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ATW Editor's Blog

Gambling on jet fuel & how hedging relates to airfares

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American Airlines’ CEO and CFO were feeling bullish today, with justification, as they reported net income of $2.9 billion for 2014, the first full year following the merger with US Airways.

An interesting part of this story was Doug Parker and Derek Kerr’s decision not to fuel hedge, a gamble that paid off as oil prices dropped from all-time highs in the latter part of 2014. Most other major airlines took the more obvious and conservative route and hedged.

That, of course, worked the opposite way for them with some taking hits in the fourth quarter, most markedly Delta Air Lines, which took a $1.2 billion fourth-quarter charge for mark-to-market adjustments on fuel hedges settling in future periods. As a result, Delta, unable to realize the benefits of a 14% year-over-year drop in the December quarter’s average price per fuel gallon, incurred a $712 million net loss in the fourth quarter.

The gamble could have gone the other way, of course, but Parker and Kerr seemed confident in their choice.

 “We didn’t think it made sense to hedge. Large drops in fuel prices are quite costly to companies” that engage in fuel hedging, Parker told analysts and reporters Tuesday.

To which Kerr added, “Somehow you’ve got to convince yourself that you know better than the oil market experts. All the rationale for not hedging in the past still exists today.”

American’s decision was gutsy, but it’s also something of a hallmark of Parker and Kerr who have been long-time partners through America West, US Airways and who created the “New American”.

IATA has forecast that the drop in oil prices - to about $85 per barrel this year, or some 20% lower than last year - will help push down average round-trip airfares by 5%.

If you understand this industry, however, and realize that hedging is a common, usually wise practice, then you’ll know there will be a lag in those fares coming down principally because of hedging. Some US self-styled air travel consumer advocates are calling on US airlines to “slash airfares and do it now”, citing the drop in oil costs.  But for most airlines, their hedging policies mean they don’t see an immediate benefit of jet fuel costs; rather, some are taking a hit. That will change as they adjust their hedges, while oil price cuts in general tend to stimulate economies and boost air travel.

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