2012 Fuel Hedging at Jetblue Airways

Abstract

In early 2012, an equity analyst, was examining the jet fuel hedging strategy of JetBlue Airways for the coming year. Because airlines cross-hedged their jet fuel price risk using derivatives contracts on other oil products such as WTI and Brent crude oil, they were exposed to basis risk. In 2011, dislocations in the oil market led to a Brent-WTI premium wherein jet fuel started to move with Brent instead of WTI, as it traditionally did. Faced with hedging losses, several U.S. airlines started to change their hedging strategies, moving away from WTI. But others worried that the Brent-WTI premium might be a temporary phenomenon. For 2012, would JetBlue continue using WTI for its hedges, or would it switch to an alternative such as Brent?

Excerpt

UVA-F-1697

Rev. Mar. 1, 2016

2012 Fuel Hedging at JetBlue Airways

In January 2012, Helena Morales was updating her JetBlue Airways (JetBlue) research report. Morales, an equity analyst, followed major U.S. airline carriers. JetBlue was a low-cost airline that had distinguished itself by offering in-flight entertainment and other amenities. JetBlue had started its operations in 2000 and experienced a remarkable growth rate, leading the company to go public in 2002 (NASDAQ: JBLU).

In 2005, JetBlue's profits suffered a first hit due to rising jet fuel costs. Keeping an eye on jet fuel oil prices was essential for an airlines analyst. Although airlines had applied fuel surcharges to the price of tickets in the past, these surcharges were viable only when matched by competitors. Given the limited pass-through to customers, fuel hedging protected the airline's cost structure from spikes in jet fuel prices and allowed airlines to follow their business plans. JetBlue entered into a variety of hedging instruments including swaps, call options, and collar contracts with underlyings of jet fuel, crude, and heating oil. Some of these derivatives could cost millions of dollars, however, and there was the risk that the airline would suffer negative effects from a sharp decline in fuel prices.

Jet fuel prices passed the $ 3-per-gallon mark in 2011, the highest since 2008 (Exhibit 1 shows spot jet fuel prices at a major trading hub: the U.S. Gulf Coast [USGC]). These levels were the result of a dramatic year in the oil market due to the Arab Spring, civil war in Libya, and demand growth from China. In its annual report, JetBlue reported that fuel costs were its largest operating expense, approaching nearly 40% of total operating costs in 2011. Table 1 shows fuel consumption and costs for the previous three years:

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Keywords: airlines, hedging, risk management