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.