Airlines can't catch a break these days no matter how hard they try. Case in point -- United Airlines has announced it could lose as much as $544 million because of falling oil prices. Say what?
United has fallen victim to its own efforts to manage what's been a devastating rise in fuel costs. The airline, like just about everyone else in the business, has been buying jet fuel using a tactic called hedging. Ben Brockwell of the Oil Price Information Service calls it "an insurance policy against prices rising."
So long as prices are rising, it works. But if prices start falling, it can quickly become a fiscal disaster, as many airlines are discovering.
Here's a very simplified explanation of how fuel hedging works, using a hypothetical scenario: Let's say oil is selling for $130 and the price is expected to rise. An airline signs a deal with a supplier to buy, say, three months worth of fuel at $110 a barrel. That's called a fuel hedge. The price of oil rises to $140 a barrel, but since the airline is locked in at $110, it can sit back and laugh as its competitors pay more for fuel. Smart move.
But let's turn that scenario on its head and say the airline hedges at $110 but the price drops to $92. Oops. Now the airline is paying more for fuel than it costs on the open market, placing it at a competitive disadvantage. The balance sheet craters...>
http://blog.wired.com/cars/2008/09/airlines-hurt-b.html