Delta Isn’t an Airline, It’s a Complex Derivatives Trading Firm.

Modern airlines are really transportation system, and part financial trading firm. And sometimes they’re more of the latter than the former.

Indeed, here’s what Delta has been up to,

Delta Air Lines posted USD1.1 billion in hedge losses during 1Q2015, and has worked to mitigate further losses from its hedge portfolio. During Feb-2015 the airline explained it took advantage of a 20% spike in forward curves to settle one-third of its 2H2015 hedges for USD300 million. It stated it extended a similar portion of its exposure out of 2H2015 to 2016. The rearrangement provides roughly USD300 million in cash receipts during 2H2015 and requires approximately USD300 million in cash payments in 2016. Delta’s logic is that by deferring settlement of a portion of its original derivative transactions, its restructured portfolio allows for additional time for the fuel market to stabilise while adding some hedge protection in 2016.

Since fuel is a huge part of the cost structure of an airline, and one that’s highly variable, one can make the case for locking in a price. But that’s another way of saying gambling on that the price of fuel is likely to rise rather than fall. In simplest terms if the market reacts differently than you’re betting, you lose money.

And the dollar amounts that the airlines are speculating in commodity markets with can be staggering.

United faced $100 million in losses for each $1 change in the price of oil at the beginning of the year. The airline lost over half a billion dollars in a single quarter in 2008 on its fuel hedges. And that’s after decrying the evils of oil speculation. The irony was completely lost on most observers.

Southwest long benefited from its fuel hedges, until they didn’t, and when they didn’t it was evil GAAP accounting’s fault.

Not all airlines do this. US Airways management has stayed out of the hedging game and brought the same philosophy to American. Asiana and airberlin have apparently gotten out of fuel hedging.

American makes the point that airline revenue and fuel prices tend to move in lock step, so they don’t really need to hedge against higher fuel prices. They’d lose big money if they bet wrong, and the transactions themselves can be costly.

That’s another way of saying that they’re in the airline business, not the commodities trading business. That also means they can only make money from their airline operation, not their trading floor.

Sub-$50 oil, though, has tempted many airlines to become day traders. Air India and Thai were in the market in 2015, and it seems to me that when Thai Airways goes all-in on oil futures and Air India wants a seat at the trading table too that the smart money has already been made.

I’m not an expert commodities investor. That’s why I invest primarily in low cost equity index funds. My nickel’s worth of free advice for the financial traders at these investment banks airlines is simple. Plastics.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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  1. Hedging, or buying forward, need not be speculation. At it’s simplest, if someone charters from me a full 747 today for a flight on March 1, at a price agreed today, then I can buy fuel today for delivery on March 1, or wait until March 1 to buy it. But I set my price to my customer on the basis of today’s price. So if I don’t buy my fuel forward, I’m exposed if the price goes up and speculating that it will fall.

    So, to the extent airlines sell non refundable tickets in advance, they should cover forward the related fuel. It’s prudence, not speculation. GAAP doesn’t understand this.

  2. Ha! Traders. You know a business is in trouble when it gets into the trading business. Usually the board and CEO have been conned by people who seem to be smarter than they are but also aren’t necessarily ethical and honest. Companies who have not been in trading don’t really understand all of the risks and potential pitfalls including rogue traders, market manipulation, etc. If one company gets into trading and has some initial success, other companies in that industry think they should do it too. I won’t claim to understand trading either. From what I’ve seen, though, traders make an awful lot of money and generally get huge bonuses based on expected outcomes not actual profits and losses. Profits can be big, but losses from trading can be huge compared to operations. IMO airlines should stick to what they know.

  3. In the long run, hedging losses and gains will nearly balance, leaving only the trading costs. If the airline is solvent for the long run, I don’t see why it should incur those costs. US Airways/American is right.

  4. Trading commodity derivatives when you have no use for the reference product is speculation. Those same transactions when you know you will be consuming (or producing) a certain amount of a commodity is far from speculation. Frankly, users of commodities who are not locking in forward prices are true speculators.

  5. i am guessing that some airlines reaped profit from hedging while imposing fuel surcharges.
    that is pretty low.

  6. @NB
    I am not an expert but reading what you say does not siund 100 pct accurate to me, since the airlines are not buying fuel for the tickets they sold, but for the entire operation of their fleet, going years forward, so it is kind of a gamble, they are not just buying todya;s prices to fuel up the next couple of months, and they also can adjust the sale price of future tickets if the fuel goes up….
    but I may be wrong all together in my 2 cents…

  7. An self proclaimed expert at runnig an airline is born every minute. The dunce that wrote this article is one of thrm.

  8. listen to @NYBanker as he’s the only commenter that seems to understand hedging; hedging “gains and losses” are offset by the rising/falling price of the underlying commodity (ie. if I hedge oil @$100/barrel and then the price is only $60/barrel then I’ve got a $40 hedging loss but I also bought the oil $40 cheaper than I had budgeted so that my net cost of the oil is the $100 I had budgeted. Hedgers base their trades on future activities but they don’t fully hedge well into the future. For example, an airline likely has a better grasp on flights/loads happening in December 2016 than in December 2017 so they’ll hedge a greater part of their fuel costs for December 2016 but then they’ll adjust their December 2017 hedges as they get closer to that date. Investors penalize companies with profit swings compared to those with smooth earnings so the hedges are meant to fight volatility, not to outguess the market. I do agree that self-insuring is best if you can afford it since you eliminate the trading costs. However, how many airlines could have survived $150/barrel oil ?? If guessing/speculating, it doesn’t matter how many times you are right since those funds get sent to investors, but guess wrong one time and the company can be bankrupt.

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