Airline Hedging

You probably have noticed that oil prices have dropped significantly over the past month. However, the Washington Post points out that many airlines are still paying the higher price because they locked in when prices were high.

A look in:

"Like insurance policies, hedging contracts protect against risk, allowing companies to manage damaging price swings....If the market price for oil is above a price limit arranged in a hedging contract, the airline gets the difference, which offsets higher jet fuel costs -- the biggest expense for most airlines.

Of course as this suggests that at times when prices are falling the airlines pay more (unless options are used):

"If the price of oil is below a preset price floor, the airline ends up paying more than the market price...."

"That's the risk you take with hedging," said AMR spokesman Tim Wagner, who would not comment on whether the airline was losing money on its third-quarter hedge. "When it was at $78 dollars per barrel, it looked like you had great deals."

But this "loss" comes when the overall firm is in a better position to handle it, which is exactly what a hedge is designed to do:

"...the airline greatly prefers falling oil prices even if it means some of its fuel hedges are rendered useless, he said...Despite the risk of paying up on some hedges, falling oil prices are a big boost to airlines and eases concerns about slowing demand."

BTW I will use this as an opportunity to mention my favorite airline hedging paper as well. It is by Carter, Rogers, and Simkins. Super short version: hedging is good for you.