Scott Kirby, CEO of American Airlines Group Inc. (AAL), recently said in an interview, “Hedging is a rigged game that enriches Wall Street.” Given airlines' differing experience with fuel price volatility over recent years, he could have been offering advice to rivals such as Delta Air Lines Inc. (DAL). American gave up hedging fuel costs in 2014, and Delta and others have now followed suit.

When oil prices were high and rising, hedging against higher jet fuel costs seemed like the wise thing to do, but the practice has backfired since oil prices began to plummet in mid-2014. In that year, Delta paid $2.87 per gallon of fuel, while American paid $2.91, but in 2015, Delta paid $2.23 (a decline of 22%) while American paid only $1.72 (a decline of 41%). Delta lost $336 million on its hedges in the last three months of the year, and while it is not taking out any new contracts for 2016, the losses on existing contracts are expected to continue, totaling between $100 and $200 million. (See also, Airlines May Enter a New Bear Market in 2016.)

US Airways gave up hedging in 2008, and following its merger with American, US Airways executives remained in charge of the combined company. Their decision to give up on hedging turned out to be well-timed, if nothing else. Delta is not the only one following suit now. United Continental Holdings Inc. (UAL) currently hedges a historically low 17% of its fuel consumption, and has not taken out any new contracts since the summer. JetBlue Airways Corp. (JBLU) and Spirit Airlines Inc. (SAVE) are also cutting down on their hedges. (See also, The Industry Handbook: The Airline Industry.)

Refusing to hedge fuel costs amounts to a bet that fuel prices will stay low, however, which could itself backfire. As recently as the second quarter of 2014, Delta was profiting from its hedges, and a different sort of effort to mitigate fuel costs, the purchase of a refinery in Delaware in 2012, turned a profit of almost $300 million in 2015 (refineries tend to benefit from falling oil prices). 

Hedging involves the writing of futures contracts on commodities – jet fuel in the case of airlines – meaning that prices can be locked in well in advance of the actual transaction. The practice reduces volatility in costs, which allows for better planning and lessens the risks associated with a sudden spike in prices. On the other hand, price volatility can be a good thing if it results in lower costs, meaning a boost to the bottom line. Delta locked in high fuel prices and passed up on a huge discount in the form of cheap oil, exasperating investors. If oil prices now rise back to the levels they reached in early 2014, Delta would lose out again. (See also, Oil Posts 5th Consecutive Weekly Gain.)

The Bottom Line

Delta and other airlines are backing away from the practice of hedging fuel prices, having passed up on large savings from falling oil prices. Meanwhile American Airlines, which swore off hedging before oil prices crashed, enjoyed a 40% cut to its fuel costs in 2015, compared to just over 20% for Delta. Assuming oil prices stay low or fall further, the strategy of remaining fully exposed to price changes will pay off, but there is the risk that Delta is speculating by not speculating, opening themselves up to pain they could have avoided by staying the course in terms of their hedging strategy.