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Alaska Air Group benefits from cautious bet on fuel prices - Puget Sound Business Journal (Seattle):
Friday, January 23, 2009
Alaska Air Group benefits from cautious bet on fuel prices
Puget Sound Business Journal (Seattle) - by Steve Wilhelm Staff Writer
Cheaper jet fuel prices are lifting Alaska Air Group more than some competitors, largely because the company has historically utilized more conservative fuel hedge tactics, which are paying off today.
Alaska Air Group, the parent of Alaska Airlines and Horizon Air, bought “call options” giving it the opportunity to buy fuel at a set price. While these require higher upfront payments, they didn’t obligate the airline to buy the fuel at the hedged prices.
Other airlines, including United and Southwest, have used another form of hedging called “swaps” or “collars,” that commits them to buy fuel at certain rates. While these are essentially contracts and are less expensive up front, they run a higher risk of creating large fuel cost penalties when fuel prices drop steeply.
On Jan. 21, UAL Corp., which owns United Airlines, reported fourth quarter cash losses of $370 million from fuel hedging, as well as another $566 million in noncash losses from hedging.
While Alaska Air Group on Oct. 23 reported $218 million in noncash losses from hedging in the third quarter, the fact that it used call options meant that it hasn’t had to pay out cash to cover hedging commitments as United, Southwest, and other carriers have had to do.
The company will issue its fourth quarter numbers on Jan. 29.
“It cost modestly more up front, but it’s a more prudent approach,” said Donald Garvett, Seattle-based aviation consultant for SH & E Inc., a global consultant headquartered in Fairfax, Va. , about Alaska’s call-option approach to hedging. “I think Alaska has done one of the smartest jobs throughout this period of extreme fuel volatility of any airline.”
So while Southwest, United and other airlines are posting warnings to investors about the costs of their hedges, Alaska is enjoying the benefit of the lower price, without as much added cost.
“No question about it, the decline is very positive for Alaska Air Group,” said Brandon Pedersen, Alaska Air Group vice president of finance.
This is somewhat of a turnabout from the period of peak fuel prices in mid-2008, when Southwest’s approach to hedging was saving it more money, and when some criticized Alaska for being too conservative.
Alaska’s fuel prices dropped by about $2.40 a gallon to about $1.60 a gallon in the fourth quarter from last summer’s peak, saving the company about $182 million on 76 million gallons used, Pedersen said.
Pedersen estimates the company paid the equivalent of 24 cents a gallon for its hedging program, which in this time of lower fuel prices is proving to be of no value. But since the current fuel prices are below the amount it paid, Alaska still will come out ahead.
“Alaska recognized that hedging is not speculation, it’s a form of matching risk and volatility — it’s like insurance,” Garvett said.
Fuel is a big part of airline costs, accounting for upward of 40 percent of operating expenses, Pedersen said. Every dollar in the per-barrel price of oil produces a $10 million change in Alaska’s expenses. A barrel contains 42 U.S. gallons.
Alaska Air Group’s approach to hedging is more expensive upfront, Pedersen said, but it was something the airline could afford, given its relatively good cash position.
“Some might say, because of the cost of coverage over the long term, ours might be more expensive, but it doesn’t expose us to the kind of volatility and risk that other approaches might carry with them,” he said. “We’re certainly faring better now, because we’re not in a position where we’re having to give back or pay substantially.”
Looking ahead, Alaska is lowering its 2009 hedges, from earlier hedging half of its projected fuel consumption at $107 a barrel, to the current $76 a barrel.
Part of this has been accomplished by terminating some original hedges and replacing them with new ones, which has cost Alaska about $35 million, Pedersen said. But he added this will give the company more pricing stability moving ahead.
The current poll of analysts by Thomson Financial Network estimate that Alaska Air Group will earn $3.33 per share in 2009, compared with an estimated loss of 32 cents a share for 2008.
This illustrates that even though the company’s passenger volume will be reduced in 2009, lower fuel prices will allow it to operate profitably, Pedersen said.
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