USAirways not hedging fuel

[WorldTraveler]

Can anyone on this forum explain to me the "Crack spread" And how this plays into the effectiveness of fuel hedges? I know that it has something to do with the cost of a gallon of heating oil compared to the cost of a gallon of JET A. Exactly what does it mean for airlines that hedge vs US who does not.

Wikipedia has a decent explanation but the basic gist is that jet fuel prices involve the "competition" between various products that a refiner could produce from a given amount of crude oil.
The crack spread for jet fuel usually increases when the demand for other petroleum products is greater than for jet fuel if refineries that specialize in jet fuel being out of service, or their relation to the transportation system for jet fuel (there is an extensive network of pipelines that serves most of the major midwest and east coast airports), there are different demand profiiles for other petrolem products such as for home heating oil (potentially caused by hard winter weather) etc. Plus, remember that there is not generally a market for jet fuel futures so you have to hedge against proxy products.

The crack spread doesn't usually make jet fuel prices necessarily better or worse based on whether you hedge or not. The real value of hedging is to protect against the overall increase in the price of the product that is being hedged. The crack spread simply increases the cost to airlines compared with other petroleum products or because of restrictions in refinery capacity for all petroleum products.

If you remember not too long ago there was a major runup in gasoline prices that occurred when several major refineries were out of service for maintenance at the same time that there was a fire at another and there was tropical weather problems that interrupted the ability to deliver crude oil to refineries. Global crude prices did not increase near as much as that US refinery capacity was cut because of the outages and the ability to get products to the refineries.

I see you got several answers while I interrupted my post for lunch but hope the combination of answers helps.... I think we are basically all on the same page.

 

[jie7114]

Thanks for all the info I'm trying to process it all.

 

[jie7114]

There was a great article in the Wall Street Journal today about this exact subject. For all of you out there that assume that hedges are a must have for an airline. The jist of the article was that the crack spread between a barrel of Jet-A and a barrel of crude oil has widened so much that the majority of the hedges these airlines have in place are not doing them a lot of good. I don't have the link to the article as I just have the paper subscription, so if anyone saw this piece and would like to post a link to the article, it was very informative. Don't get me wrong hedges worked great for LUV in the middle of this decade, I'm just not sure that in our current environment they are the best solution.

 

[WorldTraveler]

There was a great article in the Wall Street Journal today about this exact subject. For all of you out there that assume that hedges are a must have for an airline. The jist of the article was that the crack spread between a barrel of Jet-A and a barrel of crude oil has widened so much that the majority of the hedges these airlines have in place are not doing them a lot of good. I don't have the link to the article as I just have the paper subscription, so if anyone saw this piece and would like to post a link to the article, it was very informative. Don't get me wrong hedges worked great for LUV in the middle of this decade, I'm just not sure that in our current environment they are the best solution.

Hedges DO cover PART of the difference... they do not cover all of the difference, esp. if there is a difference between the hedged product and JetA.

But I think you and others want to somehow believe that US is not being harmed by not having hedges - and that is simply not reality.

What is reality is that based on the present pride of crude futures and and the hedges airlines hold, the hedges are saving between $7-15/bbl on the price of crude; that may translate with the crack spread (and it has been a whole lot more in the past than it is now) to 15-25 cents per gallon in extra costs to US compared to its network peers - who don't save much over the crack spread.

But again to assume that it is a zero sum game whether you hedge or not or to believe that fare increases can cover the entire increased cost is just not accurate.

US will have a higher cost item as long as crude oil itself is more expensive than the hedges which other airlines hold. It's that simple.

 

[FWAAA]

Kirby says that increased revenue is taking care of the fuel price increases thru 2/28:

http://www.thestreet.com/_yahoo/story/11031070/1/us-airways-higher-oil-not-so-bad.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA

http://finance.yahoo.com/news/US-Airways-says-demand-apf-3377539806.html?x=0&.v=1

If US can increase prices fast enough and far enough to cover the increased cost of fuel, its strategy of not hedging might pay off.

 

[BoeingBoy]

If US can increase prices fast enough and far enough to cover the increased cost of fuel, its strategy of not hedging might pay off.

But US also saw a drop in LF - adding to fares/fees will become a zero sum game at some point if oil stays high or goes higher - enough people will either stop flying or take a low cost carrier that it will cancel out the increased fares/fees paid by those who still fly US (and other legacies).

