Oil below $100 could bite some airlines this winter

MarketWatch (MCT) - With the price of crude down nearly 30 percent from record highs this summer, airline investors are finding that lauded fuel-hedging programs can come with some risk.

At the end of the second quarter, when oil was nearing $150 a barrel and appeared to be heading even higher, airlines snatched up contracts that locked in fuel prices below the going market price. That strategy saved them money in July, when jet-fuel prices soared to $3.38 a gallon, a 60 percent jump from the year-ago period.

But some of those gains could be undone by tumbling oil prices, leaving carriers stuck with fuel contracts above current market prices.

"Our hedges could be in the money or out of the money, depending upon where fuel prices are on any given day," said Valerie Wunder, a spokeswoman at US Airways.

"If they are out of the money, meaning that the price of oil is lower than where our hedges are, then we are losing money on the hedge," she said. "If fuel prices are higher than our hedges, then we are saving money."

Last week, Continental said it expected its end-of-quarter cash position to be slightly lower than expected from falling energy prices, while American Airlines parent company AMR Corp. said its cash position too will be impacted.

Ireland's Ryanair said it expects to break even this year, despite falling oil prices. At the time, Ryanair Chief Executive Michael O'Leary said, "While the recent fall in oil prices is welcome, it won't have much impact on our full-year results because we have already hedged (the fiscal third quarter ending Dec. 31) at $124 per barrel."

United Airlines could also get bruised, saying last Wednesday it could lose as much as $294 million in the third quarter, based on oil at around $95 a barrel. The carrier's fuel cap averages around $111 a barrel this year and $118 for 2009.

United Airlines is a subsidiary of UAL Corp.

In energy trading Tuesday, the November contract for oil traded at $105 a barrel in electronic trading, off some 29 percent from a record high of about $147 a barrel in July.

How lower fuel prices will impact airlines' end-of-the-quarter results will depend on how they mixed their hedging models.

Northwest Airlines, for example, has about 68 percent of its fourth-quarter fuel costs hedged at an average of $3.31 a gallon. If the company bought only 100 gallons for the period, its total fuel bill would be about $325 if the cost of jet fuel fell to $3.11 a gallon.

But if the airline hadn't hedged any of its fuel, it would just pay $311 per 100 gallons, a 4 percent difference that could add up to hundreds of millions for the carrier, which consumed 436 million gallons of fuel in the second quarter.

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Northwest is slated to merge with Delta Air Lines at the end of the year. Delta has said it doesn't expect any write-downs this year from its fuel-hedging programs.

At the other end of the spectrum, AMR has just 38 percent of its fourth-quarter fuel hedged at $3.33 a gallon. If the average market price in the fourth quarter were $3.11 a gallon, it would cost the airline $9 for every 100 gallons of fuel it uses in the quarter, a 3 percent difference.

If the market price for fuel were to fall to last year's average of $2.17 a gallon, back when oil was selling for around $72 a barrel, the difference in cost would widen to 17 percent.

Oil dropping to that level is highly unlikely, and the crack spread for jet fuel _ the difference between the price of a barrel of crude oil and a barrel of refined jet fuel _ remains significantly wider than in the recent past.

Airlines stress they aren't making bets on fluctuating fuel prices as much as they are trying to smooth out the risk that comes with trying to budget expenses in a volatile oil market.

"We have a systematic approach to fuel hedging, designed to dampen the volatility of fuel prices, and is not designed to speculate or make a big bet on the future price of oil," said Andy Backover, a spokesman for AMR. "We're constantly layering in hedges as the year progresses, and this approach has served us well in recent years and has been very effective."

In July, U.S. airlines collectively purchased 1.11 billion gallons of jet fuel for $4.1 billion, according to the U.S. Bureau of Transportation Statistics.

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