Damned If You Do, Damned If You Don’t: China Airlines Criticized for Fuel Hedging
You gotta feel sorry for these guys. Just consider the volatility in oil prices over the past couple of years.
Hedging, a tool used by airlines to stabilize jet fuel costs, has been blamed as the culprit behind huge losses for China’s biggest airlines.
Its three largest carriers reported 2008 losses totaling 28 billion yuan (US$4.09 billion), almost half of which was attributed to fuel hedging.
Air China lost 7.5 billion yuan on fuel-hedging contracts, and China Eastern Airlines said wrong-way bets on hedging dragged its revenue down 6.4 billion yuan. China Southern Airlines bucked the trend, however, reporting a profit of US$6.28 million after ending its hedging last June.
“The more you hedge, the more you lose when betting the wrong way,” said Theo Panagiotoulias, American Airlines vice president for Asia-Pacific. He said hedging should be used as a tool to stabilize exposure to rising fuel prices, not a gambling devise in hopes of making bigger profit.
Indeed, the revenue fiasco for some Chinese airlines has triggered discussions about the advisability of fuel hedging. (Shanghai Daily)
The companies that hedged during the incredible run-up in oil prices were lauded as heroes and geniuses. When the bottom dropped out of the market due to the recession, they were stuck out there with their pants around their ankles.
Both the run-up and the plummeting of fuel prices occurred over very short periods of time and were, in the case of the price increases, not exactly “normal” market phenomena. Tough to make bets on future prices when this kind of thing happens.
That being said, it’s usually a lot easier to guess where prices are headed. That means that it really is OK to make those forward bets. It would be a shame if, on the basis of two very weird short-term price fluctuations, fuel hedging by airlines was seen as an unwise business practice. Really too bad that the writer of the article above chose “fiasco” to describe the situation — really sends the wrong signal.
The hedging by Chinese airlines absolutely was a fiasco.
Compare the losses at the Chinese airlines to that of Southwest, which has been renowned for its hedging practices for years. For 2H08, it lost $176m on $5,463m revenue, net margin of -3%. China Eastern, on the other hand, lost 15b on only 21b of revenue, net margin of -71%. China Southern had a net margin of -20%. The airlines went far beyond hedging, and had to be bailed out.
And, frankly, there weren’t many companies that began hedging fuel prices before 2007. Southwest was pretty much the only major purchaser of jet fuel futures. The other airlines usually made comments like, “we’re not speculators” and such. Only with the huge run up in prices did hedging begin to be a widespread practice. But the lunkheads running the Chinese airlines decided to make HUGE bets.
Would it be a shame if hedging was seen as an unwise business practice? Yes. It would also be a shame if people continue to refer to what the Chinese airlines did as “hedging.”
For China Eastern, bets on the oil price were not the only problem though:
Apparently, their passenger revenues fell 5 % in 2008 compared to 2007. That’s rather bizarre, considering that passenger numbers in the PRC were up strongly, and average ticket prices presumably were up as well (what with fuel surcharges and all). According to a press release, “only” 6 bn of their 15 bn loss is related to fuel hedging contracts. If that is true, then 9 bn of losses are related to something else.
China Eastern is in quite a mess, it seems.