Get ready for the fuel hedging loss!
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Get ready for the fuel hedging loss!
Casino-Like Fuel Hedges Seen Hurting Airlines as Crude Plummets
Oil’s dramatic decline in the past month is a replay of events in 2008 and 2009 when Hong Kong-based Cathay Pacific Airways Ltd. (293), Chinese carriers and Singapore Air all reported millions in losses because of wrong-way bets on fuel.
The price fell 4.6 percent to $83.50 a barrel on Dec. 1, the lowest since August 2010.
Cathay’s Finance Director Martin Murray said in August that the airline hedged 44 percent of projected fuel needs for 2015 at $101 a barrel of Brent crude, and 25 percent of its needs for 2016 and 2017 at $99 a barrel.
Oil’s dramatic decline in the past month is a replay of events in 2008 and 2009 when Hong Kong-based Cathay Pacific Airways Ltd. (293), Chinese carriers and Singapore Air all reported millions in losses because of wrong-way bets on fuel.
The price fell 4.6 percent to $83.50 a barrel on Dec. 1, the lowest since August 2010.
Cathay’s Finance Director Martin Murray said in August that the airline hedged 44 percent of projected fuel needs for 2015 at $101 a barrel of Brent crude, and 25 percent of its needs for 2016 and 2017 at $99 a barrel.
What I don't understand is why would we make a loss? Surely the costs at $100 barrel were known and setup so that revenue matched.
Surely all we do is make LESS profit than we otherwise could have done?
Surely all we do is make LESS profit than we otherwise could have done?
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Maybe we can come up with suggestions to increase fuel consumption to offset the losses associated with the fuel price reduction?
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The whole concept of a hedging "loss" is a misnomer - that's like saying you made a loss on insurance because you didn't break your leg.... Or like saying you made a loss on Microsoft shares by not buying them in 1975.
Hedging is a tool to reduce volatility and enable airlines to better plan their cash flow needs - pretty important when a huge component of your costs fluctuates wildly.
In the long term hedging losses and gains should balance out, but of course there are no guarantees...
I must say though it's gone awfully quiet on the fuel front - don't see much mention of it in the updates anymore. And even at 44% percent hedging 66 % is unhedged meaning that there has been a HUGE decrease in one of the MAJOR expenses - it wasn't that long ago that Brent Crude was touching 140 USD/ barrel and now at 69 and heading down.
But what do we hear about? How tough the first half of the year was... I'm predicting substantially increased profits.
Hedging is a tool to reduce volatility and enable airlines to better plan their cash flow needs - pretty important when a huge component of your costs fluctuates wildly.
In the long term hedging losses and gains should balance out, but of course there are no guarantees...
I must say though it's gone awfully quiet on the fuel front - don't see much mention of it in the updates anymore. And even at 44% percent hedging 66 % is unhedged meaning that there has been a HUGE decrease in one of the MAJOR expenses - it wasn't that long ago that Brent Crude was touching 140 USD/ barrel and now at 69 and heading down.
But what do we hear about? How tough the first half of the year was... I'm predicting substantially increased profits.
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Only another several billion HKD misspent. Same as it always was. I wish I could be rewarded for doing my job so incompetently. As for the 744, yes, at $80 or less per barrel, a pretty good money making machine, and one that certainly our First Class pax prefer (the 777 and Airbus F class is hardly worthy of the term, especially compared to the 380 product with Emirates etc...). We are always one step behind....
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Hard to schedule an aircraft that is only profitable with the fuel price below a certain figure I would imagine. It would be just as hard to guess what the fuel price will be in three months time.
Give the 400s to KA for PVG and PEK.
Give the 400s to KA for PVG and PEK.
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What's stopping the airlines bypassing whoever they have hedged the price with, if it drops significantly ?
They don't actually buy anything......it's just playing Roulette, with others' money.
