At Delta’s 2024 Investor Day, an analyst asked the assembled executive team about fuel hedging. Delta CEO Ed Bastian responded that he has lost a lot of money hedging fuel in the past, and CFO Dan Janki said that Delta would never hedge fuel as long as Bastian is in charge. So, what is fuel hedging, why is Delta against it, and why is Southwest (and Ryanair in Europe) such a big proponent?
At its core, fuel hedging is locking in the price of jet fuel today for delivery at some point in the future. Fuel hedging generally eliminates market jet fuel price volatility by establishing a set price for the airline. Some airlines value that stability; others would rather focus on running the airline as opposed to speculating on jet fuel prices. Most airlines are not covered 100% by their fuel hedges, but 65-80% or even higher is a common range for airlines that claim to be hedged on fuel.
Hedging can be a double-edged sword – if jet fuel prices have gone above the hedged price for delivery, the airline saves money since they’re not buying on the open market. According to a Bloomberg report for August 2023, both Southwest and the Air France/KLM group were set to save around $1 billion each due to their hedging. But, if jet fuel prices have gone below the hedged price, the airline loses money since they are obligated to take delivery at the agreed-upon price.
An additional benefit of hedging is that it allows an airline to plan out its quarterly expenses in a more concrete manner. All too often, the price of jet fuel can suspend or kill projects towards the end of fiscal quarters or years to meet expense or profit targets. If an airline is mostly hedged, it can plan out the full quarter, half, or year without much worry about the market price of jet fuel that month. On the flip side, I always evaluate these trades from an adverse selection perspective – why is a trader, bank, or fuel manufacturer choosing to sell you a fuel hedge? A fuel manufacturer may value the stability in order volume, but traders and banks are looking to make money. And those two groups wouldn’t offer hedge contracts for very long if they didn’t make them money.
It is fascinating that different airlines continue to take divergent approaches to fuel hedging; it is an industry that isn’t afraid of copying a good idea, yet there are clear advantages and disadvantages to fuel hedging. Delta has done one thing different from other airlines: it owns an oil refinery. In some ways, that may accomplish the same effect as fuel hedging without the risks!