I thought it was a bad idea when they did the refinery deal. Looks like a lot of poor hedging planning, hedging is a huge bet to make. $4 Billion in 8 years is a lot to lose even if they are doing great today.

http://www.forbes.com/sites/uhenergy...n-hedging-fuel-costs/#2ac9667d6d02

Did you? Well that's hedging; sometimes you get it rigth, sometimes you get it wrong!

Quoting G-CIVP (Reply 1): Well that's hedging; sometimes you get it rigth, sometimes you get it wrong!

Exactly, that's why it's a bet!

The refinery is not even a rounding error, but I suspect it takes most of the time/energy. US and now AA has it right. DL will never break even on their hedges, let alone make a dime.

I don't know if buying the refinery was a good idea, but it did not cause their $4B of hedging losses. That was a result of their decision to hedge at around $90/barrel shortly before the price just imploded.

Quoting tb727 (Reply 2): Quoting G-CIVP (Reply 1): Well that's hedging; sometimes you get it rigth, sometimes you get it wrong! Exactly, that's why it's a bet!

Its not really a bet at all. There is a lot of work (technical analysis, fundamental analysis, etc.) which goes into deciding how/when/if to hedge. That doesn't mean a company makes the right move (profitable/break even), but that's not the point.

Bets such as craps, slots, etc. are random (for the most part).

Quoting tb727 (Reply 2): that's why it's a bet!

Then whence the saying, "Hedge your bets?" A hedge is something used to cut down the risk of a wager (although it, obviously, doesn't always work out as planned).

Quoting tb727 (Thread starter):

I do think it is fair to say that airline managements do not get the proper amount of grief for bad multi-billion dollar bets with investors' money. Airlines even adjust their earnings headlines to trumpet hedging gains when there are any, and bury them when there are losses.

I think the hedging era is ending, ironically just as fuel prices have started to recover.

Quoting jacobin777 (Reply 5): Its not really a bet at all. There is a lot of work (technical analysis, fundamental analysis, etc.) which goes into deciding how/when/if to hedge

Still a bet, no matter how much supporting work goes into it.

Quoting enilria (Reply 7): I do think it is fair to say that airline managements do not get the proper amount of grief for bad multi-billion dollar bets with investors' money.

I think the analysts that normally would push the issue work for banks that want to sell more hedges

Quoting MaverickM11 (Reply 8): Still a bet, no matter how much supporting work goes into it.

  

Two parties wager money over something yet to occur - namely, the price of oil at a predetermined date in the future - and when that predetermined date in the future arrives, the party who guessed wrong has to pay the party that guessed right.

Sometimes the bet pays off for the airline (Southwest in 2008) and sometimes the bet pays off for the counterparty (Delta in 2015). But either way, despite the fact that it's certainly an informed bet, it is - of course - still ultimately a bet.

[Edited 2016-06-03 13:40:09]

Quoting G-CIVP (Reply 1): Did you? Well that's hedging; sometimes you get it rigth, sometimes you get it wrong!

not really. hedging means you're trying to get it both right and wrong at the same time.

Quoting MaverickM11 (Reply 8): Quoting jacobin777 (Reply 5): Its not really a bet at all. There is a lot of work (technical analysis, fundamental analysis, etc.) which goes into deciding how/when/if to hedge Still a bet, no matter how much supporting work goes into it.

Quoting commavia (Reply 9): Quoting MaverickM11 (Reply 8): Still a bet, no matter how much supporting work goes into it.    Two parties wager money over something yet to occur - namely, the price of oil at a predetermined date in the future - and when that predetermined date in the future arrives, the party who guessed wrong has to pay the party that guessed right.

Anything which entails risk then is a bet...including but not limited to stepping outside one's house.

Point is all types of risk is taken on a daily basis. Some use intelligent methodologies to deal with the risk and some simply go out on a whim without any thoughts of the process or consequences. DL probably used the former.

Quoting hivue (Reply 6): A hedge is something used to cut down the risk of a wager (although it, obviously, doesn't always work out as planned).

  

Nobody's perfect, but Delta made horrible decisions hedging. They are right about many things, but they did not understand you are supposed to lock in low prices -- not high prices.Really! That is very important!

And commodities trade in a band, so you pretty much know what's low and what is high. The band is roughly $20 to $160. That won't change in the coming 20 years.

As has been articulated by AA, it is far better not to hedge, than to lock in high prices.

  

You'd think Forbes could at least find a picture with the current livery.

Odd.

Delta hedged very well in the 72 oil embargo and thruout the 70s which is a big reason they had 45 years in a row of profitability . They leased tankers and pipeline and were the star performers in cheap fuel. Too bad they do not have that same talent in predicting oil.

I still think they had a streak of bad fortune by having Michelle Burns at the financial helm and are still trying to right that wrong.

Cheers

Sometimes NOT hedging is the bigger bet/risk. It just depends on the situation.

[Edited 2016-06-03 16:30:15]

Quoting jacobin777 (Reply 5): Its not really a bet at all.

