Summary
Airlines that hedged their jet fuel may now be looking at substantial unrealized losses (perhaps some has already been realized) depending on where they initiated their jet fuel hedge. Will this result in a nasty earnings surprise?
Analysis
Southwest Airlines has been the most successful airline at hedging their forward jet fuel purchases and as time went on, other airlines emulated their program.
Hedging jet fuel requires a company to purchase either NYMEX futures in crude oil or heating oil or make an over the counter paper transaction. In all cases, the airline is long the commodity at some price.
Hedges put on a year ago when crude oil was trading $80 per barrel look brilliant. Earlier in the year as crude soared to $145 per barrel any hedge strategy look good.
However, now that crude prices have retreated to about $100, hedges that were put on at $110, $120 or $130 for example are underwater and in the red. Airlines that hedged at these level no longer get the benefit on that portion of fuel that was hedged, they have a high cost basis. In fact, it is possible that a liquidity crisis develops as the NYMEX or swap margin calls grow.
United Airlines, as reported by the Sun Times, has over a $500 million dollar hedge loss. There are probably others with hedge losses that will create an earnings surprise to the downside.
As a result, it is recommended to examine a carriers previous quarterly SEC filings to estimate the effect of the changing oil market on hedging gains or losses.
