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Hedging provides a $2bn relief to Asian Airlines against rising fuel prices


Top Asia-Pacific airlines which locked in prices of fuel earlier this year are sitting on a fair value gain of $2 billion as crude oil tops multi-year highs.

by Anmol Karwal

Published: June 7th 2022

High fuel costs, the biggest expense for airlines, are hitting carriers just as they started to emerge from the pandemic. With supply squeezed by sanctions on Russia, crude oil prices have rocketed by more than 50% since the start of the year.

While rising fuel prices could threaten profitability, hedges added by Asian airlines like Singapore Airlines, Cathay Pacific and ANA Holdings, at levels much lower than current market prices, have provided some relief. An analysis by EuroFinance suggest that these companies are now sitting on a mark-to-market gain of $2 billion on these contracts. 

Hedging gains

Following the outbreak of covid-19 pandemic, airlines slashed flight schedules amid lockdowns and border closures. As a result, Asian airlines found themselves hedged against millions of barrels of unneeded fuel purchases, leading to fuel hedging losses of $3.2 billion, as earlier reported by EuroFinance. 

Subsequently, this led to an overhaul of hedging strategies, whereby some airlines decided to lower dependency on hedging while few even discontinued the practice. But as oil prices started to rise, many have boosted their hedge ratios back to pre-pandemic levels, helping them smoothly expand capacity and maintain gross margins despite rising input costs.

Consider the Hong Kong-based Cathay Pacific which operates a two-year rolling fuel hedging programme under which it had locked prices for an average of 38% of its estimated fuel consumption till December 2023, as compared to 31.5% before the pandemic.

As a part of its strategy, the company keeps adding layers of hedges, mainly crude oil swaps as consumption nears and with 100% and 45% of its fuel consumption hedged for Q1 and Q2 2022 at $53/barrel at the start of the year, EuroFinance estimates the company to be sitting on a mark-to-market gain of $937 million. 

“Having a prudent fuel hedging policy in place which is to manage the short-term and medium-term volatility of the fuel price, we believe that is the prudent approach going forward.” said Rebecca Jane Sharpe, CFO at Cathay Pacific 

Singapore’s flag carrier, Singapore Airlines had hedged 40% of its estimated fuel consumption till June 2023 had already booked a profit of $111.6 million in the first quarter of the year and EuroFinance estimates a further gain of $450 million from its outstanding hedge position at the end of Q1. 

“The only place we’re going to find some relief as far as high fuel prices is concerned is our hedging program” said Kai Ping Tan, CFO at Singapore Airlines 

The company used jet fuel and Brent crude swaps, option and collar contracts to lock in fuel price at $60/barrel. For calculating hedging gains, EuroFinance has assumed option contracts to be in the money. 

Meanwhile, Air New Zealand held swaps and options contracts for 2.05 million barrels of Brent crude at the starting of the year, out of which 1.35 million barrels locked prices of fuel for approx. 65% of its consumption till June 2023 and the remaining for the second half of the year. 

After realising a $206 million loss from hedges in 2020, the company had restructured its hedging policy by incorporating a higher proportion of options contracts in its portfolio, thereby limiting losses if prices fall but also resulting in a fair value gain of only $62 million, as per EuroFinance estimates.

“The increased fuel prices we are seeing have been mitigated somewhat by our hedge position, but we expect to see fuel costs rise in the second half… our hedge portfolio has been structured to allow full participation to downward pricing movements through to June 2022.” said Richard Thomson, CFO at Air New Zealand. 

Tokyo-based ANA Holdings had ramped its hedging contracts to cover 35% of its fuel purchases for a year as compared to only 25% before the pandemic. With majority of contracts consisting of crude oil swaps, the company is expected to gain $228 million from its hedging portfolio. 

Meanwhile, the flag carrier of Australia, Qantas airlines had hedged 90% of its fuel consumption till June 2023 at the starting of the year, resulting in a mark-to-market gain of $217 million.

Despite the benefits of hedging in a rising cost environment, it is far from a universal practice for airlines. Many carriers in Europe and America have abstained from forward buying and so is the case of AirAsia and Emirates, both of which stopped using fuel derivatives since the rampage caused by the pandemic. 

Recovery through airfares

While these contracts will help well-hedged airlines to operate and benefit from the travel surge at least till they mature, if oil prices continue to sustain at higher levels and once existing hedging contracts run out, a now well-hedged airline will face the same cost pressures as an unhedged airline.

Therefore, most airlines have imposed fuel surcharges resulting in an increase in fares. This certainly is a problem for airlines. Following the pandemic, as most airlines are keen to get people back in the air, raising ticket prices does the exact opposite. But unless airlines want to start incurring losses again, they may have little choice.

This has been a key strategy for an unhedged AirAsia, which was amongst the first companies to impose fuel levies across all flights. 

The company said in its first quarter filings that, “Due to a hike in fuel prices, the Group has reintroduced a fuel surcharge for all domestic flights in Malaysia and the Philippines, as well as for international flights across all countries from March 2022 onward” 

FX headwinds 

For Asian airlines with exposure to dollar-denominated fuel cost, the appreciation of the dollar has added to the challenge as these companies will need to spend more local currency to purchase fuel.

“There's no escaping higher fuel prices, stronger U.S. dollar, dragging the expenditure line.” said Kai Ping Tan, CFO at Singapore Airlines.  

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