Oil price making life miserable for airlines

If oil prices stay high, an airline’s last defence against record oil prices might  be swept away.  The barrier commonly called fuel hedges — financial transactions that essentially act as insurance against higher oil prices — will run out at year’s end. Houston-based Continen-tal has none in place for 2005, in part because it was just too expensive with prices this high.  Airlines either can’t or don’t want to enter into long-term pricing deals when oil is this high, noted Betty Simkins, an associate professor of finance at Oklahoma State University. “It’s sad because the industry is hurting so much,” Simkins said.  Research by Simkins and colleague Dan Rogers at Portland State University showed that among airlines that have hedged, most carriers significantly reduced their hedging by the end of 2003.

Struggling the past three years with changing travel trends and the financial aftermath of the 2001 terrorist attacks, many airlines have seen their credit erode, making it even more expensive to buy this fuel price protection. The strategies used for hedging come in a variety of forms, but the goal is generally to use these financial transactions to profit if prices rise beyond a certain level. These earnings help offset the rise in fuel prices. The hedges are normally based on crude oil prices because there are far more parties speculating on crude, making it easier to find someone to be on the other side of the bet. Continental also started 2004 without hedges in place, but when prices took off early this year, the Houston carrier had a change of heart. It hastily locked in a price that would have seemed excessive a year before but now looks like a savvy move.

Currently any airline locking in a hedge would be paying to protect itself from oil prices rising well past the $50 level. For example, if an airline were to get a hedge at around the $55 per barrel level, it would need to lock in a price ensuring it could buy crude for no more than $60 per barrel. Continental has 46 percent of its fuel volume in the fourth quarter hedged at $36.50 per barrel. But at year-end, the carrier goes back to paying full price. The average price of jet fuel increased from less than 86 cents in the third quarter of 2003 to nearly $1.20 in the same period in 2004. Continental and most other airlines are ill-prepared for such a jump in their second-biggest ex-pense after labour. “With the current weak domestic yield environment caused in large part by the growth of low-cost competitors and fuel prices at 20-year highs, our cost structure is not competitive,” Continental said in a filing with the Securities and Exchange Commission several days ago.  

The fuel crisis has helped force some carriers into bankruptcy, with ATA Airlines, the 10th-largest carrier in the US, joining the list this week. Larry Kellner, Continental’s president and chief operating officer, said the carrier is preparing by doing everything possible to fly more efficiently. “I think the real hedge is to have a fleet that is much more fuel-efficient than our competitors,” Kellner said during a conference call to discuss third-quarter earnings last week.  “None of our major competitors have significant hedge positions in 2005.”  The carrier also is outfitting some planes with winglets, which improve mileage by reducing drag, and doing things like determining if it can cut down the amount of extra fuel it must carry on some flights. (See Pages 12 and 13)