An Open Letter to All Airlines - Quit Whining and Hedge Your Fuel Costs

Includes: DAL, NWA, UAL, UAUA
by: Dan Knight

I received an email from United Airlines (UAUA) today, "An open letter to all airline customers" was the subject line. In it, they bemoan the fact that speculators are a larger percentage of traded contracts than years before and that they believe the speculators are responsible for driving up the price of oil, and thus their fuel costs. Look in your junk email box and you probably received it as well.

There has been a lot of debate over this recently, but as outlined in the WSJ a couple days ago, commodities speculators aren't dealing in the underlying, just the cash settlement difference of the futures contracts. Unless there has been significant hoarding or some other tangible change in the supply or demand for the commodity, speculators, and hedgers for that matter, don't materially affect the underlying price. If prices are getting too disconnected from fundamentals, then other speculators will come in and short contracts, driving the price to equilibrium.

In futures markets, there are only 2 types of participants - hedgers and speculators. Another category might be called "investors", since many have noted that a lot of institutional money has moved into the market, to capture asset class exposure, but that begs the question whether commodities are truly assets, since they don't pay any dividends, interest or generate earnings. In a sense, these institutions are speculating that the commodities will generate a real return over time, which is debateable.

Typically speculators buy from hedgers, or other speculators betting against them. The airlines missed the boat by not buying oil futures and thus hedging their fuel costs. Of course Southwest famously did and has reaped tremendous benefits for it. Few other industries have such an overwhelming exposure to a potentially hedgeable cost as the airlines and oil. The admonitions should be towards the airlines who didn't manage their businesses prudently, and we're all paying for that - not from what the speculators are doing.