Fuel hedging
Seems I was a little optimistic suggesting a loss around $4B! I remember talking to a previous CE when fuel was at a record low in the late 90s - he said that CX did not try to predict or react to fuel price changes. They just stick to a general policy of hedging more close in contracts and less further off into the future. Its only in hindsight that we know what should have been done!
Its been a while since I did the theory behind option pricing so any financial experts reading this please forgive me;-)
There are two main ways to 'hedge' fuel prices - options or future's positions. The former costs money - think about it, how much would you want to be recompensed for promising to deliver fuel at the current spot rate one year into the future? If you wrote(sold) an option at say $50 for delivery in Jan 2010, think about how much you would lose if the price rose to $75 or $100! So one factor in pricing an option is volatility of the underlying price - the greater the volatility the greater the price. Oil has gone from below $50 two years ago to $150 and back to a five year low! So buying options is a very expensive way to protect against price rises. Theoretically, a correctly written option should break even! That is, the change in the oil price should equate to the option price, on average - if you can call anything that has happened over the last two years as 'on average'!
So much of CX's hedging has been through futures positions. I am not qualified or experienced to comment on what should have been done. Qantas made a record profit last year with a more aggressive hedging policy. Lets see how they do versus CX over the next 12 months!
If the hedges were not mark to market, then we would record a small loss for 2008 - I think $300m was quoted. But then if the fuel price remained at Dec 31 prices for the next 30months we would gradually lose $7.6B on the hedges - and then save about $50B on the fuel price!
Three scenarios moving forward: 1) fuel prices remain the same and we make no more hedge gains/losses and we save $20.3B this year($approx $50B over the life of the hedges); 2) fuel prices rise, we make some profits on the fuel hedges(as they have been marked down to Dec 31st value) and we don't save as much on the actual fuel delivery; 3) fuel prices fall more, we make more losses on the hedges but we save more than $20.3B this year and more than $50B over the life of the hedges.
We want scenario 3 - the more we lose on hedges, the more we save in operating costs. Hedging is only a fraction of total fuel costs! Our fuel bill for first half of last year was $19B.
From the release to the HKSE it states that we have written down the fuel hedge book by $7.6B but hand in hand with that was a reduction in our fuel costs of $7.9B, from the July peak prices, for the second half of 2008.
Personally I don't see any machiavellian machinations in the accounting of the hedge book!
Last edited by Numero Crunchero; 9th Jan 2009 at 04:59.
Reason: speelin and gramma