American Airlines' fuel-buying bet pays off in record profit

2014 was a good year for nearly every major airline because fuel costs, their biggest expense, plunged

American Airlines, the world's largest carrier, took a big gamble in fuel buying last year — and it paid off in record profit.

"This was the best year in the long, proud history of American Airlines," Chief Executive Doug Parker said Tuesday. The Fort Worth airline reported 2014 net income of $4.2 billion, up 115% from the previous year, thanks partly to huge savings in fuel costs.

It was a good year for nearly every major airline because the cost of fuel, their biggest expense, plunged. It has fallen about 50%, from $2.97 a gallon at the end of 2013 to $1.48 a gallon Tuesday, according to the U.S. Energy Information Administration. For most airlines, fuel costs represent about 30% of total expenses.

But for top carriers other than American — including Delta, United and Southwest — the savings could have been much better. That's because the airlines entered into fuel-buying contracts to protect themselves against spikes in fuel prices. It's a practice known in the industry as fuel hedging.

American Airlines, which merged with US Airways, last year adopted that carrier's policy of not hedging, which allowed American to take full advantage of the steep plunge in fuel prices. The result was more than $600 million in fuel savings for American Airlines for 2014, with even bigger savings expected this year if fuel costs stay low.

"We believe 2015 will be yet another record year, exceeding the earnings from 2014," Parker said.

Because Delta, United and Southwest locked in the price for a portion of their total fuel spending through hedging, they paid above-market fuel costs for much of the year.

Delta reported $180 million in fuel-hedge losses in the last three months of 2014 as price declines accelerated, while United lost $237 million and Southwest lost $13 million, according to the airlines.

"American doesn't hedge," said Seth Kaplan, managing partner for the trade publication Airlines Weekly. "So, they have won big time."

Still, the carriers enjoyed significant savings for the full year even after accounting for the hedging losses: Southwest saved $470 million in fuel, United saved $493 million and Delta saved $574 million, which included profit from a refinery Delta operates.

Airline executives have dismissed calls to pass their good fortune on to passengers through lower fares. Instead, they said they plan to invest their profits into buying new planes, paying down debt, sharing profit with employees and boosting returns to shareholders.

Airfares have risen gradually over the last few years. The most recent data from the U.S. Bureau of Transportation Statistics show that the average domestic airfare for the April-through-June period was $396, up 2.5% from the same period in 2013.

"We will continue to prudently reinvest in the business on investments that align with our return on invested capital goal, pay down debt and return value to our shareholders," said Richard Anderson, chief executive at Delta Air Lines.

It makes sense for executives like Anderson to be cautious, analysts say. The airline industry has historically been volatile, with fuel price swings, hurricanes, labor disputes, epidemics and other calamities turning sunny economic times into disaster.

American establishes airfares based on demand, not on its expenses, Parker told analysts during a conference call Tuesday.

He added that the steep drop in fuel costs won't change the way American operates.

"We are well aware that much of the tail wind pushing our industry in 2014 was a significant and recent drop in oil prices," Parker said. "Our perspective is that Brent [crude oil] was over $100 a barrel for over four years and has been under $100 a barrel for merely four months. So we are going to continue to run American as though we are still operating with $100-per-barrel oil."

Passenger rights groups point out that when fuel prices surged in 2008 and again in 2011, the airlines used the higher fuel prices to justify steep airfare hikes. Now that fuel prices have dropped, they argue that fares should drop.

"We have seen six months of steadily dropping gas costs," said Paul Hudson, president of Flyersrights.com, a 50,000-member passenger rights group. "By any measure, the money saved by the airlines should be reflected in lower airfares."

Last month, New York Sen. Charles Schumer called on the U.S. Department of Justice and the Department of Transportation to investigate why airfares have not dropped with fuel prices.

"The industry often raises prices in a flash when oil prices spike, yet they appear not to be adjusting for the historic decline in the cost of fuel," he said.

That volatility has United and Southwest rethinking their strategy for fuel buying in 2015, opting to cut back on fuel hedging for the next two years.

Southwest says it plans to end all hedging contracts in 2015; United says it plans to hedge only about 16% of its fuel supply in 2015, buying the remaining 84% on the open market.

Ending fuel hedging could be a mistake, said Richard Gritta, a University of Portland finance professor and airline expert.

"If I knew my house was not going to burn down, why would I buy insurance?" he said. "But you don't know that."

Delta said it would take a conservative approach and keep its fuel hedging strategy.

"I don't think we are going to jump to do anything extreme," said Paul Jacobson, Delta's chief financial officer.

hugo.martin@latimes.com

Twitter: @hugomartin

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