What they have done, in this case, is bet on the price at a future date.....if the price has risen, the other party pays them the difference....if, as seems likely,the price has dropped below the gambled price, the airline has to make a payment of the shortfall.
Real product is traded on the Rotterdam Spot- Market, where any fuel which is "left over" from meeting "proper" orders, is punted. Many small , independent distributors used to use this and that is a primary reason why smaller suppliers had such wildly varying prices compared to the big multi-nationals.Unfortunately, most independents have disappeared....this affectsthe consumer because there's no competition to the majors.
Bear in mind that at any time, there are considerable stocks in storage, refineries, at sea and already pre-bought.- so any price fluctuation takes a while to come through to the consumer. Only in the case of Duty or VAT is the effect often immediate.
In the case of a price-rise, oldstocks are oftensold at the higher price inorder to finance the next lot which may cost more than the revenue takenfrom the lot just sold...A"loss" on paper, but in practice, the value of the stockholding increases.
As my overdraft soared, I had great difficulty explaining to the bank- manager that although the price had risen by 50%, my margin was still 5% of 1 1/2 times the turnover, compared with the "old" price....He couldn't grasp the fact that price-rises would eventually slow or stop and the profits would eventually repay the loan.
The scale of Aviation fuel, makes price-fluctuation really scarey. Don't blame the bean-counters at Airline-level, for this one.
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The Casino analogy is exactly correct. Even though many might do it fuel hedging is really just gambling--in our case with OUR money. Nothing more, nothing less.
Think about it -- why not just hold YOUR OWN cash reserves for your cash flow needs--invested in something sane--to account for fluctuating fuel prices. As has been demonstrated no one has a clue when new reserves will be found or catch up, or conflicts and bubbles will make prices spike. Over time, supply will catch up and the price will be where it should be.
The fact that hedge fund brokers make vast amounts of money verifies this--just like a casino they take their cut on every game and the gambler always loses over time. No matter if one 'wins' or 'loses' on a particular hedge one still pays the house and this is real lost money.
Think about it -- why not just hold YOUR OWN cash reserves for your cash flow needs--invested in something sane--to account for fluctuating fuel prices. As has been demonstrated no one has a clue when new reserves will be found or catch up, or conflicts and bubbles will make prices spike. Over time, supply will catch up and the price will be where it should be.
The fact that hedge fund brokers make vast amounts of money verifies this--just like a casino they take their cut on every game and the gambler always loses over time. No matter if one 'wins' or 'loses' on a particular hedge one still pays the house and this is real lost money.
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Hedging is not gambling
Shep,
I normally like your posts but this one is slightly off the mark. Hedging is not gambling. If you are an oil producer, you might be happy to enter into a future price agreement so that you know it is still economic at that future price, to pump the oil 6/12months from now.
If you are an oil consumer, you need to know what the price of oil is so that you can set ticket prices accordingly.
If you imagine oil price fluctuations fitted a perfect sine curve, then over time it would not matter whether you hedged or not. When oil prices peaked, you make a loss, when they trough you make double the profit. If you hedged, the price you paid would simply be the midpoint fuel price (almost - there are interest rate issues/volatality - but let's keep it simple) - so your profit would be steady over time. When oil prices are low, you lose money on the hedge but make on the spot price - and vice verca when oil prices are high.
Now whilst there are certainly 'waves' in prices, they don't fit any perfect curve. And on top of that - 'animal spirits' of fear and greed can take over.
When prices were very low(decade low), before I moved to the left seat, I remember asking the then CEO if we were hedging more than normal given the $15/barrel price! He dismissed me out of hand - I suspect the bean counters had got greedy - why hedge when you might make more money.
Juxtapose that with 2008 - everyone knew Oil would go up forever right? Fear took over - and they made a billion dollar 'mark to market' loss on their hedging. I haven't gone back through the Annual Reports for a while but I am pretty sure they never recovered, in future hedging gains, as much as they lost in that year.