Maybe "gamble" would be a better word.

Quoting PPVRA (Reply 15): Sometimes NOT hedging is the bigger bet/risk. It just depends on the situation.

While I somewhat agree, why hedge when the prices are so high when you can raise ticket prices or have a fuel surcharge during price peaks. I'm sure with the lower prices now they are still charging a little bit more for tickets today to cover some of these losses. Prior to the merger, didn't Continental hedge at some crazy high number like $140?

Quoting enilria (Reply 7): I do think it is fair to say that airline managements do not get the proper amount of grief for bad multi-billion dollar bets with investors' money. Airlines even adjust their earnings headlines to trumpet hedging gains when there are any, and bury them when there are losses.

Exactly. This was kinda my point at posting this article. Times are great right now with these big quarterly profits so people forget about this.

Both the past and present CEO's have talked about this. They have made some past bad decisions on hedging, but they have also said that owning a refinery allows them direct insight inside the oil business. They get analysis on treads well ahead of anyone else. I thought it was genus to buy a small refinery, specially since one of an airlines biggest expense is fuel.

If your competition hedges and you don't, statistically, over time, you'll do better. But if fuel jumps like crazy, you're going to have a big problem since your competition will have lower costs than you.

The fact that airlines got burned with hedging when fuel fell, probably resulted in the missing one of the best opportunities to hedge in many years (at

Quoting jacobin777 (Reply 11): Anything which entails risk then is a bet...including but not limited to stepping outside one's house. Point is all types of risk is taken on a daily basis. Some use intelligent methodologies to deal with the risk and some simply go out on a whim without any thoughts of the process or consequences. DL probably used the former.

Agree with every word of that. For decades, airlines made educated bets on the price of oil in order to mitigate some portion of the uncertainty and volatility risk, and sometimes said bets paid off and sometimes they didn't. But hedges against risk are bets.

Quoting Beatyair (Reply 17): They get analysis on treads well ahead of anyone else.

I'm skeptical that Delta's ownership of a refinery truly yields any material asymmetric information (market sensing) advantage.

Quoting Beatyair (Reply 17): I thought it was genus to buy a small refinery, specially since one of an airlines biggest expense is fuel.

Delta's vertical integration with an oil refinery is interesting, and appears to have succeeded in reducing the crack spread, albeit not just for Delta but it's competitors, too.

AA has approached hedging against fuel price volatility differently, preferring not to hedge directly or vertically integrate like Delta, but instead to leverage incredibly cheap borrowing costs to accelerate its fleet replacement cycle by inducting hundreds of new 737s and A320s that "offer a 35 percent reduction in fuel cost per seat versus the MD-80 and a 12 percent and 15 percent fuel cost reduction per seat, respectively, versus the 757 and 767-200."

Like with so many other things going on in the industry these days, these divergent strategies among the major U.S. competitors - in particular AA and Delta, who in many cases seem to diverge the most - essentially provide a laboratory to assess what ultimately works. In the near-term, it appears that - as Delta itself essentially now acknowledges - the USAirways (now AA) decision to stop hedging late last decade was the right one. On these more recent strategic decisions - only time will tell.

Quoting MKIAZ (Reply 18): If your competition hedges and you don't, statistically, over time, you'll do better.

No, it's not that "cut and dry." The mere fact that one airline hedges and another doesn't does not mean that the hedger will necessarily "do better," "over time" or at all. If the hedger makes stupid bets, they may do worse. It's impossible to speak in absolutes because each individual situation is different.

[Edited 2016-06-04 08:23:15]

Quoting tb727 (Reply 16): While I somewhat agree, why hedge when the prices are so high when you can raise ticket prices or have a fuel surcharge during price peaks. I'm sure with the lower prices now they are still charging a little bit more for tickets today to cover some of these losses. Prior to the merger, didn't Continental hedge at some crazy high number like $140?

Hedging is more about predictability than trying to score cheap fuel, or anything else. If there's high volatility in the price of anything, hedging means you can fix the cost of that product for a period of time and not worry about what the price will be during that time.

Imagine you have a $1 million USD loan and your company is based in a country with a weak and unstable currency. If the currency exchange moves 50% in a couple of days (it can and it has happened before) your million dollar debt now has become $1.5 million. This can threaten your very existence depending on the size of the company or how indebted you are. If you hedge prior to such an exchange movement, you can fix the exchange rate at a level you can still afford and protect yourself from nasty surprises in the currency markets. You won't know whether you realized a profit or a loss until you actually use that fixed rate contract, but you already guaranteed a reasonable exchange rate for the day you need to pay back that loan.

Quoting jacobin777 (Reply 11): Point is all types of risk is taken on a daily basis. Some use intelligent methodologies to deal with the risk and some simply go out on a whim without any thoughts of the process or consequences. DL probably used the former.

Quoting tb727 (Reply 16): Maybe "gamble" would be a better word.