Jim

 

[autofixer]

The good news is oil failed to break through its technical resistance level of $103-$104. If it does not make another run at those levels soon, we are more likely to see $80 or less per barrel soon. Let's keep our fingers crossed.

 

[BoeingBoy]

The good news is oil failed to break through its technical resistance level of $103-$104. If it does not make another run at those levels soon, we are more likely to see $80 or less per barrel soon. Let's keep our fingers crossed.

I'm not sure counting on the mobs in the middle east to do what's best for the "haves" of the world is a good plan...

Jim

 

[autofixer]

I'm not sure counting on the mobs in the middle east to do what's best for the "haves" of the world is a good plan...

Jim

Your right, that is the wild card.

 

[autofixer]

Oil is making another run at its technical resistance again. This is typical for markets to make one or two runs at a resistance. Oil looks like it is laying up against its technicals right now at 0930. This may be the most critical time for the markets in a couple of years.

There it is, oil just broke the technical resistance of $104 at 1213PM. It took two hours, but it pushed through. This means technical damage has been done and the way is now wide open to the next resistance level of $147 and deep, deep recession. This does not mean oil WILL reach $147 per barrel, it just means it has no technical obstructions. Hold on we are still on this wild ride. Don't beleive any politician or talking head on T.V. They all have hidden agendas, the market is real and has no agendas. There are a hundred reasons that oil is rising, but they are moot. The market is real and the price is real and every modern recession has been preceeded by an oil price spike. This is going to be bad.

 

[BoeingBoy]

Looks like the price of crude in in the hands of the protesters in various Middle East countries. Geitner (sp?) was quoted yesterday as saying that there was plenty of crude in the SPR and it didn't seem to sooth the market. If the protests spread to one or two of the big producers and turn nasty - Saudi Arabia for example - all bets are off for where the price might go. Most of those OPEC countries have the minority religious people (Sunni, Shia?) heavily concentrated in the oil producing region of the countries while the rulers are of the other religious sect.

Jim

 

[WorldTraveler]

Looks like the price of crude in in the hands of the protesters in various Middle East countries. Geitner (sp?) was quoted yesterday as saying that there was plenty of crude in the SPR and it didn't seem to sooth the market. If the protests spread to one or two of the big producers and turn nasty - Saudi Arabia for example - all bets are off for where the price might go. Most of those OPEC countries have the minority religious people (Sunni, Shia?) heavily concentrated in the oil producing region of the countries while the rulers are of the other religious sect.

Jim

not only does the potential for religious fanaticism have the potential to influence oil prices but there is no doubt that those countries are working real hard to see how high they can push fuel prices w/o crashing global economies. At the same time the airline industry is trying hard to figure out how high of prices it can tolerate before their business models fall apart. Keep in mind also that this is the first oil spike that has occurred since the DL-NW and CO-UA mergers and the FL-WN merger was announced. Capacity discipline from both network and low fare carriers can go a very long ways to allowing for the price increases that have been implemented to have some benefit.

Remember though that while US might be able to cover the increase in fuel prices through fare increases, other airlines are paying less for fuel because of their hedges - so they will have an advantage over US when it comes to the bottom line.

Interesting times but as always, there is a tightrope act in process in the airline industry.

 

[BoeingBoy]

but there is no doubt that those countries are working real hard to see how high they can push fuel prices w/o crashing global economies.

The Saudi have said that they will increase production if Libyan exports drop, and it looks like they might have to with a fire in a production plant that normally produces 500K bbls/day (about 1/3 of Libya's production). However there is still the possibility that the rioting will spread, and any extra output from Saudi would be a much lower grade crude than Libyan which is light, sweet crude (the NYMEX futures are for light/sweet crude).

Jim

 

[bigbusdrvr]

The Saudi have said that they will increase production if Libyan exports drop, and it looks like they might have to with a fire in a production plant that normally produces 500K bbls/day (about 1/3 of Libya's production). However there is still the possibility that the rioting will spread, and any extra output from Saudi would be a much lower grade crude than Libyan which is light, sweet crude (the NYMEX futures are for light/sweet crude).

Jim

----------------------------------------------------------------------------------------------
Member Banned for Egregious Postings