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How Much Longer Can We Expect Oil Prices to Benefit Airlines?

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Fuel prices in 2015

From $105 per barrel in July 2014 to an average of $66.70 per barrel for 2015, fuel prices have brought a sigh of relief for airlines in the last two years. Airlines have reaped huge benefits from this slump in the form of lower input costs, resulting in better profitability and a huge cash surplus.

Airlines used this cash to restructure their fleets and add capacity. However, the sudden fall in oil prices has also triggered a deluge of hedging losses for these airlines.

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Hedging losses

Airlines generally use hedging as a tool to protect them against unexpected fuel price fluctuations. The recent fall was very sharp and many airlines suffered huge hedging losses. Delta Air Lines (DAL) and United Continental Holdings (UAL), which use complex derivative hedges, suffered immense losses due to the falling oil prices. This pricing environment subdued the airlines’ bottom lines. In contrast, American Airlines (AAL), which follows a no-hedging policy, took full benefit of the lower fuel prices.

Most airlines have reduced their hedges for 2016. The only exception is Southwest Airlines (LUV), which can expect to see continued, significant hedging losses in 2016.

Expectations for 2016

According to most energy analysts, oversupply issues are expected to keep oil prices subdued for at least the first six months of this year. The airlines have been keeping a close watch on any news for production cuts by OPEC members. Although OPEC has been growing oil production levels amid already low oil prices, it expects oil prices to rebound in the coming years.

Investors should remember that fuel prices should rebound eventually once key economic production starts falling. Airlines stand to lose in the event of a sudden rise in oil prices if they are unable to pass on the higher costs to their passengers.

Investors can gain exposure to airlines through the iShares Transportation Average ETF (IYT). IYT holds 5.4% in Alaska Air Group (ALK), 4.65% in United Continental (UAL), 4.3% in Delta Air Lines (DAL), 3.9% in Southwest Airlines (LUV), 3.6% in American Airlines (AAL), and 1.9% in JetBlue Airways (JBLU).

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