After the rapid fall in oil prices since last summer airlines could be forgiven for thinking their fuel nightmares were over. But fuel hedging which helped to mitigate rocketing fuel prices in the first half came back to haunt many in the final quarter.
Airlines that struck fuel hedging agreements around the $100 to $120 mark, which appeared attractive when fuel was climbing towards $145 and threatening to go ever higher, have caught a cold. Few could have imagined the speed of the fall that followed. Consequently fuel hedging losses have dominated a host of balance sheets over the last few weeks.
"2008 was an unprecedented year, with the extreme volatility, the price of Brent going from $90 per barrel at the start of the year to $40 per barrel at the end of the year, having been $145 per barrel at its peak in the summer," says Leo Drollas, deputy executive director and chief economist at the London-based Centre for Global Energy Studies. Consequently airlines' fates depend on "when you hedged, for how long and what type", he notes.
Notably, the long-successfully hedged Southwest Airlines posted a fourth quarter net loss after incurring losses of $117 million on its fuel hedging portfolio.
"Energy prices have been all over the map in 2008 and they've collapsed and we've had to adjust and adjust aggressively," says Southwest Airlines chief executive Gary Kelly. The carrier has modified its fuel hedge positions from 2009 through 2013, capping its net liability for the period at about $1 billion. "With respect to our fuel hedging strategy, we have not changed our fundamental philosophy that we must protect our cost structure from market volatility and catastrophic increases," says Laura Wright, Southwest's chief financial officer. "However, in the current environment, we do not believe it is the time to be long on energy."
Southwest was far from alone in reporting fuel hedging losses. Adding Alaska, American, Continental, Delta, United and US Airways takes the total to over $1.5 billion in fuel hedging losses for the fourth quarter alone.
Singapore Airlines is the latest in a string of Asian airlines to disclose or warn of losses relating to fuel hedging, revealing $225 million losses on hedging. Air China, China Eastern, Cathay Pacific, Shanghai Airlines and Thai Airways have all also flagged up mark to market losses. A Merrill Lynch report predicts nine Asian carriers will report $3.8 billion in estimated losses from contracts tied to fuel hedging in 2008.
In Europe Ryanair's third quarter - for which it hedged last summer around 80% of its requirements at $124 per barrel - posted a loss of just over ?100 million, largely reflecting a 71% increase in its fuel costs. The heavily-hedged Air France-KLM has just disclosed a hedging loss of ?370 million for its third quarter. It has carried out no new hedging since October and is unwinding several of its fuel hedging positions.
Chief executive at Air Astana, Peter Foster, says carriers cannot be blamed for taking a hit on hedging losses amid the high volatility in the market and in fuel prices, as the trend appeared to be upward.
Air Astana itself, however, is among those that did not hedge at this time, largely because the fuel prices did not reflect the reduced oil price. Consequently it is among those benefiting most from lower fuel prices.
"There was no point hedging when the fuel price was still so high," says Foster, saying it instead focused on lobbying to get the price of fuel from its local suppliers down.
The price gap has narrowed significantly over recent weeks and Air Astana is ready to "take some aggressive [fuel hedging] positions". In a way the airline's inability to hedge previously was a "blessing in disguise", says Foster, as the airline has not been caught out.
Hedging brings the benefit of stability to one of an airline's key and potentially volatile costs. Many carriers are hedging now in the current lower oil price environment.
Those who have taken a hit from fuel hedges point to the positives that remain from lower oil prices. Cathay Pacific says fuel hedging losses should be put in context. "They are unrealised. The amount of losses actually realised and payable will depend on future movements in fuel prices," it says, adding it has and will continue to benefit from lower oil prices notwithstanding the mark to market losses.
Delta Air Lines chief executive Richard Anderson says fuel hedges "turned out to be an expensive insurance policy in the short term", but notes every $1 decline in a barrel of crude oil equals about $100 million in lower expenses. Since Delta averaged about $100 a barrel in 2008 and expects an average price of $50 this year, the reduction in fuel costs could save Delta $5 billion annually, he says.
While Ryanair took a hit on fuel hedging in the third quarter, chief executive Michael O'Leary says it "has been vindicated" in not hedging in the fourth quarter by the big drop in oil prices. It has since returned to hedge at lower prices for its next financial year, saying it has already secured a 38% reduction in its fuel costs for the first half of its next financial year. "Next year we will enjoy significantly lower oil prices [while competitors will be paying more]," says O'Leary.