A Risky Bet That Fuel Prices Have Peaked


With OPEC cutting oil production and demand still outpacing supply, it would seem oil prices have nowhere to go but up. It would make sense, then, for fuel-guzzling companies to lock in prices now by hedging. Indeed, that's what many airlines and other big-time fuel-burners did in 1999 and 2000 before prices spiked, saving themselves bundles of dough.

So why are UAL Corp. and Northwest Airlines Corp. doing just the opposite? After years of successful hedging strategies, the two airlines have abruptly stopped buying fuel futures, joining a band of transportation companies that are scaling back their use of the futures market or giving it up altogether. Their rationale: They claim that after last year's runup in energy prices, they couldn't find any futures contracts or swaps that would save them money over what's available on the spot market.

But there's another reason: They're placing a high-stakes wager that fuel prices have peaked. They figure the slowing economy -- both in the U.S. and other parts of the world -- will sap oil demand so much that OPEC will be lucky to sustain today's prices, much less hike them through planned output curbs in February and March. "The industrial side of the economy is in some sort of recession," says Matthew K. Rose, chief executive of Burlington Northern Santa Fe Corp. "We could see lower fuel prices in the second half of the year." The railroad, which had 42% of its fuel supplies hedged last year -- for savings of $50 million in the fourth quarter alone -- now has just 24% of its supplies hedged.

CAUGHT SHORT. Dropping their hedge programs could be costly. In 2000, U.S. airlines paid $15.5 billion for fuel, or 53% more than in 1999. But as prices peaked in the closing quarter of last year, United Airlines and Northwest saved $131 million and $121 million, respectively, thanks to futures contracts that assured deliveries at locked-in prices.

By contrast, companies that hadn't hedged were caught short. Trans World Airlines Inc.'s Chapter 11 bankruptcy filing on Jan. 10 sprang directly from the $250 million fuel-cost hike it suffered last year, says CEO William F. Compton. Yet, United and others are convinced that the need to hedge is over. "There's a risk, clearly," concedes United Airlines President Rono J. Dutta. "But we think it's a sensible risk."

Most other big energy consumers disagree. Indeed, after being burned last year, some companies are busy covering their flanks. Union Pacific Corp. -- which didn't hedge at all -- paid some $440 million more for diesel fuel last year than in 1999. It has hedged some 8% of its supply for this year. Dow Chemical Co., which saw 30% savings last year from its hedges, says it's sticking with the strategy. Continental Airlines Inc. and Delta Air Lines Inc. also continue to hedge. Continental has 50% of its fuel needs for the first quarter and 40% for the second. Delta has locked in 45% of its needs for this year. Package shippers FedEx Corp. and United Parcel Service Inc. are similarly well-hedged. Proclaims FedEx Chief Financial Officer Alan B. Graf Jr.: "So far, the benefits have been very strong."

"SMALL PRICE"? Still, those benefits doesn't come cheap. It costs from a penny to 10 cents a gallon to hedge fuel needs through futures contracts, depending on the price, duration, and amount of fuel that's being secured. Multiply that by the hundreds of millions of gallons many companies burn in a quarter, and those charges can add up.

But considering how volatile fuel prices have been lately, hedging can still worthwhile. The chance to prevent "catastrophic changes" in balance sheets makes most hedges a bargain, argues Ken D. Miller, senior principal energy analyst at refining consultants Pervin & Gertz. "That insurance cost is a pretty small price to pay."

Perhaps it's no coincidence that the same companies that were savvy enough to save the most money on hedges, are abandoning it now. "When fuel prices are high and are expected to stay flat, there's no point in incurring that additional cost," says UAL's Dutta. Maybe they know something the rest of us don't. But if it turns out they're wrong, their shareholders will be the losers. By Pallavi Gogoi and Michael Arndt in Chicago


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