ANALYSIS: Should airlines hedge their bets on fuel?

[flee 5]

Volatile oil prices bring into focus airline strategies for protecting themselves from spiralling fuel costs and whether they can avoid taking too much of a gamble.

 

When Delta Air Lines announced its intention to acquire an oil refinery earlier this year, the unusual move drew a mixed response from analysts. Some praised its innovation, arguing that its daily consumption of 210,000 barrels of jet fuel justified cutting out the middle man. Others questioned whether airlines should be in the business of refining crude oil.

 

But one thing no one disputed was the urgent need to offset fuel price volatility. According to IATA's latest forecast, Brent crude, the main European benchmark, is likely to average $110 a barrel this year - but in just six months spot prices have ricocheted wildly between $128 and $88.

 

For airlines that rely on stable ticket pricing to deliver profitability, such swings have brought fuel hedging firmly back into vogue during the post-2008 recovery. In its simplest form, hedging allows fuel prices to be fixed or capped for future expenditure, smoothing out unforeseen spikes in the oil price and bringing some certainty to margins.

 

But as Delta has experienced, this can be a double-edged sword. The airline wrote down fuel hedging losses of $155 million in the second quarter of 2012, alongside mark-to-market paper losses of $800 million for future hedges. It took the hit after West Texas Intermediate (WTI) crude, the main US benchmark, slumped from $110 a barrel in February to $78 in June, making spot prices much cheaper than the futures contracts Delta was locked into.

 

The spread between WTI and Brent reflects differing stockpiles on either side of the Atlantic, as well as variations in demand and transportation costs. Both benchmarks feed into secondary jet fuel prices - which, as of 6 July, have fallen by 10.9% year on year to an average of $117.40 a barrel, according to Platts.

 

Delta will not be the only carrier to record hedging losses in Q2 2012, but its results are the first worrying sign that the industry has repeated the mistakes of 2008, when airlines locked in sky-high hedges only to see Brent crash from $147 a barrel in July to $36 in December.

 

"There was a fear that oil prices were going to go to $200 or $300 a barrel," says Mike Corley, president of hedging consultancy Mercatus Energy Advisors. "The fear of being exposed to $200 a barrel was so great that a lot of people convinced themselves prices could not decline. Prices were rising so fast that many airlines started hedging without even really thinking about it."

 

Full article here: http://www.flightglobal.com/news/articles/analysis-should-airlines-hedge-their-bets-on-fuel-374733/

[BC Tam 2]

Simpleton like oneself fail to see how acquiring an oil refinery can help negate fluctuations in price of the final product used, which in Delta's would presumably be Jet-A1

Prices of the raw product needed by the refinery, be it Brent or WTI, will still oscillate according to market forces

Hence, so will cost of Jet-A1 from that particular refinery

Anyone can help ?

[nrazmoor 0]

Even IOCs/NOCs company find it difficult to manage a refinery these days because of lower margin and due to volatility of oil prices, and all of sudden Delta plan to acquire an oil refinery.... Well, good luck to them

[KK Lee 5]

In a volatile market, 50% of demand should be hedged. Anything more is gambling.