Airlines bet oil will correct; stay away from hedging
Top global airlines are staying away from further hedging jet fuel purchases that account for around a third of their costs, betting that a recent surge in oil prices to two-year highs will slow.
January 06, 2011 / 12:11 IST
Top global airlines are staying away from further hedging jet fuel purchases that account for around a third of their costs, betting that a recent surge in oil prices to two-year highs will slow.
Skimping on cover risks a squeeze in earnings for these companies, which typically have razor-thin margins and had just returned to profitability in 2010 after economic turmoil had sapped corporate and consumer demand for air travel.Two factors are giving airlines pause: they have withstood prices far higher than current levels and the global economy now seems better placed to cope with the surge; and the industry hasn't forgotten Japan Airlines' bankruptcy, triggered by wrong bets on crude prices."The risk is if oil prices rise too rapidly beyond a certain level, airlines will be exposed to the price risk and the hedging portfolio will not be effective," said Kelvin Lau, an aviation analyst with Daiwa Institute of Research in Hong Kong.While there are no available figures on the volume of options being traded, transactions in OTC swaps contracts that are sometimes used by airlines as a betting tool have been falling.The visible volume of Asian regrade and jet fuel swaps purchased by banks in the last quarter of 2010, when oil prices crossed USD 90, dipped compared with the same period last year and also versus the three months to July 2008 when prices climbed to a record high of USD 147 a barrel, Reuters data showed. "I am not seeing any airline coming out (to hedge) aggressively yet. Many appear quite comfortable with their positions," said Shukor Yusof, aviation analyst with Standard & Poor's Equity Research. "The current oil prices are not too acute for them to rush into the (hedging) market just yet."Otc swaps Some 2.85 million barrels worth of the two contracts changed hands in the October-December period last year, versus 3.55 million during May-July 2008, when Japan Airlines was disastrously betting that oil prices would keep rising."It is not the right time to do hedging now," said a Singapore-based distillates trader. "It is too risky unless you expect prices to keep going up."Airlines contacted by Reuters supported the view that most are either well covered, or are not in a rush to hedge.Delta Air Lines Inc, the world's second-biggest airline behind United Continental measured by passengers carried, said on December 15 that its hedge position for 2011 is about 40%, and of that, 40% is capped in the low-to-mid USD 80 a barrel range.Cathay Pacific, Hong Kong's flagship carrier, is hedging 35% to 40% for the 2010-11 financial year compared with 50% a year earlier, while Malaysia Airlines is covering 33% in 2011 compared with 60% last year.A slowdown in hedging will reduce the volume of business of banks that sell options and other derivatives to airlines to cover their bets.Oil prices hit a 26-month high over USD 92 a barrel on December 31, closing the year up 15%. Strong growth from Asia, especially China, and a rebound in demand from recovering economies elsewhere fueled a four-month rally that pushed crude over the USD 70- USD 80 range it held for much of the year. Prices touched a peak of more than USD 145 a barrel in July 2008.Jet fuel physical prices were nearly USD 107.00 a barrel on Tuesday, versus 2010's average at USD 90.27 a barrel and 2008's average at USD 121.73 a barrel.Learning from Japan Airlines "Fuel hedging allows airlines to forecast their expenses in the coming 6-12 months. But you can never get it 100% right," said Yusof at Standard & Poor's. "They have been very cautious, and concerned about the potential of losing money when they get it wrong, as seen previously."Japan Airlines chalked up USD 441 million in hedging losses, which contributed to a USD 25 billion bankruptcy earlier in 2010. The hefty losses, in an environment where most airlines were recovering, suggested the carrier had raised the volume of its hedges when oil was at its peak. This left it over-exposed when prices collapsed.Apart from hedging, another tool often deployed by airlines to cope with higher jet prices is a surcharge on the fuel they levy on tickets. This levy is often adjusted when prices rise.Singapore Airlines (SIA), the world's second-biggest carrier by market value, in early December raised its fuel surcharge by USD 3.00 to USD 25.00 per sector, its first increase since June 2008 after jet fuel prices went above $95.00 a barrel."A fuel surcharge is collected to mitigate the effects of escalating fuel prices," said Nicholas Ionides, vice president of public affairs at SIA.The airline has also reduced its hedging to about 20%, down from 30%-40%, said Lau at Daiwa Institute of Research.Thai Airways has also raised its fuel surcharge since late November."These actions could help cover the impact of oil prices, so we think our fourth-quarter performance shouldn't be affected by this," said Raj Tanta-Nanta, vice president for investor relations at Thai Airways. Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
