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 In theory, airlines are among the top beneficiaries of a six-month
slump that halved crude prices to five-year lows. Oil is the biggest
variable cost for airlines, often representing a third or more of
their total operating expenses.
But now, carriers such as Delta Air Lines and even Southwest
Airlines, known for a successful hedging program that locked in
cheap fuel prices before they rose a decade ago, see some of the
benefits of cheap fuel eaten away by hedging costs.
That is largely because they have used common but risky hedging
strategies, among them a "costless collar": selling financial
options that pay off when oil prices fall and using the proceeds to
buy protection against soaring costs when prices climb, according to
three people familiar with the programs.
The two carriers have been moving quickly to strategise how to meet
demands from brokers and banks for additional collateral to cover
potential losses from a strategy that made perfect sense just six
months ago, those people said. The airlines have also held a series
of meetings that included airline executives, brokers and
consultants, according to the people, who declined to be named
because of the sensitive nature of the discussions.
 With oil prices tumbling faster and further than anyone had
anticipated, the collar hedges left the airlines with insurance
against high costs they no longer need and on the hook for
protection they sold against a further slide, with potential
liabilities on the rise.
Southwest spokesman Chris Mainz said the meetings were part of a
routine, although a rapidly changing market called for close
attention.
"We continue to benefit from declining fuel prices," Mainz said in
an email. "Obviously we're going to move faster when the price drops
in the 40 percent range. (Our fuel team) have been very busy
actively managing our portfolio to respond to the changes we are
seeing in the market."
Delta spokesman Trebor Banstetter said the Atlanta-based carrier was
not surprised by the slide, having been prepared to meet its
financial obligations if needed.
BOON TO RIVALS
Southwest, Delta and other carriers that sources declined to name,
will benefit from the drop in oil prices because they hedge only a
portion of the fuel they buy. Southwest, for example, expects to
cover only 20 percent of its fuel consumption with hedge contracts
this quarter.
Delta expects a $1.7 billion gain from lower fuel prices in 2015,
despite $1.2 billion in estimated hedge losses.
Yet rival American Airlines, which has not entered any hedge
contracts since late 2013, are set to see a greater boost to their
bottom lines.
Industry consultants say hedged airlines have a few choices to deal
with the price slide, including selling forward positions on crude
oil or jet fuel, changing the prices at which they hedge or selling
assets, such as planes.
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What airlines exactly plan to do remains unclear, people familiar
with the discussions said.
A lack of disclosure requirements makes it almost impossible to tell
how or when airlines have hedged, and none would discuss details of
their strategies. Collar transactions looked well suited to the
market when prices hovered around $100 per barrel for most of the
past four years, allowing airlines to cap their fuel costs at little
or no cost, analysts said.
"(Costless) collars are an effective strategy that works best when
prices stay within a range," said John Saucer, vice president of
research and analysis, at Mobius Risk Group. "But it becomes a very
different animal when the market goes against that."
In their October quarterly filings, Southwest and Delta said they
used a mix of options and fixed-price swaps.
Southwest also explained that collar trades "carry more risk than
purchased call options" because of possibly greater liability when
the contracts expire.
The world's biggest low-cost carrier said that a 25 percent decline
of crude prices from Sept. 30 would probably force it to pay $615
million in cash collateral, aircraft collateral and letters of
credit.
Delta said it would pay $800 million to counterparties if oil fell
20 percent between Oct. 1, 2014 and Dec. 31, 2015. Brent already has
tumbled 36 percent since then to trade at about $60 a barrel on
Monday.
These hedges weigh on the costs of their future fuel consumption,
too.
 At current prices, Southwest says it expects to keep only about 80
cents of savings for every $1 in oil price decline, while Delta puts
this figure at about 65 cents. American instead will reap the full
benefit of cheap fuel.
And every cent counts. Delta has said that one cent change in the
price per barrel of oil is worth $40 million to the carrier.
(Reporting by Catherine Ngai and Jeffrey Dastin in New York; Editing
by Tomasz Janowski)
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