U.S. airlines, burned twice last year by shocking oil price volatility, are under new pressure to hedge now and hedge smart as oil gains from its January lows.
But as usual, the stability of the airline industry is tenuous. And carriers are wary of hedging too aggressively, fearful of locking in at above-market fuel prices.
They don't want to overhedge, but they don't want to be caught with rising fuel prices, said Helane Becker, airline analyst at Jesup & Lamont Securities. They're working on being perfectly hedged.
Airlines don't hedge to make money, Becker said. For them, hedging is to make sure they know what their costs are going to be.
The industry was blindsided in the first half of 2008 by a spike to record high oil prices, which directly influence jet fuel costs.
While carriers cheered a subsequent decline, some wrote off millions of dollars in the last three quarters as their fuel-hedge portfolios lost value. The ironic twist led airlines like Southwest Airlines (LUV.N) and US Airways Group (LCC.N) to unwind fuel hedges or stop hedging altogether.
Hedges are like insurance contracts companies use to blunt the risk of sudden price fluctuations in commodities crucial to their operations. So carriers use derivatives markets to lock in fuel costs and smooth out volatility.
Oil prices have nearly doubled since January 20. Nymex crude traded near $65 a barrel on Friday, still down about 57 percent from a record high near $150 a barrel reached last year.
Given airlines' present limited pricing power against (expected oil price gains), and indications of a resurgence in demand for raw and refined petroleum products, there is growing pressure on airlines to hedge effectively, said airline consultant Robert Mann.
ALL COSTS ARE VARIABLE
For major airlines, fuel rivals labor costs as the top expense. When oil prices rallied last year, talk of airline bankruptcies was rampant and some said carriers must merge or die.
Only one major airline merger occurred in 2008 -- Delta Air Lines (DAL.N) and Northwest Airlines. Other carriers sought strategic partnerships like the one formed by United Airlines (UAUA.O) and Continental Airlines (CAL.N).
Meanwhile, all the major airlines undertook massive downsizing to improve efficiency and bolster fares. Airlines also began charging for items and services like baggage checks that once were included in the ticket price.
Such steps were a huge help to the struggling industry. Now, some experts view capacity cuts as the most effective way to blunt the impact of volatile fuel prices.
If they were in better health, they would be more than willing to implement a bigger hedging strategy, but they just can't afford to do it because they're so cash strapped, said Basili Alukos, airline analyst at Morningstar.
They view hedging as risky because prices can go against them, Alukos said. And they all subscribe to the theory that in the long run, all costs are variable.
(Reporting by Kyle Peterson, editing by Leslie Gevirtz)