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What Is the Impact of Rising Oil Prices for Airlines in 2016?

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Falling fuel prices

Falling crude prices since mid-2014 have brought much-awaited relief for airlines. Crude has fallen from a high of $105 per barrel in July 2014 to ~$30 per barrel in February 2016. After a brief rally at the start of February, prices have fallen again.

Since fuel is a major input cost for airlines, airline companies have benefited immensely from the crude oil slump. However, the sudden fall in oil prices has also triggered a sea 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, so many airlines suffered huge hedging losses. Airlines that use complex derivative hedges, including Delta Air Lines (DAL) and United Continental Holdings (UAL), suffered immense losses due to the price fall, which dampened their bottom lines.

In contrast, American Airlines (AAL), which follows a no-hedging policy, benefited fully from lower fuel prices.

Most airlines have reduced their hedges for 2016, with the only exception being Southwest Airlines (LUV). LUV will continue to see huge hedging losses in 2016.

Expectations for 2016

According to most energy analysts, crude prices are expected to rebound in the second half of 2016. In fact, crude has already seen brief rallies since the start of the year. One such rally was on the back of Saudi Arabia and Russia’s proposing to freeze production levels at January 2016 levels, provided others would follow suit.

Though we may not be certain of the timing, investors should remember that airlines stand to lose significantly in the event of a sudden rise in oil prices—moreso if they are unable to pass on the higher costs on to customers.

Investors can gain exposure to airlines through the PowerShares Dynamic Leisure & Entertainment ETF (PEJ), which invests ~27% of its portfolio in airline stocks.

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