Initial financial reporting for full-year 2008 indicates that the steep drop in fuel prices in the second half of the year was a double-edged sword for airlines around the world, many of which suffered significant losses on hedging programs. Some have serious hedging liabilities going forward if per-barrel crude oil prices remain low; programs that often paid off in the past now are biting back.

Merrill Lynch estimates that nine major Asian carriers alone will combine for $3.8 billion in fuel hedging losses for 2008 and can expect an "especially unpleasant" first half of 2009 partly owing to hedging liabilities. In the US, perennially profitable Southwest Airlines posted losses in both the third and fourth quarters on hedging charges and has conceded it has a net hedging liability of around $1 billion in 2009-13 even though it has moved to reduce its hedging position.

Some airlines, such as SWA, have been hedging aggressively for years, a strategy that proved beneficial when crude oil prices skyrocketed to as high as $150 per barrel in the 2008 summer. Others that had been reluctant to place bets on fuel prices in the past scrambled to hedge last year as fears of $200 oil became prevalent. But oil prices have receded rapidly since last July, sitting at around $50 per barrel currently, leaving numerous carriers paying well above market rates for a good percentage of their fuel.

"The steep reduction in fuel prices is cold comfort for many carriers locked into higher prices," the Centre for Asia Pacific Aviation said last week. "Hedging contracts have provided some spectacular losses for many carriers in the past few months."

Air China, for example, suffered mark-to-market fuel hedging losses of $994.5 million for 2008, according to CAPA. Cathay Pacific Airways and China Eastern Airlines both recorded mark-to-market hedging losses of more than $900 million.

Thai Airways moved fast to hedge in the first part of last year and is paying the price. In the last six months of 2008 it hedged more than 40% of its fuel needs at $86-$125 per barrel, well above market rates. The carrier, which likely will report a full-year loss for 2008 for the first time in more than 40 years, cannot extricate itself from the high level of hedging at high prices until at least March.

Airlines around the world have been defending their hedging as necessary, noting that predictions of $200 oil were within the mainstream of expert opinion in the early part last year. Thai called hedging a "risk management tool" and claimed it wasn't expecting the program to be a means to "making profit."

United Airlines Chairman, President and CEO Glenn Tilton, who came out of the oil industry, said the "implosion" in oil prices has created a "huge commodity bubble, just as we had a huge credit bubble." UA recorded mark-to-market hedging losses of $547 million in the fourth quarter alone and posted a $5.3 billion net loss for the full year. CFO Kathryn Mikells said hedging is akin to "taking an insurance policy out" and that one should not "expect them to pay."

American Airlines Chairman, President and CEO Gerard Arpey noted that hedging "is designed to dampen the impact of fuel price volatility and it is not designed to take risky speculative bets on what we believe the price will be at a specific point in the future. In periods [during which] the fuel prices rise, hedges can buffer expense increase, while in the periods where fuel prices are falling, hedges will offset some of that favorable impact." Overall, he asserted, hedging has been a positive and will continue to be so going forward.

AA predicts that average system price for jet fuel will be $2.06 per gal. in 2009. But it won't be able to enjoy the full benefit of those prices because it has 35% of its anticipated full-year fuel consumption hedged at an average cap of $2.59 per gal.

SWA has moved to "substantially" reduce its fuel hedge position given the "rapid collapse in energy prices," and estimates that about 10% of its consumption will be hedged through 2013, according to CEO Gary Kelly. He said that the LCC's jet fuel costs per gal. "could exceed market prices" by 16-17 cents from 2009 to 2011, by 10 cents in 2012 and by 8 cents in 2013.