Narrowing WTI/Brent spread could aid US airlines

Wed Nov 23, 2011 11:41am EST

* Southwest sees benefit from smaller spread

* Delta switched to Brent earlier this year

* AMR cites improvement in WTI trades

By Karen Jacobs

Nov 23 (Reuters) - The narrowing price gap between the two main benchmarks for crude oil could bring relief for U.S. airlines burned this year by their divergence.

Carriers like Southwest Airlines , United Continental Holdings and Alaska Air had markdowns or special expenses in the third quarter tied to hedges in West Texas Intermediate crude oil, which fell in price while jet fuel prices, which have been more closely tracked by North Sea Brent crude this year, remained high.

"To the extent we see WTI and Brent come together, I think that's helpful and the hedges that we have in place will really give us much better protection than they were when WTI was trading at a discount," Southwest Airlines Chief Financial Officer Laura Wright said in a recent interview.

Crude prices affect the cost of jet fuel, which vies with labor as airlines' biggest cost. Airlines use fuel hedge contracts to protect against price swings.

U.S. airlines mostly manage their exposure to fuel through WTI, the U.S. benchmark crude. Brent is a European benchmark.

U.S. crude prices rose to a five-month high above $102 a barrel last week on news of a plan to enable crude landlocked at an Oklahoma storage hub to be moved to the Gulf Coast for refining.

As a result, banks influential in commodity trading revised their forecasts, saying the Brent/WTI spread would narrow faster or further than previously expected..

The premium of Brent to WTI stood at around $11.40 a barrel on Wednesday, down from as much as $27.88 in October.

The widening of the spread to more than $25 earlier this year "was an exceptional situation that had a lot to do with the anomalies of the North American production situation and the landlocked crude in North America," said Bill Warlick, a senior director at Fitch Ratings who watches airlines.

"That's likely to be addressed now, and so we would expect some continued reduction in the spread," he added.

Rising fuel costs have cut airline profits and forced carriers to curb unprofitable routes and capacity this year.

RARE DIVERGENCE

After years of WTI trading at a $1-$2 premium to Brent, the relationship inverted last year and Brent's premium over WTI began to rise. Concerns about rising oil inventories and strained pipeline capacity in North America have weighed on WTI, even as war in Libya and emerging market growth helped push up prices of Brent.

The growing gap has caused trouble for airlines that use WTI futures contracts to hedge energy costs.

For example, United Continental cited a $52 million third-quarter charge related to "fuel hedge ineffectiveness," and Southwest posted a rare net loss of $140 million for that period as it took a non-cash markdown of more than $200 million tied to its hedge portfolio.

While Southwest's Wright declined to comment on what hedging strategy changes the tightening spread could prompt at her carrier, she said some decisions "become much easier now that the differential has narrowed."

Delta Air Lines Inc shifted its jet fuel hedges to Brent from WTI earlier this year. A Delta spokesman said last week that the carrier had no comment on its preference even with the recent change seen with WTI.

Fitch's Warlick said the narrowing spread was a positive, though not an enormous one, for airlines.

"A lot of airline management teams have been tweaking their approach to hedging for a while now in response to this spread," he said. "It's good for U.S. airlines to the extent that they are more exposed to WTI-based hedging strategies."

AMR Corp's American Airlines said it tends to hedge more in refined products rather than crude, and it does not expect the WTI-Brent spread issue to significantly affect its hedging strategy.

"We do have some WTI hedges, so the recent tightening of the WTI-Brent spread has helped the performance of those trades," American Airlines spokesman Sean Collins said.

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