Asia-Pacific airlines wobble over fuel hedging

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					Asia-Pacific airlines wobble
over fuel hedging
Oil's unprecedented volatility in 2008 cost some airlines hundreds of millions of
dollars in hedging losses each, but most are hamstrung by structural practices
and mindsets that prevent them from putting in place a more responsive hedging
program.
Some carriers were able to trim hedging costs when oil markets steadied last
year, but most will still struggle to find the right balance when prices suddenly
turn, traders and bankers say. Those who hedge are still a minority in this region.
"The problem with the airlines is that they treated hedging as a profit/loss
mechanism rather than as insurance, which should then be regarded as cost and
as cover in case of the unexpected happening," said Clarence Chu, a trader with
Hudson Capital.
Companies such as airlines mark-to-market derivative positions as profit or loss,
in line with accounting rules.
"Most still view it the same way, even after the last round of losses. I'm not sure if
you can say they have learnt their lessons but at least they are more willing to
listen now," Chu said.
Carriers tend to hedge their positions with a limited number of counterparties,
mostly banks, shying away from the wider market with clearing house or
exchanges such as NYMEX and ICE, where prices are more competitive.
RIGOROUS BUT SLOW PROCESS
Despite JAL's $441 million in hedging losses and its subsequent $25 billion
bankruptcy, the disruption to oil and financial markets was minimal. This was
unlike the fall of Lehman Brothers two years ago, which forced counterparties to
use clearing facilities due to mutual fears over credit worthiness and banks'
squeeze on loans during the financial crisis.
The ready supply of credit and banks' move to boost customer flows offer airlines
few incentives to explore alternative ways to hedge, traders said.
"They're still hedging the same way, with the same few banks that they have built
comfortable relationships with. It's a bilateral relationship, the banks allow them
to trade on credit," another industry source said.
"Airlines can probably get more transparent prices from the open market on the
exchanges such as NYMEX, but they have often baulked at having to pay clearing
fees and maintaining margins."
Most airlines, like other big listed firms whose core business is not trading, have
stringent measures to guard against price speculation.
But the safeguards, such as a rigorous regime that goes up to top management
before airlines can take new positions to mitigate loss-making hedges, also slow
their reactions and limit options when prices spike or fall dramatically.
This is unlike traders and banks which take daily positions -- entering or exiting
the market when necessary to limit losses or maximize gains -- but also do so for
speculative purposes.
One lesson some airlines did learn was not to hedge too far forward and to cut
back on hedging volumes in order to manage premium costs when markets
stabilize.
This has helped carriers such as Singapore Airlines, Cathay Pacific and Qantas,
which managed a turnaround after the losses in 2008 and reported net hedging
gains last year.
Their recovery could have been partly achieved by managing hedging volumes,
which were reduced to pre-2008 levels of 20-40 percent of fuel consumption and
limited their hedge to just 12 months ahead.
An SIA spokesman said the airline was now hedging 20-60 percent of its fuel
requirements, down from 30-60 percent, and had stopped hedging on diesel,
after a review last year.
"The objective of our fuel hedging program is to smoothen volatility in fuel prices.
We hedge on a declining wedge profile, where the hedged volume is progressively
built up over time," he told Reuters. "We use a combination of hedging
instruments, namely swaps, collars and call options."
In the July-September quarter last year, SIA showed a net hedging gain of about
$45 million, recovering from net losses above $200 million for financial year
2008/09.
It cut hedging volumes to 22 percent of fuel consumption, or about 3.5 million
barrels of jet fuel, at an average of $100 a barrel versus current prompt jet swap
levels of
$75.00-$85.00.
Hong Kong's Cathay Pacific reported unrealized mark-to-market gains of HK$2.1
billion ($270 million) for first-half 2009, rebounding from losses of $978 million
in 2008.
RISKS OF REDUCED HEDGING
However, traders cautioned that reducing hedging to as low as 20 percent could
again expose airlines to volatile swings, especially if fuel demand rises with a
recovering economy.
Traders said the market was at its most volatile in 2008, when prices rose from
below $100 a barrel to a record above $140 in July. Prices then sank to below $40
by end-2008, marking the worst year for most regional airlines.
Reflecting this, the 30-day-at-the-money implied volatility for U.S. crude, which
gauges the expected price movement based on options premiums, was the
highest-ever above 100 percent in December 2008, when oil nosedived. Volatility
was around 45 percent in July.
The monthly value for January this year stands at about 34 percent, the lowest
since 12 months earlier, and has been rangebound between 30 and 50 percent
since May last year.
"It all boils down to making the correct call on the market and being nimble and
flexible enough to act on that," a Singapore-based Western investment banker
said.
"In short, they have to think like traders."

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