Fuel Hedging
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As we aircrew say - 'If in doubt sit on your hands and don't panic'. Wonder if anyone can attribute this mistake to an actual person.
Just think how that 1 Billion could have sorted out the COS troubles we have.
NC must have some idea.
Just think how that 1 Billion could have sorted out the COS troubles we have.
NC must have some idea.
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Hedging, Futures, Hedge Fund
And don't forget this is US$1Bn we are talking here.
If you are so clever at hedging then why bother running an airline, why not just be an oil futures trader instead and forget about all those pesky jets and crew. Or just run a hedge fund because it doesn't amount to much more than that. It is just a bet you take out with an oil futures trader who is now very happy that he won the bet.
Were these decisions taken at board level or was it delegated to a 22yr old new graduate management trainee?
If you are so clever at hedging then why bother running an airline, why not just be an oil futures trader instead and forget about all those pesky jets and crew. Or just run a hedge fund because it doesn't amount to much more than that. It is just a bet you take out with an oil futures trader who is now very happy that he won the bet.
Were these decisions taken at board level or was it delegated to a 22yr old new graduate management trainee?
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The key phrases to think about are
these are not cash losses & and not all airlines follow the same accounting rules. Different airlines have different ways of reporting hedging losses.
Can anyone explain what the loss would have been if you used different accounting rules?
these are not cash losses & and not all airlines follow the same accounting rules. Different airlines have different ways of reporting hedging losses.
Can anyone explain what the loss would have been if you used different accounting rules?
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...gosh, this is awful. I certainly hope this doesn't affect the management bonuses. At the least the person responsible can count on the usual promotion and solid protection from the highest levels. Wouldn't want the Swire 'way' to be undone by a little matter of incompetence and stupidity.... 
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It is a shame that Tony Tyler doesn't explain what he means by "Mark to Market". I suggest you have a look at google. You will see it has a wide meaning and I suppose one has to guess exactly what he means (maybe thats the idea
)
My best guess is the Accounting Rules CX operate under require them to do a snapshot at a given date of the value of their forward cover on oil. So on their balance date 31st December (I think) they will compare the prices of all their forward cover against the closing price of oil. For example, if you have a forward contract to buy 1000 barrels of oil in Jun 09 at $100 and oil closed at $40 you record a loss $60,000. That doesn't mean $60,000 is taken out of your bank account. It is a pure accounting non-cash event driven by the desire to be conservative. Strangely, this is recorded against revenue generated in 2008, but the contracts all mature in 2009 and 2010.
Obviously, if oil rises again these contracts become valuable (you can sell them if you don't want the oil). It is also worth remembering that CX will have sold airfares and Cargo Contracts back in mid-08 and they will be costed on (hopefully) high value oil; these oil futures remove an element of risk.
I note the CX share price didn't do much today so the market probably has a good handle on it. For those with Foreign Currency mortgages, you can do a similiar calculation. A lucky few, will smile. The rest will be staring at some ugly figures. However, either way, it doesn't mean that much as it is just a snapshot in time and can change rather rapidly.
Before the conspiracy theorists run riot: CX probably has little say in the Accounting Rules; these will be set by the Stock Exchanges (operating under strict (ish) government control) of not only HK, but the UK as the parent company Swire is also listed in the UK....
Before you flame me... guys do degrees in this stuff and all the above is my best guess
)My best guess is the Accounting Rules CX operate under require them to do a snapshot at a given date of the value of their forward cover on oil. So on their balance date 31st December (I think) they will compare the prices of all their forward cover against the closing price of oil. For example, if you have a forward contract to buy 1000 barrels of oil in Jun 09 at $100 and oil closed at $40 you record a loss $60,000. That doesn't mean $60,000 is taken out of your bank account. It is a pure accounting non-cash event driven by the desire to be conservative. Strangely, this is recorded against revenue generated in 2008, but the contracts all mature in 2009 and 2010.
Obviously, if oil rises again these contracts become valuable (you can sell them if you don't want the oil). It is also worth remembering that CX will have sold airfares and Cargo Contracts back in mid-08 and they will be costed on (hopefully) high value oil; these oil futures remove an element of risk.
