Airline CFO: Hedging Saved Us $400 Million

Airlines fight a constant battle with fuel price volatility. Since the industry spends about a third of its operating costs on fuel alone, airlines employ an arsenal of financial instruments like derivatives, options, and caps, to hedge against wild swings in the energy market.

Photo: CNBC

And it’s serious business: in some instances, a company’s hedging book could be the difference between a profit and a loss in a quarter.

So, who’s the best?

According to analysts, it’s Alaska Air Group—the predominantly western US carrier that operates Alaska Airlines and Horizon Air.

The company's CFO Brandon Pedersen told CNBC that its hedging program has “been very, very good for us. We’ve saved roughly $380 million, up through December 31st. And that’s even approaching $400 million through the first couple of months of this first quarter."

This is an impressive figure considering the company’s roughly $2 billion market cap and the fact that its entire hedging team totals only 3 people.

The company runs a systematic, some might say robotic, approach to its hedging strategy. Pedersen was quick to point out that the program has operated essentially unchanged since its inception about 10 years ago, pausing briefly only once a few years back when a run-up in oil prices caused the company to reevaluate its strategy.

At the heart of it, it’s simple: Alaska Air begins to hedge about three years in advance. Each quarter, the company adds an incremental amount to that position (usually an extra 5 to 7 percent of its future consumption) until it hits 50 percent. It’s a strategy that is constant, regardless of volatility in the energy market.

“Our program is really designed to be price agnostic. We go into the market and buy at current prices and what it is, is what it is,” Pedersen explained.

Since it uses caps only, the company says it remains insulated from major hedging losses if prices suddenly drop—like they did in 2008 when crude oil plummeted more than 70 percent in less than 6 months.

“We can participate in the downside, but we are locked in on the upside, if you will. Our cost then really becomes the premium that we pay,” added Pedersen.

Make no mistake about it, those premiums aren’t cheap.

Ranging anywhere from 10 to 20 percent for every barrel of oil hedged, the costs have totaled the company around $200 million, Pedersen said.

Those costs are the reason why others in the industry resort to strategies different from Alaska’s, according to analysts.

Alaska Air Group houses one of the stronger balance sheets in the industry, and with about $1 billion in cash, it has the luxury to expense millions in hedging premiums when others might not.

For now, it’s part and parcel of a strategy that seems to be working. The company’s stock has risen more than 200 percent over the past 3 years, outperforming its peers relative to the NYSE Arca Airline index, which is up only 60 percent over that same period.

And analysts say they’re expecting even more upside from the company in the future.