So in principle hedging is good - in practice, human beings screw it up.
And it is a bit like frequent flyer programs - if no airline had them, they would all be better off. So if one airline hedges 'successfully' it has a temporary pricing advantage over unhedged competitors.
So it's a case of 'getting it wrong together' is safer than 'getting it right or wrong solo'.
Mutual Fund managers, car manufacturers, service providers etc etc all have the same insane 'better to be wrong together' paradigm!
I normally like your posts but this one is slightly off the mark. Hedging is not gambling. If you are an oil producer, you might be happy to enter into a future price agreement so that you know it is still economic at that future price, to pump the oil 6/12months from now.
If you are an oil consumer, you need to know what the price of oil is so that you can set ticket prices accordingly.
If you imagine oil price fluctuations fitted a perfect sine curve, then over time it would not matter whether you hedged or not. When oil prices peaked, you make a loss, when they trough you make double the profit. If you hedged, the price you paid would simply be the midpoint fuel price (almost - there are interest rate issues/volatality - but let's keep it simple) - so your profit would be steady over time. When oil prices are low, you lose money on the hedge but make on the spot price - and vice verca when oil prices are high.
Now whilst there are certainly 'waves' in prices, they don't fit any perfect curve. And on top of that - 'animal spirits' of fear and greed can take over.
When prices were very low(decade low), before I moved to the left seat, I remember asking the then CEO if we were hedging more than normal given the $15/barrel price! He dismissed me out of hand - I suspect the bean counters had got greedy - why hedge when you might make more money.
Juxtapose that with 2008 - everyone knew Oil would go up forever right? Fear took over - and they made a billion dollar 'mark to market' loss on their hedging. I haven't gone back through the Annual Reports for a while but I am pretty sure they never recovered, in future hedging gains, as much as they lost in that year.
So in principle hedging is good - in practice, human beings screw it up.
And it is a bit like frequent flyer programs - if no airline had them, they would all be better off. So if one airline hedges 'successfully' it has a temporary pricing advantage over unhedged competitors.
So it's a case of 'getting it wrong together' is safer than 'getting it right or wrong solo'.
Mutual Fund managers, car manufacturers, service providers etc etc all have the same insane 'better to be wrong together' paradigm!
Headging almost always these days is insuring that the future price paid will not go beyond a limit, it is very expensive just for one way, so on the other side they will also have received a premium for the down side, thus accepting a price band for future contracts. The contracts can be sold at any time before expiry, they are not locked in, the immediate loss is the premium paid.
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Thanks Número for the insight and I do see your point and do understand futures and futures contracts--either individually or in a pool.
But why not simply have shorter term contracts and/or pay market prices while holding your cash in reserve offsetting what you might have hedged (investing this capital in a 'safe' investment). As you said, folks have gotten this right as much as they've gotten it wrong and there are significant transaction costs which net the managers money (i.e. the 'casino's cut). And while the theory of stabilizing volatility and output may be great I've never seen it work well in practice. Why not just let the market run unencumbered by producers ? Why use your capital to bear their risk ?
I do the same thing buying future airline tickets (at a much lower cost) and can cancel without penalty to cover non-rev commutes. But they are bearing my risk because they have no idea that I have no intention of using any of them if I can get on a non-rev flight. So they really don't get a stable demand from me or really gain anything by offering a discount. All I do is tie up the money for awhile (and this may not even be my money in the first place if I float it on a credit card then have it refunded)--so it's easy to see how this neither promotes a stable demand or necessarily benefits both parties by hedging.
At least from what I've seen of this it's still gambling--granted it's gambling dressed up in a tuxedo and with a 'system' but gambling nonetheless. Mostly because while we might guess at future energy supplies and industrial demand our track record has shown we haven't a clue. This uncertainty IMHO would be better off mostly offset by reserves (which could maintain capital value over time) able to absorb the transients and spikes.
