Oil is the lifeblood of a lot of companies in the U.S., and as its price swings higher or lower, it can change their fortunes along with it. But not all of those companies are extracting oil from the ground, or selling it to consumers -- some are using it as an input for their own products.
Now that oil prices have plunged below $40 per barrel, it's time for a few industries to get aggressive in protecting themselves from higher oil prices. Hedges, like buying oil for future delivery in the futures market, can effectively lock in oil prices for a company months, or even years, in advance. If oil is a big input to a company’s business, it can be advantageous to lock in oil prices while they’re low.
It's no secret that airline profits have been rising as oil prices have been falling. Fuel can be as much as 35% of an airline's operating costs, so falling oil is great for the industry. As you can see below, American Airlines Group (NASDAQ:AAL), Delta Air Lines (NYSE:DAL), and Southwest Airlines (NYSE:LUV) are all seeing profits rise with the drop in oil.
That's why now would be a great time to aggressively hedge against a potential rise in oil prices, even years from now. Oil for delivery in January 2018 closed on Monday at $51.30 per barrel, and all the way out to January 2023, oil is only at $63.00 per barrel.
Locking in those costs today would lower commodity risk that could derail profits years down the road. In an industry like airlines, where bankruptcy seems to be part of the business cycle, that may be a bet worth taking.
Most of the plastic products you use every day are actually made from oil in one form or another. That's why oil is a big input cost for chemical companies like Dow Chemical (NYSE:DOW) and BASF (NASDAQOTH:BASFY), and is such a driver of their earnings.
Often, chemical prices follow oil prices higher or lower, but often, low oil prices mean expanded margins for chemical companies. Locking in low costs now could lead to greater earnings in the future.
The risk in hedging oil prices for chemical companies is that hedging too early could lock in higher prices than the spot market allows. But with oil now floating near $38 per barrel, I think it's unlikely we see prices remain this low for too long.
Hedging can be a blessing and a curse
Watch the market long enough, and you'll see the ups and downs of hedging. Oil companies will hedge production only to see oil prices rise, losing out on millions in the process. Or airlines will lock in oil prices, and then see them collapse, and be forced to lower prices against competitors who didn't hedge. But if you time it right, hedging can be a huge benefit to a business.
With so many forces pushing oil prices lower, I think it's just a matter of time before prices rise, even if they don't rise to $100 per barrel again. Now is the time to lock in some of those low prices for the future benefit of investors.