Air Travel Collapse Makes Oil Hedges More Expensive

The pandemic and the resulting plunge in air travel have caused airlines to largely abandon oil hedges against higher oil prices, thus making it more expensive for oil producers to lock in higher oil prices on the options market, Bloomberg reported on Friday, citing hedging specialists.

Typically, oil producers in the United States and elsewhere hedge part of their future production to lock in oil sales at a certain price, ensuring that they will get that price for their barrels, even if oil prices collapse. At the other end of the options market typically come airlines, which make oil hedges at low prices to ensure they have low cost for fuel—their biggest expense.

With the collapse in air travel this year, however, airlines have largely abandoned the options market, trying to ensure their survival by cutting costs, including by mass layoffs, delay of new aircraft purchases, and dropping routes.  

“It’s becoming extremely difficult for big producers to hedge without the large airline flows around,” Thibaut Remoundos, founder of London-based Commodities Trading Corp, told Bloomberg. Some of those producers have to pay a premium for the put options they buy, and they are expensive, he said.

Apart from oil companies, Mexico also makes oil hedges every year. This week, signs emerged on the market that the Mexican hedge for 2021 may already be underway, traders and brokers told Bloomberg. 

The Mexican oil hedge, or the Hacienda Hedge, is considered the biggest hedging bet on Wall Street as well as perhaps the most secretive. Such hedges minimize the losses in case oil prices crash. Earlier this year, it was the oil hedge that is thought to have saved Mexico’s economy from ruin. 

Every year, Mexico buys put options from investment banks and typically hedges a whopping 200-300 million barrels of oil. With the put options, it has the right, but not the obligation, to sell oil at a previously set price and timing.

By Charles Kennedy for Oilprice.com

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