Last updated: 03:00 PM ET, Thu April 07 2016

How Airlines Are Keeping Fuel Costs Low (And What Does It Mean For You?)

Airlines & Airports | Josh Lew | April 07, 2016

How Airlines Are Keeping Fuel Costs Low (And What Does It Mean For You?)

Airlines have been enjoying low fuel prices recently. More than anything else, the low cost of gas has helped formerly struggling carriers earn impressive profits over the past year or so. 

The air travel industry is at the mercy of oil markets, but it does have some strategies that can protect it from price spikes going forward. 

Locking in lower prices

Airlines have used futures to hedge against high oil prices in the past. During the last significant crude spike, Southwest was able to come out ahead of other airlines thanks to its superior hedging strategy. While its competitors were on the edge of bankruptcy, Southwest was still flying relatively high. 

Hedging does not always work. Oil and gas prices are now extremely low, but some carriers still have futures contracts that make it impossible to take full advantage of these low prices. As long as prices remain low, buying futures can actually be a disdvantage. 

Betting on higher prices

Some analysts think that the price of oil has now bottomed out. It is difficult to be certain. A new Reuters report suggests that some airlines are now trying to secure futures for the coming years. This will allow them to get fuel at 2016 prices in 2017, 2018 and even further in the future. The report said that unnamed airlines had purchased futures for as far ahead as 2019. 

The idea behind this is that, even if projections are wrong and prices remain low, airlines will still be able to make profits if they lock in current prices for the next three years.

Limited downside

Airlines who forego this kind of hedging strategy may, possibly, be able to score cheaper fuel in the future. However, they could also end up paying significantly higher prices for their gas. In other words, there is a small risk for ailrines who purchase futures now, but there is a huge risk for airlines that do not purchase those futures. 

If prices are higher in the coming years, then the un-hedged airlines would be at a (potentially huge) disadvantage. According to the Reuters report, most airlines seem to be opting for the safety net of futures, even though there is a chance of slightly less profits. 

What does this mean for fliers?

We have already seen that lower fuel prices do not necessarily mean universally lower airfares. However, low prices do mean that airlines can lower fares on competitive routes and still make a profit. If you happen to fly regularly on one of these contested routes, then the fact that many airlines are hedging is good news for you. Regardless of what happens in the oil market over the next couple of years, airlines will still probably keep fares low to keep the pressure on competitors. 

Also, at least in the near future, a huge spike in oil prices won’t mean significantly higher fares if most major airlines are hedged.

On the other hand, if a majority of carriers do not have low prices locked in, then they will be forced to raise fares or add surcharges. Airlines that hold futures would most likely follow their lead in order to capture extra profits, even though they wouldn’t be paying as much for fuel. 

So it seems that there is a lot of upside and limited downside for both fliers and airlines if a majority of carriers are deciding that they want to lock in current fuel prices for the next two or three years. 


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