Oil's Dropped, but Price Contracts Haven't

By Steven Mufson
Washington Post Staff Writer
Thursday, October 30, 2008

As oil prices were spiking in July, Southwest Airlines chief executive Gary C. Kelly told a conference that his company was "very well prepared to weather the storm" and "prepared for $4 jet fuel." But it turned out that what Southwest wasn't ready for was $2 jet fuel.

Famous for its ability to play the oil markets to lock in low fuel costs, Southwest made some bad bets in late spring and summer. Now, it's paying a heavy price just when it should be celebrating lower costs. A $189 million loss on fuel contracts put the company in the red for the first time in 17 years.

Southwest isn't alone. Though plunging oil prices have been a silver lining for the ailing economy, many companies are still covering high costs they locked in months or weeks ago.

Light, sweet crude for December delivery settled at $67.50 a barrel yesterday on the New York Mercantile Exchange. But many airlines, spooked by forecasts by analysts such as those at Goldman Sachs who were predicting $200-a-barrel crude oil, locked in prices higher than yesterday's for large portions of their fuel needs.

A wide variety of other companies did, too. Coca-Cola Enterprises, the world's largest Coke bottler and distributor, said it had suffered $11 million in losses on "ineffective" attempts to hedge future fuel prices. Britannia Bulk Holdings, a British dry bulk shipping firm, said it had "significant" losses on purchases made earlier in the year for bunker fuel, the type of petroleum its ships use. In a statement, it said "the company entered into a bunker fuel hedge which is currently uncompetitive because it is hedged to prices which are significantly above the current market price of bunker fuel."

Even professional traders have been burned. T. Boone Pickens, whose BP Capital fund lost 33 percent in July and 9 percent in August, lost 21 percent in September. In a recent television interview with Charlie Rose, Pickens said he had lost about $2 billion.

If savvy oil traders are losing big, how can ordinary consumers decide what to do? Yet that's what heating oil users have to decide. Heating oil dealers are offering customers three choices: a price set on day of delivery, a fixed price locked in now (at a premium over current prices), or a fluctuating price with a cap (for which consumers would pay a smaller premium).

Kevin Rooney, chief executive of the Oil Heat Institute of Long Island, estimates that half of the island's 600,000 homes using heating oil locked in prices or caps two years ago. With prices on the decline now, he estimates that only about 15 percent have locked in for this winter.

"We get dozens of calls every day asking what prices are and for projections, as though I have some kind of crystal ball," Rooney said. "If I knew, I'd be taking this call from a South Seas island villa." Rooney works in Hauppauge, N.Y.

Some companies have done relatively well at hedging fuel prices.

Royal Caribbean Cruises, for whom energy costs amount to about 10 percent of revenue, has smoothed out its energy costs by betting on prices. Though its costs might be higher now because it hedged 55 percent of the fuel needed for the quarter, for the entire year, the company is looking to spend less than it would have without hedging. It expects its full-year fuel costs to come to $686 million this year, up less than 25 percent while expanding service. Crude oil prices so far in 2008 are averaging almost 50 percent more than in 2007.

"We have a program in place meant to remove some of the volatility from our income in the event of extreme swings in fuel prices," said Ian Bailey, head of investor relations at Royal Caribbean. "We don't try to time the market or take positions. We're not in this to try to speculate."

Whether that will look smart next year depends on how low oil prices go. Royal Caribbean has already locked in prices for 39 percent of the fuel it expects to need in 2009.

Many companies still prefer to pass on energy costs to customers. FedEx, for example, has a fuel surcharge it adjusts every month.

Procter & Gamble also tries to factor energy costs into its business, though the company cautions that lower oil prices don't immediately translate into lower prices.

"We have commodity costs that should be headed down, not in the October to December quarter because we're still paying today for $120 to $140 [a barrel] oil today in our costs, but we should see costs moving down in the first half of calendar 2009," Clayton C. Daley Jr., chief financial officer of Procter & Gamble, said on CNBC yesterday.

"The time it takes for feedstocks to show up in our costs is three to six months later, and then, of course, they have to pass through our inventories and our accounting systems as well," he added.

Airlines have been big losers as declining oil prices have made their oil gambles look bad.

In addition to Southwest, United Airlines' parent company, UAL, booked a $519 million loss on fuel-hedging contracts in the third quarter. The values of the contracts have fallen sharply along with the price of oil.

There were good reasons for airlines' efforts to move aggressively to reduce fuel costs. Fuel expenses supplanted labor as the top cost at airlines in 2006. From that point on, the fate of airline stocks has depended largely on the direction of oil prices, with shares deteriorating badly as oil prices ran up earlier this year.

Oil prices peaked at $147 in July. At the time, Wall Street analysts were predicting even higher prices. A Goldman Sachs analyst predicted in June that oil would hit $200 a barrel by the end of the year.

Believing the forecasts, airlines made hedging bets that oil was going to go higher, aviation consultant Julius Maldutis said. But they were wrong. "All the specialists who predicted oil would go above $147 should really be embarrassed at this point," Maldutis said.

Staff writer Sholnn Freeman contributed to this report.