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Airlines Again Consider Locking In Jet Fuel Prices

With costs near record highs, hedging contracts are much more expensive. But some view them as insurance against further increases.

September 05, 2006|From the Associated Press

Airlines that pay for their jet fuel when they fill up their planes have been shelling out well over $2 a gallon lately -- nearly four times the average price they were paying four years ago.

High fuel prices have dealt a much milder blow to carriers that have used a practice known as fuel hedging. It most often involves purchasing futures contracts that allow airlines to fix or cap the price they'll pay several months or years in advance.

Southwest Airlines Co. has led the pack, followed by Seattle-based Alaska Air Group Inc., the parent company of Alaska Airlines and Horizon Air. Both companies are bracing to pay market rate for more of their fuel in the coming years after ramping down their hedging programs as persistently high oil prices sent the cost of those futures contracts soaring.

But now, with some experts predicting that crude oil could creep up an additional $10, $20 or even $30 a barrel, some airlines are taking cautious steps toward hedging again.

"The idea is to spend some money now to avoid the harm that would happen to our business if fuel went up by a significant amount," said Brad Tilden, Alaska Air's chief financial officer.

Some airlines hedge against jet fuel prices, which have averaged about $2.17 a gallon over the last three months -- up from an average of about 55 cents a gallon in 2002, according to Energy Information Administration data on spot prices in three major U.S. markets.

Others base their contracts on the price of crude oil, which has been trading above $70 a barrel since spring, compared with an average of less than $15 a barrel in 1998.

Fuel hedging contracts have become proportionately more expensive because they are tied to the price of crude or jet fuel.

Although hedging is speculative by nature, companies view it more like an insurance policy than a risky gamble.

"You're basically buying a level of certainty," said John Heimlich, vice president and chief economist for the Air Transport Assn. "The market price may be higher, it may be lower, but I know what I'm going to pay, and I can set my business plan accordingly."

In the last several years, Southwest has reaped sweeter rewards from fuel hedging than any other airline in the industry -- nearly $1.8 billion in savings from 1999 to 2005.

Southwest had 85% of its fuel hedged at a rate based on $26 a barrel for crude last year, when oil was often trading at twice that price. That shaved about $892 million off the company's 2005 fuel bill.

Seven years ago, the Dallas-based low-fare carrier set a goal of having most of its projected fuel consumption hedged, said Laura Wright, the company's chief financial officer.

"We sleep better at night," she said, "if we know what that cost is going to be."

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