbes.com Reuters, 03.20.03, 4:49 PM ET By Meredith Grossman Dubner

CHICAGO (Reuters) - U.S. airlines will likely wait to lock in costs on future jet fuel purchases to see if oil prices -- already at three-month lows at the start of an Iraq war -- fall even further, analysts said Thursday.

Jet fuel, which makes up about 15 percent of airlines' operating costs, is the industry's second-largest expense after labor and is also one of the toughest to manage. Airlines try to control fuel costs by hedging, which helps them protect against higher prices down the road.

Airlines consume 18 billion gallons of jet fuel a year, and each penny increase in jet fuel means an additional $180 million in costs for the industry, according to the Air Transport Association, the airlines' main trade group.

Jet fuel, which peaked near $1.20 a gallon last month, will cost the industry about $16 billion this year if it remains near 90 cents per gallon.

Jet fuel prices are closely tied to heating oil and crude oil. Nearby heating oil futures have slipped more than a third in the last week to 83 cents a gallon, down from an all-time high of $1.31 a gallon four weeks ago.

Nearby crude oil futures in the last week have plunged about 27 percent to $29 a barrel from just four weeks ago, when they hit a 12-year high of $40 -- their highest level since the 1991 Gulf War.

"To the extent that (crude oil) gets back down into the low $20s, maybe (airlines) do start layering on more hedges. But I don't think you're likely to see that until we get down to that level," said William Warlick, airline analyst at Fitch Ratings.

FIGHTING TO OFFSET LOSSES

Airlines can hedge fuel costs with futures and options on heating oil and crude oil, or through forward contracts with the oil companies themselves, among other strategies.

"The reason you hedge is to reduce the volatility of your earnings. The war introduces a whole new component into volatility of earnings," said David Swierenga, chief economist at the Air Transport Association.

Many airlines, expecting that an Iraq war and the strike in Venezuela could prompt a spike in oil prices, put on hedges late last year when crude was more than $30. Others, though, were hesitant to commit to hedges at those prices, fearing they would lock themselves into fuel prices that would be too high once a war passed, said Ray Neidl, analyst at Blaylock & Partners.

UAL Corp.'s United Airlines, which filed the largest bankruptcy in aviation history in December, has said it has no hedges for its 2003 fuel purchases. US Airways Group , also in bankruptcy, may have a small amount of hedges, if any, analysts said.

Low-cost carrier Southwest Airlines and No. 4 U.S. airline Northwest Airlines have both said they are fully hedged for first-quarter fuel purchases. Southwest is also roughly 87 percent hedged for the second quarter at $23 a barrel.

Other airlines are currently hedged between 40 percent and 60 percent for fuel costs at prices between $20 and $30 a barrel, Neidl said.

"In contrast to the early 1990s where many, if not most, U.S. airlines were unhedged, the U.S. airlines have become more proactive and are more hedged with respect to fuel price exposure," Deutsche Bank analyst Susan Donofrio said in a recent research note.

The biggest eight U.S. airlines posted losses of more than $11 billion for 2002. Airlines have tried to offset rising fuel costs by tacking on ticket surcharges, but travelers have not been receptive in an environment where demand for air travel is already weak.

"The war premium seems to be disappearing because people ... are assuming that this war will be quick," said Aaron Brady, senior analyst at Energy Security Analysis near Boston. "(But) if there are dramatic developments like Saddam blowing up all his oil fields, you can bet that prices will reverse rather quickly."