You can call it whatever you want, and there is a *HUGE* industry that has grown to support it and sell the idea, but at the end of the day you're trying to predict the price of oil, which is a 100% gamble/bet/luck/risk/chance. That industry has an interest in selling you on the idea that it's anything but a gamble, but that's all it is. If there were any strategy to it and consistent positive benefits, we wouldn't be having this discussion.

Quoting commavia (Reply 19): For decades, airlines made educated bets on the price of oil in order to mitigate some portion of the uncertainty and volatility risk, and sometimes said bets paid off and sometimes they didn't.

I probably could add it all up if I cared enough, but it certainly seems on average, over the long term, airlines are solidly worse off because of hedging.

Quoting PPVRA (Reply 20): Hedging is more about predictability than trying to score cheap fuel, or anything else

I hear that a lot too, but it seems like a story people tell themselves when they've been screwed by their hedging strategy. How are "predictably high prices", plus the cost of hedging, better than volatile low prices?

Quoting Beatyair (Reply 17): They get analysis on treads well ahead of anyone else. I thought it was genus to buy a small refinery, specially since one of an airlines biggest expense is fuel.

If DL has such "analysis" then the fact did horribly with their transactions, similar to lighting a pallet of $100 bills on fire, does not bode well for their analysis.

Quoting commavia (Reply 19): No, it's not that "cut and dry." The mere fact that one airline hedges and another doesn't does not mean that the hedger will necessarily "do better," "over time" or at all.

Hedging includes transaction costs. Not hedging avoids transaction costs. So, typically it is said that not hedging will definitely save you money over any long term horizon. The trouble is that short term oil price shocks may empty out your treasury and cause your company to buckle.

Quoting PPVRA (Reply 20): hedging means you can fix the cost of that product for a period of time and not worry about what the price will be during that time.

That is exactly right, but the difference between a bet and a sensible hedge depends on the concurrence of the time you incur your cost (to produce your product) and the time you make money (by selling).

In your example, someone has to pay off a USD loan, but makes his revenue in a local currency. So the "cost of production" (the loan) has already been incurred, and you just to want to reduce the risk of this cost not being aligned with revenue in the local currency. So by hedging against changes in the exchange rate, you actually reduce your risk (NB: you also forgo the the chance of the exchange rate moving in your favour). A trader would say: You had an open position in USD on the cost side, you closed that position with the hedge (essentially converting your future revenue to USD already).

DL's story is different:
(a) the cost of production had not yet been incurred --> they did not have any open position to close (as they had not yet sold all their plane tickets 3 or 4 years into the future);
(b) so going long on oil (logging it in for a given price), they had their future costs fixed at a time when they did not yet know what the competitive future airfare would be - they actually created an open position:
(c) without the hedge, they could have increased fares like everybody else would have in the case of increases in the oil price - or reduced the fares in case the oil price goes down. (Unlike in the loan example, this would not have been a terrible thing.)
(d) with the hedge, they would probably still have increased fares* if oil went up and made a speculation profit - or they make a loss from the hedge if the price goes down (as they do now). (*maybe a little less than others to gain market share)

So by and large, it has been a bet. At least if they hedged for a really long time into the future (which buying a refinery does). Which doesn't mean some hedging is a bad idea because of

Quoting Flighty (Reply 22): So, typically it is said that not hedging will definitely save you money over any long term horizon. The trouble is that short term oil price shocks may empty out your treasury and cause your company to buckle.

Quoting MaverickM11 (Reply 8): Quoting enilria (Reply 7): I do think it is fair to say that airline managements do not get the proper amount of grief for bad multi-billion dollar bets with investors' money. I think the analysts that normally would push the issue work for banks that want to sell more hedges

Excellent point

Quoting Flighty (Reply 12): Nobody's perfect, but Delta made horrible decisions hedging. They are right about many things, but they did not understand you are supposed to lock in low prices -- not high prices.Really! That is very important!

I don't think we could do any better, but who wants to invest in a company engaged in such bets? The industry is risky enough.

Quoting tb727 (Reply 16): Exactly. This was kinda my point at posting this article. Times are great right now with these big quarterly profits so people forget about this.

True

Quoting commavia (Reply 19): Quoting Beatyair (Reply 17): They get analysis on treads well ahead of anyone else. I'm skeptical that Delta's ownership of a refinery truly yields any material asymmetric information (market sensing) advantage.

I think it gave them advantage on the way up and not on the way down, obviously. It is fair to say that the crack spread is still quite low which is the main benefit of the refinery. I saw that Google and Facebook are building Transatlantic and Transpacific fiber cables, apparently not because they want to dominate, but because they want enough oversupply to keep pricing down on the bandwidth they do buy. The refinery is similar.

Quoting MaverickM11 (Reply 21): I hear that a lot too, but it seems like a story people tell themselves when they've been screwed by their hedging strategy. How are "predictably high prices", plus the cost of hedging, better than volatile low prices?

There was never such a thing as low prices in those days. Prices were high and going higher, or at least everyone thought so.

Quoting Economist (Reply 23): DL's story is different:

Sounds about right. My only (limited) experience with hedging is on the currency side. This stuff gets a little complex on the details.