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European airlines may quit fuel hedging after $4.66 billion in losses


Treasury teams at European airlines are bracing for a shakeup as time-honoured fuel hedging policies are reviewed in the wake of pandemic-related losses.

by Nicholas Dunbar & Manpreet Singh

Published: 1 December 2020

The airline sector has been upended by the Covid-19 pandemic. When global demand for flights collapsed, European carriers found themselves hedged against millions of tonnes of unneeded fuel purchases – at the same time as plummeting oil prices dragged the contracts underwater.

As first reported by EuroFinance in April, European airlines such as Ryanair, Air France, EasyJet and International Airlines Group faced mark-to-market losses of up to $6.82 billion on these fuel hedges. This estimation was based on the companies’ disclosure on fuel hedging percentage and estimated fuel consumption for 2020.

Now, with passenger demand not predicted to fully recover for several years, some $4.66 billion of the estimated losses have been realised, according to EuroFinance analysis of the companies’ Q3 financial disclosures. Some, like IAG and Lufthansa, have been so chastened by the experience that they have stopped hedging completely – and may never resume.

That’s the message from Steve Gunning, CEO of IAG, which owns British Airways. In his Q3 investor call Gunning noted that “given what we’ve experienced and endured this year, we are actually doing a sort of fundamental review of that policy to see whether we need to learn from 2020 and take a different tack”.

Adding further on fuel hedges he said, “No, we’re not taking out further hedges at this point”.

The company at the end of Q3 reported a €1,599 million ($1,856 million) loss on over-hedging of which €330 million ($383 million) came in the third quarter. CEO Gunning commented on this by saying, “this (over-hedging) was driven by the fact that because we’ve reduced our capacity plans going forward, we are effectively more hedged or over-hedged than we were before”. The company has ‘de-designated’ its rest of fuel hedges. An IAG spokeswoman declined to comment on staff changes at the airline’s fuel management team.

Range options

IAG’s German rival Lufthansa posted €764 million ($886 million) fuel over-hedging losses in Q3 and the company anticipates adding more given the lower demand for flights in Q4. The airline also noted in its investors call that it believes the effect of over hedging will ‘fade out’ in the first quarter of next year due to the fact that it had ‘stopped’ the fuel hedging at the beginning of the crisis.

Lufthansa’s 2019 annual report mentions that the company almost exclusively used range options for its fuel hedging needs, a kind of derivative where the cost of the bought call option on fuel is offset by a put option sold to the counterparty. In December 2019, these contracts on a notional 6.2 million tonnes of fuel had a mark-to-market value of just €80 million. The size of the over-hedging losses which the company posted at the end of the Q3 may be the result of settling in-the-money puts on fuel that was no longer required, as well as the expiry of call options.

Lufthansa, which received €9 billion in state aid from the German government this year, recently announced industry outsider Remco Steenbergen as its new chief financial officer. It remains to be seen how this former chocolate company CFO will take on fuel hedging strategy. He will take charge on 1st Jan 2021. According to sources close to Lufthansa, there have already been changes at the airline’s Hamburg-based fuel risk management team.

Air France KLM which uses the combination of swaps and options has posted a loss of €612 ($710 million) million at the end of Q3, of which €112 ($130 million) is unsettled for the period Oct 2020 to March 2021. The airline received a total €10.4 billion in state aid from the French and Dutch governments.

The Irish budget airline, Ryanair which uses forward hedging contracts posted an ineffectiveness charge of €647.4 million ($751 million) at the end of September 2020. The company has also reduced its fuel hedge levels for next year to 40% which in the past has been at a 90% level. Even though the company has suffered losses on over hedging of fuel consumption, it is still committed to fuel hedging strategies.

The airline has settled 70% of ineffectiveness hedges this fiscal year and believes that it won’t have any further loss related to this in further quarters. The company also recorded €153 million ($178 million) ineffective hedges for the period from October 2020 to March 2021.

Unlike its Lufthansa and Air France KLM, Ryanair hasn’t received any state aid. Rating agency Fitch has reaffirmed Ryanair’s rating at BBB with a negative outlook. The company had issued a bond worth €850 million and €400 million equity in September 2020.

Another budget European Airline, EasyJet has posted a loss of £353 million ($458 million) for fuel hedge loss in its year ending September. The company is currently hedged at 51% of its estimated fuel consumption for the next year and 44% for FY 2022. In fact, EasyJet had increased its fuel hedging for FY2022 from 35% to 44%.

However, the company has paused its additional hedging for the period from April 2020 to October 2021 but it will continue for the latter period as the company takes advantage of ‘low-price environment’.

Both EasyJet and Ryanair escaped the fate of fellow low cost carrier, Norwegian Airlines which in November filed for bankruptcy protection in Ireland. The company had limited hedging for 2020 and paused it for FY21. At the end of Q2, the company had recorded NOK 1057 million ($120 million) in fuel hedge losses.

European airlines are now a long way from their comfortable position two years ago when they hedged almost 60-90% of their estimated fuel consumption in anticipation of rising fuel costs. In the future, they may come to resemble US counterparts such as American Airlines, United Airlines and Delta that quit their hedging habit several years ago.