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Covid-19 puts airline hedge strategies under new focus


An OPEC-Russia oil price war and Covid-19 brought oil prices to historic lows, while flights have ground to a halt. That has created a fuel hedge headache for airlines.

by Nicholas Dunbar and Manpreet Singh

Published: 20 April 2020

In normal times, airlines worry about increases in fuel costs affecting their bottom line. Companies such as Ryanair, EasyJet, Lufthansa, Air France and International Airlines Group are well known for their extensive fuel hedging programmes.

That was before the Covid-19 pandemic grounded airline fleets worldwide, at the same time as oil prices plunged almost two thirds. This catastrophe was something which no airline was prepared for, with underwater hedging contracts adding to liquidity pressures. Absent a rebound in oil prices, hedging losses are likely to be realised in the airlines’ financial results.

Even before the pandemic reduced the demand for oil, crude oil prices plummeted from the high of $66 per barrel in 2019 to sub $25 per barrel in the first quarter of 2020 due to talks between OPEC and Russia breaking down which led to a ramp up in oil supply.

International Airlines Group, whose fleet includes British Airways and Iberia, could be facing mark to market hedging losses as high as $3.2 billion. EuroFinance calculated this figure based on IAG’s disclosures on 28 February that it had hedged 90% of its 9.6 million tonne fuel consumption for 2020, and subsequent moves in the oil futures curve.

Ryanair which last year hedged 90% of its forecast 2020 fuel consumption may be sitting on mark-to-market losses as much as $1.5 billion, according to calculations by EuroFinance based on its financial disclosures. Its dollar hedge price per barrel is $83 which is way above the current June oil futures price of $30, creating a loss of $53 per barrel.

Budget airline Easyjet may have lost $1.3 billion using a similar calculation to Ryanair, while Air France KLM lost an estimated $800 million based on the swap or forward contracts in its hedging portfolio. Most of the major European airlines had hedged above 60% of their anticipated fuel consumption before Covid-19 decimated their flight schedules.

Percentage of fuel consumption hedged

US airlines such as American Airlines, United Continental and Delta Airlines which have shunned fuel hedging are in a better position compared with pro-hedging airlines. The exception being Southwest Airlines which hedged 59% of its 2020 fuel consumption at $88.2 per barrel.

Options versus forward contracts

The price at which Easyjet hedged its fuel consumption for 2020 at $89 per barrel is highest among major airlines, while Lufthansa airlines have the lowest at $63.32 per barrel. However, the choice of hedging instrument has a major impact the financial result, in particular the use of forward contracts versus bought options, where the mark to market loss is limited to the premium paid for the option.

Airline Hedging Price

So Ryanair which exclusively uses forwards may be on the hook for $1.3 billion, and under the terms of the contracts may be required to post this amount in collateral to counterparties. The use of forwards by Easyjet explains why its losses on fuel hedging are also likely to be high. But Lufthansa and Southwest Airlines, which favoured an option-based strategy are likely to have taken a much smaller hit.

Mark to market chart

Lufthansa says it uses exclusively options in its fuel hedging. In a March 18 earnings call, CFO Ulrik Svensson said: “there is no commitment to buy any fuel”. Along with Lufthansa, other airlines such as Southwest Airlines follow a similar strategy while Air France uses a combination of options and swaps for fuel hedging. In an SEC filing published on 5 March, Southwest said, “The Company’s fuel hedging portfolio allows for full participation in declining market prices”.

Ryanair in its latest statement said that the airline will take a hit of approximately €300m as an exceptional charge due to ineffectiveness of its fuel hedges. Without commenting on its hedging, IAG said on 30 March it had extended a $1.4 billion undrawn credit facility for a further year, as part of total cash and undrawn facilities of €9.4 billion. On 6 April Easyjet said it had used a Covid Corporate Financing Facility provided by the Bank of England to issue £600 million of commercial paper, while drawing down on an existing $500 million revolving credit facility, secured against aircraft assets.

IAG and Ryanair declined to comment on their hedging losses. Easyjet and Air France KLM didn’t respond to requests for comment.

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