Feb 10 (Reuters) - Asia's largest airlines that fly
international routes, such as Singapore Airlines <SIAL.SI>,
Cathay Pacific <0293.HK> and Qantas <QAN.AX>, hedge their fuel
requirements, but most still do not.
Those who do have rigid safeguards, such as limiting the
volumes hedged each time and maintaining a tight deadline for
risk managers to do so, mainly to protect against unauthorised
speculation.
SIA, for example, has a policy of requiring risk managers to
put in place a hedge position within five days, sources said.
Airlines use a variety of instruments to hedge their
exposures, such as Over-The-Counter Swaps, Futures and Options,
on jet fuel, gas oil (diesel) or crude oil swaps and futures.
For related analysis click on: [ID:nSGE60I04Q]
For related factbox on JAL's hedging losses, click on:
[ID:nSGE60U01U]
* OPTIONS
- One of the most commonly used instruments is the Option,
which gives users the right, but not the obligation, to buy fuel
at a pre-determined future price. It provids protection against
prices rising to unmanageable levels, at a relatively low cost.
Most airlines, who are natural buyers of options, do so at a
pre-determined price, known as a Call option, at a cost called a
premium, which is a fraction of the actual contract price.
The reverse, that is to sell a contract at a pre-determined
price, is called a Put Option.
If prices hit or cross the pre-determined level, airlines
will activate the option to buy fuel at that price, regardless of
how much higher prices rise. The counterparty, normally a bank,
will pay the difference between the strike price and the market
price at the time.
- SIA said it has hedged 22 percent of its fuel consumption,
or about 3.5 million barrels of jet fuel, at an average of $100 a
barrel versus current prompt jet swap price of $75.00-$85.00.
- Some airlines prefer the more sophisticated "Zero-Cost"
option, in which they need not pay the Option premium as long as
the contract stays within a pre-determined price range.
In this case, the airline buys a Call Option at a certain
premium and sell a Put option at the same premium value.
As long as prices stay within range of their Put and Call,
they do not incur any cost on the Option, making it an attractive
hedging tool.
If prices rise above the Call, the buyer is "in-the-money"
and makes the price difference and the price of the premium from
the counterparty.
If prices for below the put, the reverse is true, that is,
the buyer will have to pay the premium and make up the difference
in price to the bank.
- However, most banks impose a "Knock-in, Knock-out" clause,
where they pre-determine a certain loss ceiling and after which
they can exit the contract.
But the same does not apply to the airlines and they would
have to either ride a money-losing contract till expiry or sell
it at a loss.
"The Zero-Cost option looks attractive but, in reality, it
provides only limited insurance and has unlimited risk," said
Clarence Chu, a trader with Hudson Capital.
- When the market was volatile in second-half 2008, most
airlines lost money on physical jet fuel cargoes versus the
relatively thin volumes that they hedged when crude benchmarks
were on the way up to above $140.
When prices dived to below $40, they were unprotected on
downside of their Zero-Cost Options.
Worse, some kept doubling their exposures down by buying more
Zero-Cost options at lower price ranges, hoping to mitigate
earlier losses, as prices spiral downwards.
But they end up incurring more losses as crude continue its
freefall all the way to below $40..
"There is no such thing as free money and the banks are not
there to make money for you," an industry source said.
* SWAPS/FUTURES
- The other option for airlines is to hedge by buying
Outright forward crude, or jet fuel swaps or futures.
This locks in their fuel exposures at a fixed price, in which
they usually take the contract to expiry and settling the
difference between the contract price and the month-average cash
levels as at the expiry date.
- However, the settlement typically involves larger sums of
upfront cash and liquidity in the jet fuel market can sometimes
be quite thin.
"The main drawback on hedging directly on swaps is that it
requires more upfront capital because you are dealing with the
entire outright price of the contract, unlike options where you
are dealing with a premium cost," another trader said.
"For an airline with large volumes, the amount of capital
required would be huge and quite undesirable."
- Some airlines, particularly more sophisticated Western
carriers, conduct their own hedging with the open market on both
swaps and options.
None in Asia currently do so on the perception that they
could be speculating. Other hindrances are cost and logistics
constraints such as building credit ties with counterparties
other than banks, such as physical traders, and incurring
exchange fees and maintaining trading margins.
(Reporting by Yaw Yan Chong; Editing by Ramthan Hussain)
((yanchong.yaw@thomsonreuters.com; +65 6870 3851; Reuters
Messaging: yanchong.yaw.reuters.com@reuters.net))
((If you have a query or comment on this story, send an email to
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Keywords: AIRLINES HEDGING/ASIA TOO
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