European airlines have over the last decade been extremely active in the fuel-hedging market, seeking to lock in a US dollar cost item against revenues often in weaker currencies.
But their fuel hedging amid historically low fuel prices has led to a variety of outcomes emergent in the latest round of European airline results.
UP AND DOWN
Disclosing results on 25 July, Ryanair predicted it could save to €120 million ($130 million) thanks to a post-Brexit play on its 2018 fuel hedging. The Irish carrier also added that its hedging could bring a net benefit of €200 million for this financial year.
Lufthansa Group has reported that it suffered a €571 million fuel-hedging hit over the first six months of 2016, its hedging strategy proving misjudged in light of plummeting oil prices.
Both carriers are publicly listed, which makes a stable share price a fundamental priority. Fuel costs are not only substantial for these companies; they are also the most volatile liability.
If these airlines bought their fuel on the spot market, fluctuating prices could cause an otherwise profitable airline to post losses.
For listed airlines, losses can have a dramatic impact on stock price. This in in turn may lead to a shareholder revolt, as well as affecting how lenders view the business.
A tried and tested method to control this volatility is fuel hedging. Essentially, this entails locking in the future price of fuel now. If prices rise, the contract becomes more valuable. The reverse is also true.
However, hedging does fundamentally stabilise the cost.
European airlines have been some of the most active in fuel hedging, as their revenues are often in weaker currencies than the US dollar-denominated commodity.
But not all airlines hedge, and historically low oil prices, currently at roughly $42 per barrel, strengthen the argument for spot market buying.
THE LAND OF THE BRAVE
In North America, hedging has become something of a dirty word in recent times.
US carrier Delta Air Lines chief Ed Bastian told Bloomberg earlier this year: "We've lost over the last eight years about $4 billion cumulatively on oil hedges."
He added that when it came to hedging in the future, he did not get paid to make those kind of bets.
In 2012, Delta bought its own refinery to try to control its fuel supply.
American Airlines does not hedge, Allegiant Air stopped in 2007 and others in the USA and Canada have reduced their fuel hedging in recent times.
The current low oil prices are leading airlines around the world to take a similar approach.
"Airlines can choose to buy on the spot market or in the futures market depending on their risk management strategies. Bottom line, low oil prices have given plenty of breathing space for airlines to manoeuvre their operating costs," Endau Analytics' founder Shukor Yusof tells FlightGlobal.
"The trend for the first half of 2016 is that airlines are hedging less than a quarter of their fuel needs. Some airlines in Southeast Asia are not hedged at all, preferring to buy on the spot market and betting that oil prices are likely to stay at similar or perhaps even lower levels until end-2016."
However, the low oil prices currently seen are by no means guaranteed to continue. A black-swan event could easily reverse the trend, Yusof adds.
"A spike in oil demand or any geopolitical unrest in the Middle East could push energy prices up."
Fundamentally, though, airlines are still extremely exposed to oil price fluctuations.
Yusof says that a narrow band of a $5-15 per barrel cost rise is manageable. However, any more than that and "financially weaker airlines will feel the brunt first. It also depends on how quickly jet fuel prices rise."
This vulnerability to sudden swings means that listed European airlines will likely continue to pursue their fuel hedging, despite it occasionally disbenefiting the carrier's finances, as illustrated by Lufthansa's latest results.
The German airline giant notes that it only hedges fuel for a maximum of two years in order to limit its exposure to jet fuel price swings.
Ryanair, which benefited from its fuel hedging, is equally cautious: the carrier only hedges up to a year-and-a-half in advance because it trades in jet fuel, which, unlike Brent crude, is "not hugely liquid after 12-18 months", the airline's finance chief Neil Sorahan told FlightGlobal earlier this year.
SAFETY FIRST
North American airlines, such as American Airlines, may potentially gain when jet fuel prices crash. But their revenues are in US dollars, which means they do not have currency risk attached to the acquisition of the commodity.
European airlines, though, are exposed to US dollar currency risk, and therefore perhaps cannot be quite as comfortable as US airlines are in pursuing anti-hedging strategies. Taking bets on both the oil and FX spot markets would leave them extremely vulnerable to macro events.
Indeed, even when an airline's fuel hedging is misjudged, it is easy to overstate the overall effect. Lufthansa still reported a first-half net profit of €429 million for 2016, despite its disadvantageous fuel hedging.
Trying to predict how much oil will cost in the future may be a mug's game. But locking in that cost for a short period of time remains a smart move, making a volatile liability as stable as it could ever be for an airline.
Source: Cirium Dashboard
