Jerry Lademan (3:01)

I've been retired for almost two years. I still check it every day.

Waylon Wong (3:06)

Old habits, huh?

Jerry Lademan (3:08)

Yep. You just get used to. But yes, it is something that on, on any Bloomberg screen I can think of in a, in the treasury department of any airline, there will be on the screen fuel prices.

Waylon Wong (3:21)

Sometimes when I drive past a gas station, I look at the price on the sign and do some quick mental math about how much it'll take to fill my tank.

Darian Woods (3:28)

That's your version of what airline executives are doing.

Waylon Wong (3:31)

Exactly. But they do it on a much bigger scale.

Jerry Lademan (3:34)

The impact for an airline is a lot more than a driver. It's tens of millions of dollars on an annual basis for each movement of just one cent in a gallon of jet fuel.

Darian Woods (3:45)

And the war in Iran is making prices spike more than just a cent per gallon. This week the global average price for jet fuel was creep towards $5 per gallon. That's more than double what it was a month ago.

Waylon Wong (3:57)

The CEO of Delta Air Lines said in an industry conference last week that the spike in fuel prices has generated $400 million in additional costs so far this month. It's a big unexpected hit.

Darian Woods (4:10)

And there are two ingredients in the price of jet fuel. The first is the price of oil, specifically Brent crude, which is the global benchmark. The second ingredient is what's called the crack spread. That's a little oil industry jargon which Jerry explains like this.

Jerry Lademan (4:26)

Think of it like the refining margin, the cost of refining, the product, the profit for the refiners, transportation, and a whole number of other factors. The crack spread can have its own movements independent of the underlying price of oil.

Waylon Wong (4:41)

The current crack spread for jet fuel is also way up compared with last month and last year. One reason is because Middle Eastern refineries that produce jet fuel and other products can't ship food through the Strait of Hormuz.

Darian Woods (4:54)

Now airlines can't control the global price of oil or what's happening with refineries. One notable exception in the US though is Delta. It owns its own refinery through a subsidiary. This vertical integration helps the company save money on refining oil into jet fuel.

Waylon Wong (5:11)

As for other airlines, former United CFO Jerry Latterman says they generally try to keep their fuel costs down by using more energy efficient planes and carrying less weight. But for many years, airlines have also done something called fuel hedging. This practice was common in the US but that changed.

Darian Woods (5:30)

And before we get into why that changed, first we should talk about what fuel hedging is. It involves financial instruments like futures Contracts. You might be familiar with this term from the stock market. Investors that use these contracts agree to buy or sell a certain asset like a stock at a specific price on a specific future date.

Waylon Wong (5:50)

There are futures contracts for all kinds of commodities, including crude oil. So an airline that is fuel hedging might enter into a contract to buy crude oil at a set price in the future. Let's say it agrees to pay $100 a barrel six months from now.

Darian Woods (6:06)

And six months goes by. And let's say the cost of crude oil has gone up to $150. The futures contract, it locked in a price of $100, though. So now the airline has made a $50 profit. Of course, if oil prices have gone down to $50 a barrel, the airline loses money.

Waylon Wong (6:26)

Now, it's important to note there are not actual, like literal barrels of crude oil trading hands here. What we're talking about is the airline making money in the markets on this trade. And that money helps the airline build a financial cushion for when they actually do go to pay for jet fuel.

Jerry Lademan (6:46)

It's really viewed as insurance to protect the financials against a sudden spike in jet fuel.

Darian Woods (6:54)

And for years, this insurance policy worked well. So, for example, American airlines said in 2003 that it saved almost $150 million in fuel costs thanks to hedging. Southwest Airlines pursued an aggressive hedging strategy. The company estimated that it saved $3.5 billion between 1998 and 2008, savings to expand operations and hire workers.

Waylon Wong (7:21)

However, Jerry says most of the major airlines in the US eventually soured on fuel hedging. One reason the Wall street transaction fees to make these hedges got expensive.

Jerry Lademan (7:32)

Like any insurance, there's a cost to it. You're paying a premium for the privilege of locking it in, and it's sort of built into that price and it's expensive. And what I think the US Airlines found is that it wasn't worth that expense.

Darian Woods (7:50)

Plus, Jerry says the airlines found that they could make money the old fashioned way by raising prices.

Jerry Lademan (7:57)

The better answer was to, in a fair manner, pass costs on to consumers. And the industry found that they were able to adjust fares to cover. You know, I'm not saying 100% of a spike in fuel price, but a significant increase in fuel, and that's a much, much healthier way for an industry to manage its costs.

Waylon Wong (8:22)

United, American, and Delta stopped hedging in the 2010s. There was an unexpected drop in the price of oil during that period. Airlines that had bet on higher prices ended up with heavy losses on their hedges. The president of American Airlines told the Wall street journal in 2016 that hedging is a rigged game that enriches Wall Street.

Darian Woods (8:43)

Meanwhile, Southwest kept going with hedging because it was under more pressure to keep prices low. That's according to Kerry Tan. He's an economist at Loyola University Maryland who studies the airline industry.

Kerry Tan (8:54)

Delta can charge a premium on prices because of the perceived higher quality experience and the clientele being much less price sensitive than your traditional passenger on Southwest.

Waylon Wong (9:11)

But even Southwest stopped hedging a year ago. The company said the premiums it paid to make these trades had gotten too costly and that it would find other ways to address fuel prices.

Darian Woods (9:21)

Today, none of the major airlines in the US Are hedging. Many outside of the US Are, but even airlines like Cathay Pacific and Qantas are increasing airfares or fuel surcharges. It appears that hedging alone isn't enough to keep prices low for flyers.

Waylon Wong (9:38)

So will U S based airlines dust off their old hedging playbooks and get their investment bankers back on speed dial? Carrie says the big variable is how long oil prices will stay elevated.

Kerry Tan (9:49)

If you're a hedging fuel, you're trying to make a bet that prices are going to go up. But today, right now, it's hard to say whether prices are going to be chronically high or if they're going to revert back or what's going to happen even months from now.

Darian Woods (10:07)

Kerry's hedging his statements now. It's possible that the airlines believe that they can ride out a few months of higher oil prices with higher fares or by implementing fuel surcharges. But if the war persists, then all bets are off.

Waylon Wong (10:23)

This episode was produced by Corey Bridges with engineering by Jimmy Keeley and Maggie Luthar. It was fact checked by Sierra Juarez. Kicking Cannon is our show's editor and the indicator is a production of npr.

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