Hedge fund managers have made some pretty decent windfalls and this money has to come from somewhere. Whether you win or lose the bet this is still ultimately paid.
Cheers
But why not simply have shorter term contracts and/or pay market prices while holding your cash in reserve offsetting what you might have hedged (investing this capital in a 'safe' investment). As you said, folks have gotten this right as much as they've gotten it wrong and there are significant transaction costs which net the managers money (i.e. the 'casino's cut). And while the theory of stabilizing volatility and output may be great I've never seen it work well in practice. Why not just let the market run unencumbered by producers ? Why use your capital to bear their risk ?
I do the same thing buying future airline tickets (at a much lower cost) and can cancel without penalty to cover non-rev commutes. But they are bearing my risk because they have no idea that I have no intention of using any of them if I can get on a non-rev flight. So they really don't get a stable demand from me or really gain anything by offering a discount. All I do is tie up the money for awhile (and this may not even be my money in the first place if I float it on a credit card then have it refunded)--so it's easy to see how this neither promotes a stable demand or necessarily benefits both parties by hedging.
At least from what I've seen of this it's still gambling--granted it's gambling dressed up in a tuxedo and with a 'system' but gambling nonetheless. Mostly because while we might guess at future energy supplies and industrial demand our track record has shown we haven't a clue. This uncertainty IMHO would be better off mostly offset by reserves (which could maintain capital value over time) able to absorb the transients and spikes.
Hedge fund managers have made some pretty decent windfalls and this money has to come from somewhere. Whether you win or lose the bet this is still ultimately paid.
Cheers
Last edited by Shep69; 7th Dec 2014 at 02:52.
Insurance as opposed to "self insurance"...
Numero, I think you're fundamentally correct.
One of the big problems when throwing [potentially extremely large] numbers around is our lack of numerical expertise and cognitive skill to appreciate the magnitude represented, and the consequent effect. As far as management is concerned, they are also shackled by the Dunning-Kreuger effect - ie they mistakenly rate their ability as superior and expect others to share that illusion.
[Now. I don't believe Pilots are immune either - a non scientific flight deck sampling would reveal that more that 50% believe they are in the top 10% of aviating ability
]
The problem from the management perspective: They are bad at big numbers, have huge egos and monumental sized vanity shields protecting them from their weaknesses, as they go about the daily tasks of misclassifying, underestimating others and overestimating themselves. They bring those cognitive resources and biases to forming opinions on a wide range of issues such as pay negotiations, fuel hedging, and the risk being killed by lithium batteries. Add the ideological filters and the realm of numbers become entangled within their belief system, representing what they wish the world to be rather the world as it is.
One of the big problems when throwing [potentially extremely large] numbers around is our lack of numerical expertise and cognitive skill to appreciate the magnitude represented, and the consequent effect. As far as management is concerned, they are also shackled by the Dunning-Kreuger effect - ie they mistakenly rate their ability as superior and expect others to share that illusion.
[Now. I don't believe Pilots are immune either - a non scientific flight deck sampling would reveal that more that 50% believe they are in the top 10% of aviating ability
]The problem from the management perspective: They are bad at big numbers, have huge egos and monumental sized vanity shields protecting them from their weaknesses, as they go about the daily tasks of misclassifying, underestimating others and overestimating themselves. They bring those cognitive resources and biases to forming opinions on a wide range of issues such as pay negotiations, fuel hedging, and the risk being killed by lithium batteries. Add the ideological filters and the realm of numbers become entangled within their belief system, representing what they wish the world to be rather the world as it is.
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Do airlines provide transportation to passengers/cargo, or are they fuel hedge-fund managers?
Also, it still is gambling (wether or not other carriers also do it) since the airline is taking a risky action in the hope of a desired result . (Gamble definition, Google online)
Also, it still is gambling (wether or not other carriers also do it) since the airline is taking a risky action in the hope of a desired result . (Gamble definition, Google online)