January 10, 2015 / 12:07 AM / 3 years ago

United Airlines dumps losing hedges, mulls new ones for long term

(Reuters) - United Airlines (UAL.N) has paid a premium to dump old losing bets on higher oil prices, and is reviewing its strategy for insulating itself from oil market volatility, in a sign of how some airlines’ efforts to hedge their fuel costs have backfired.

People are seen at the United Airlines terminal at Newark International Airport in New Jersey, July 22, 2014. REUTERS/Eduardo Munoz

The Chicago-based carrier reported Friday that it has shrunk its hedge position to cover 22 percent of the fuel it consumes in 2015, down from the 24 percent it had anticipated when oil prices were higher.

The airline said it did so at a cost, raising its average fuel expenses last quarter to $2.83 per gallon from up to $2.76 per gallon, the price it had estimated on Dec. 8.

This move represents just one step of a broader effort parent company United Continental Holdings Inc has taken to evaluate its fuel hedges, a United spokesman told Reuters.

At stake for United and its rivals are potentially billions of dollars in gains or losses that could flow from what amount to sophisticated bets on the future of oil and jet fuel prices. Guessing wrong could hurt profits and leave an airline vulnerable to competitive pressure from rivals that guess right, and have more cash to spend on new planes or better-appointed airport facilities.

Oil is the largest variable cost for airlines, often representing a third or more of their operating expenses. Plunging oil prices, down more than 55 percent since June, overall have buoyed airline profits and sent their shares soaring.

But the oil price drop caught many carriers off guard, as they had purchased financial instruments that protected against rising prices and that required them to pay hundreds of millions of dollars in collateral when prices fell.

United Airlines now must decide whether the cost of closing more of its existing hedges outweighs the risk of posting more collateral if prices continue to fall.

NEW HEDGES

Company officials have met to discuss whether United should unwind its hedges more than it announced Friday, the spokesman said.

They have also frequently discussed whether prices have bottomed out enough for them to make new hedges that could cover multiple years of fuel consumption, although they have yet to make any decisions and are keeping all options on the table.

A multi-year bet by Southwest Airlines Co (LUV.N) more than a decade ago protected the airline while oil costs for the industry soared.

“Southwest looked clairvoyant when they hedged at $30 (per barrel), and then the price shot up to $70 or $80,” United’s Chief Financial Officer John Rainey said in one section, reviewed by Reuters, of a recent memo to the carrier’s pilots.

“We’re mindful of this possibility and are closely evaluating our options.”

Yet locking in prices long-term comes at a premium, with $50 call options nearly twice as expensive when they expire in Dec. 2017 than those that last until Dec. 2015, for example.

And losses from a bad bet would be significant, as a $1 change in the price of oil amounts to $100 million for United, according to the memo.

“It’s prudent to be a little bit cautious here, and we’d like to see if there’s a new trading band that forms,” Rainey said.

Reporting by Jeffrey Dastin and Catherine Ngai in New York. Editing by Joe White and Christian Plumb

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