Your next flight doesn't have to be so expensive. Here's why

NPR. This is the Indicator from Planet Money. I'm Darian Woods. And I'm Whale and Wong. I think by now it's been familiar exercise since the war in Iran started. You open a browser tab, you look at air fairs for a summer vacation, and then you close your laptop and you throw it into the ocean. Yes, it is a ricochet effect economically about this straight-of-our-moves closing and how that's affecting airline prices. Yeah, jet fuel accounts for around 20% of its typical airlines costs. And the price of jet fuel has actually shot up more than crude oil, gasoline, or diesel. So many people who are shopping for air fairs right now are feeling this pain. Hiking air fairs is this obviously either that airlines can pull when their costs go up. But there's another one that these companies do have at their disposal. It's a strategy known as fuel hedging. Airlines like Cathay Pacific, Lothanza, and Quantis do it. But most airlines in the US haven't done it for a decade. So today on the show, what is fuel hedging? Why did airlines in the US stop doing it? And what will they do now? This message comes from Wise, the app for international people using money around the globe. You can send, spend, and receive in up to 40 currencies with only a few simple tabs. Be smart, get Wise. Download the Wise app today or visit Wise.com. Tease and C's apply. There's so much TV out there that we can't get to it all. Good stuff falls through the cracks. That's why we're recommending some great TV we missed. Find out what's good to watch on NPR's pop culture happy hour. Listen via the NPR app or wherever you get your podcasts. Jerry Ladman is an airline veteran. He worked in the industry for around four decades, mostly on the finance side. He was treasurer of continental airlines and eventually became the chief financial officer at United Airlines. One constant in his career was looking at oil prices. I've been retired for almost two years. I still check it every day. Oh, how bad, sir. You just get used to it, but yes, it is something that on any Bloomberg screen I can think of in the treasure department of any airline, there will be on the screen fuel prices. Sometimes when I drive past a gas station, I look at the price on the sign and do some quick mental math about how much it'll take to fill my tank. That's your version of what airline executives are doing. Exactly, but they do it on a much bigger scale. The impact for an airline is a lot more than a driver. It's tens of millions of dollars on an annual basis for each movement of just one cent in a gallon of Jeff Ful. And the war in Iran is making prices spike more than just a cent per gallon. This week, the global average price for Jeff Ful was creeping towards $5 per gallon. That's more than double what it was a month ago. The CEO of Delta Airlines said in an industry conference last week that the spike in fuel prices has generated $400 million in additional costs so far this month. It's a big unexpected hit. And there are two ingredients in the price of Jeff Ful. The first is the price of oil, specifically Brent Crude, which is the global benchmark. The second ingredient is what's called the crack spread. That's a little oil industry jargon for you, which Jerry explains like this. Think of it like the refining margin, the cost of refining the product, the profit for the refiner's transportation and a whole number of other factors. The crack spread can have its own movements independent of the underlying price of oil. The current crack spread for Jeff Ful is also way up compared with last month and last year. One reason is because middle eastern refineries that produce Jeff Ful and other products can't ship through the straight of hormones. Now, airlines can't control the global price of oil or what's happening with refineries. And notable exception in the US though is Delta. It owns its own refinery through a subsidiary. This vertical integration helps the company save money on refining oil into Jeff Ful. As for other airlines, former United CFO Jerry Latterman says they generally try to keep their fuel costs down by using more energy efficient cleans and carrying less weight. But for many years, airlines have also done something called fuel hedging. This practice was common in the US, but that changed. And before we get into why that changed, first we should talk about what fuel hedging is. It involves financial instruments like futures contracts. You might be familiar with this term from the stock market. Investors that use these contracts agree to buy or sell a certain asset like a stock at a specific price on a specific future date. There are futures contracts for all kinds of commodities, including crude oil. So an airline that is fuel hedging might enter into a contract to buy crude oil at a set price in the future. Let's say it agrees to pay $100 a barrel six months from now. And six months goes by and let's say the cost of crude oil has gone up to $150. The futures contract locked in a price of $100 though. So now the airline has made a $50 profit. Of course, if oil prices have gone down to $50 a barrel, the airline loses money. Now, it's important to note, there are not actual like literal barrels of crude oil trading hands here. What we're talking about is the airline making money in the markets on this trade. And that money helps the airline build a financial cushion for when they actually do go to pay for debt fuel. It's really viewed as insurance to protect the financials against a sudden spike in jet fuel. And for years, this insurance policy worked well. So for example, American Airlines said in 2003 that it saved almost $150 million in fuel costs thanks to hedging. Southwest Airlines pursued an aggressive hedging strategy. The company estimated that it saved $3.5 billion between 1998 and 2008. It used these savings to expand operations and hire workers. However, Jerry says most of the major airlines in the US eventually soured on fuel hedging. One reason the Wall Street transaction fees to make these hedges got expensive. Like any insurance, there's a cost to it. They're paying a premium for the privilege of locking it in and it's sort of built into that price. And it's expensive. And what I think the US Airlines found is that it wasn't worth that expense. Plus Jerry says the airlines found that they could make money the old fashioned way by raising prices. The better answer was to, in a fair manner, pass costs on to consumers. And the industry found that they were able to adjust fairs to cover, you know, I'm not saying 100% of a spike in fuel price, but a significant increase in fuel. And that's a much, much healthier way for an industry to manage its costs. United American and Delta stopped hedging in the 2010s. There was an unexpected drop in the price of oil during that period. The airlines that had bet on higher prices ended up with heavy losses on their hedges. The president of American Airlines told the Wall Street Journal in 2016 that hedging is a rigged game that enriches Wall Street. Meanwhile, Southwest kept going with hedging because it was under more pressure to keep prices low. That's according to Carrie Tan, his economist at Loyoli University, Maryland, who studies the airline industry. Delta can charge a premium on prices because of the perceived higher quality experience. And the clientele being much less price sensitive than your traditional passenger on Southwest. But even Southwest stopped hedging a year ago. The company said the premiums it paid to make these trades had gotten too costly and that it would find other ways to address fuel prices. Today, none of the major airlines in the US are hedging. Many outside of the US are, but even airlines like Cathay Pacific and Quantis are increasing airfares or fuel surcharges. It appears that hedging alone isn't enough to keep prices low for flyers. So, will US-based airlines dust off their old hedging playbooks and get their investment bankers back on speed dial? Carrie says the big variable is how long oil prices will stay elevated. If you're a hedging fuel, you're trying to make a bet that prices are going to go up. But today, right now, it's hard to say whether prices are going to be chronically high or if they're going to revert back or what's going to happen even months from now. Carrie's hedging is statements. Now, it's possible that the airlines believe that they can ride out a few months of higher oil prices with higher fares or by implementing fuel surcharges. But if the war persists, then all bets are off. This episode was produced by Corey Bridges with Engineering by Jimmy Keely and Maggie Luthar. It was fact-checked by Sarah Huaddez, kicking cannon is our show's editor and the indicator is a production of NPR.