I note the CX share price didn't do much today so the market probably has a good handle on it. For those with Foreign Currency mortgages, you can do a similiar calculation. A lucky few, will smile. The rest will be staring at some ugly figures. However, either way, it doesn't mean that much as it is just a snapshot in time and can change rather rapidly.
Before the conspiracy theorists run riot: CX probably has little say in the Accounting Rules; these will be set by the Stock Exchanges (operating under strict (ish) government control) of not only HK, but the UK as the parent company Swire is also listed in the UK....
Before you flame me... guys do degrees in this stuff and all the above is my best guess
So can someone please explain to me how this hedging stuff really works?
I would have thought they would have purchased options to buy fuel at a certain price (say $150pb). And then, if the price of fuel goes up to $200pb, then they simply use these options to buy at the hedged price of $150. Saving = $50pb less what the options cost.
But now the price has gone the other way, there's no point buying at the hedged price of $150 when they can buy on the market at $50, so they just let the options lapse. Total losses = whatever it cost to buy the options.
But seeing as the losses are so high, this is obviously not how it works???!!
I would have thought they would have purchased options to buy fuel at a certain price (say $150pb). And then, if the price of fuel goes up to $200pb, then they simply use these options to buy at the hedged price of $150. Saving = $50pb less what the options cost.
But now the price has gone the other way, there's no point buying at the hedged price of $150 when they can buy on the market at $50, so they just let the options lapse. Total losses = whatever it cost to buy the options.
But seeing as the losses are so high, this is obviously not how it works???!!
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What is hedging
"If a business is big, secure and profitable enough to handle any market volatility there is no point in starting to hedge.
In fact, to begin to hedge would incur costs, and is therefore ideally avoidable.
Furthermore, without careful management, it can be disastrous."
Full Article:
BBC NEWS | Business | Q&A: What is hedging?
In fact, to begin to hedge would incur costs, and is therefore ideally avoidable.
Furthermore, without careful management, it can be disastrous."
Full Article:
BBC NEWS | Business | Q&A: What is hedging?
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Apparently one of the financial houses did an analysis on this and said that based on all the figures they guess that CX paid US$70 per barrell, and bought a whopping 30million barrels including options. How much that actually equates to, I have no idea.
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Heard this the other day - not true but makes a good story:
In the middle of last year the Manager responsible for the new Business Class was moved to Fuel Hedging..............................
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I did notice a rather brief one line announcment from the Chairman saying the Director of Finance would be "retiring" in March. Was this the head that had to roll?
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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!
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
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In the words of that old negro spiritual song - is this an excuse to "Let My People Go" cos' we can't afford to keep them now.....
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Furthermore, it will be interesting to see whether any profit taken due to a turn round in the oil price is 'ring fenced' so as not to be taken into account for profit sharing in 2009/2010, after all, that's never happened before....
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Fuel Hedging
Numero Crunchero and Sue Ridgepipe have obviously thought about this problem. Page 23 of CX's 2007 Annual report lists the hedges used, these include 'collars'. If I remember correctly with a collar there is a two way bet; if the oil price goes above a certain price the bank pays the airline BUT if the prices falls the airline pays the bank ! At the end of 2007 about 6 m barrels had been hedged into 2009. I suspect that the collars are causing the problem.
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kitsune
Yes I would love to go back and change some of my predictions;-)
I still think we will be profitable at the operating level. With cargo fines and the hedging writedowns the bottom line result is now likely to be around a $7-8B loss - depends on what they do in the balance sheet for the 772s.
If I am wrong about the 'operating profit' I will buy you a beer;-)
I still think we will be profitable at the operating level. With cargo fines and the hedging writedowns the bottom line result is now likely to be around a $7-8B loss - depends on what they do in the balance sheet for the 772s.
If I am wrong about the 'operating profit' I will buy you a beer;-)
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Hedged at $145 a barrel?
If you hedged at $145 a barrel that could look like a smart move in 2012, when oil will more than likely be back to $150 a barrel plus. Trouble is will CPA still be around then? With management making those sort of hedging blunders I very much doubt it. Think I'll book my flights with BA until we get the true story. 
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