Airlines rein in hedging despite oil price crash

Filed on November 13, 2008

LONDON - Europe's major airlines are deciding against striking new fuel hedging agreements for next year despite the plummeting oil price, as the global credit crisis and the collapse of Lehman Brothers hikes the cost of securing deals.

British Airways, Ryanair and Lufthansa have all said their hedging deals will be significantly reduced in the new year, snubbing the opportunity to lock in fuel bills despite oil falling to 22 month lows.

Oil has come down from highs of $147 a barrel in June to $55 today, leaving current airline hedging policies at around $90 or more looking well out of date.

But analysts and airlines have argued that it is far harder and more expensive to secure new hedging deals from banks in the wake of the credit crisis, especially after the collapse of Lehman Brothers -- a big player in the market.

"The hedging market is very illiquid at the moment -- its hard to find a counter-party in the deal," said Mark Thompson, airlines analyst at Morgan Stanley.

Germany's Lufthansa said at its third quarter results late last month that its hedging for the current year had been cut to 72 percent from 85 percent of its total bill as a result of the loss of a contract with Lehman Brothers.

Its hedging for 2009 is down at 57 percent, at an average of $91 a barrel.

Lehman became the biggest investment banking casualty of the credit crisis in September when it filed for bankrutpcy, meaning many airline hedging deals collapsed.

Michael Cawley, deputy chief executive at Ryanair, confirmed the banking crisis had affected the type of deals the airlines could get.

"There is a far less liquid market for futures in all parts including oil, so when we go to hedge it's not as easy as just making a phone call."

"There are far fewer people now who are prepared to take the chance, even with Ryanair," he said.

Neil Glynn, at Irish stockbrokers NCB, added that jet fuel itself has become much more expensive in relation to the price of crude. The spread between the two has widened to twice historic norms in recent weeks -- from 27 percent to as much as 60 percent.


British Airways has had 35 percent of next year's fuel bill hedged at $100 a barrel since the summer, but at its half year results last week said it remained hedged at less than 40 percent despite the changing conditions.

Finance Director Keith Williams said that if oil averaged out at $75 a barrel and the dollar at 1.65 to sterling, the carrier would lower its fuel bill to 2.8 billion pounds in 2009/10 from around 3 billion this year.

"The oil price is connected to economic downturn. The airlines are mindful that the economic outlook is looking substantially weaker, and that takes the pressure off," said Collins Stewart's Andrew Fitchie.

Air France-KLM uniquely hedges five years in advance, but at a recent investor roadshow finance director Philippe Calavia agreed with BA's strategy of making no major changes to existing hedging policy.

"In spite of the recent drop in the oil price, a positive factor for the economy and the group ... Air France-KLM will pursue its hedging policy," he said, adding however that any future hedging contracts would of course reflect the recent fall in prices.

Ryanair was about a year too early with its strategy of not hedging fuel, but then famously lost millions of euros as oil reached unprecedented highs during the summer.

It then hedged at triple figures a barrel for the current quarter, but is now switching back to an unhedged approach because of the sharp fall.

"Looking back it was stupid not to hedge on oil but we're not hedged for the remainder of the year (to March 2009) and that's a good thing," O'Leary said in a recent interview with the Irish Examiner.

The Dublin-based airline has taken a hedge for 25 percent of its fuel needs for the first half of the 2009/2010 fiscal year at an average $77 per barrel, but is willing to leave the rest to chance.

"The absence of fuel hedging, so long a handicap for profitability (for Ryanair), is now proving to be an asset," Cazenove analyst Edward Stanford said in a note, referring to the likely comparative fuel bills for this year and next.

(Additional reporting by Maria Sheahan in Frankfurt, Andras Gergely in Dublin, Bill Rigby in New York, Barbara Lewis in London and Ben Harding in Madrid; Editing by Chris Wickham)

3 EAK0699 ;EN;x;O;00228000; BC-Oil Prices, 2nd Ld-Writethru,0923 222 biz glbh bud intw eurw Oil falls below $56 on grim world economic outlook Eds: UPDATES prices, analysis, OECD, IEA forecasts; CHANGES headline, byline; REMOVES dateline; ADDS contributor's line. pvs/pg By PABLO GORONDI Associated Press Writer

Oil prices continued to slide, to near $55 a barrel Thursday before rebounding slightly, as bad economic news from the world's largest economies heightened fears that a severe global downturn will slash demand for crude.

By midday in Europe, light, sweet crude for December delivery was down 13 cents to $56.13 a barrel, after falling to as low as $54.67, in electronic trading on the New York Mercantile Exchange.

In London, December Brent crude fell 36 cents to $52.01 a barrel on the ICE Futures exchange.

The Nymex contract fell $3.50 overnight to settle at $56.16, the lowest closing price since January 2007, after the U.S. Energy Department slashed its 2009 oil consumption forecast.

“As the global economy continues to weaken, we're going to see further downward pressure on oil," said Stephen Roach, chairman of Morgan Stanley Asia, in Singapore. “I think we'll certainly challenge the $50 threshold. We could challenge the $40 threshold."

According the Paris-based Organization for Economic Cooperation and Development, the world's developed economies have slid into recession and will shrink further in 2009.

The OECD said Thursday that gross domestic product was likely to fall by 0.3 percent in 2009 for its 30 member countries, representing democracies with market economies.

It said the U.S. economy would contract by 0.9 percent, Japan's by 0.1 percent and the euro area by 0.5 percent.

The latest forecasts were a sharp downgrade since the last set in June, when the organization forecast OECD growth of 1.7 percent in 2009 and indicated that the worst of the financial crisis might have passed.

The International Energy Agency also made downward revisions to its global oil demand forecasts for this year and 2009 on Thursday, as rich-world economies sink into recession and growth slows in developing countries.

The IEA now expects global oil demand to average 86.2 million barrels a day this year, nearly flat compared to 2007, and 86.5 million barrels a day next year. Its forecast cuts 330,000 barrels a day from the previous 2008 estimate and 670,000 barrels a day from next year's.

The German economy, Europe's biggest, also tipped into recession in the third quarter as weakening exports fueled a bigger-than-expected fall in national output.

Gross domestic product contracted by 0.5 percent in the July-September period compared with the previous quarter, the Federal Statistical Office said, following a 0.4 percent fall in GDP in the second quarter.

The U.S. Energy Department said Wednesday it expects U.S. consumption of petroleum to drop next year more severely than any time since 1980. The department's Energy Information Administration said 2009 petroleum consumption is projected to sink by 250,000 barrels per day, or 1.3 percent, more than twice that projected in its previous outlook.

Signs that U.S. consumer spending has plummeted also fueled pessimism. Department store retailer Macy's Inc. said sales fell more than 7 percent in the third quarter and consumer electronics retailer Best Buy Co. slashed its fiscal 2009 guidance on fears that consumer spending will erode.

“It's not just gloom and doom sentiment, it's indeed real," said Victor Shum, an energy analyst at consultancy Purvin & Gertz in Singapore. “Companies are showing poor earnings and announcing major job cuts."

The grim company news helped send the Dow Jones industrial average down 4.7 percent Wednesday, with Asian and European stocks following suit Thursday. Japan's benchmark Nikkei 225 index fell 5.3 percent while Hong Kong's Hang Seng plunged 5.9 percent. London's FTSE was down 1.9 percent and Germany's DAX was 1.2 percent lower.

Oil traders have looked to stock markets for guidance on investor expectations about economic growth.

The Organization of Petroleum Exporting Countries, which produces about 40 percent of world supplies, has signaled it may cut production before its next meeting in December on top of a 1.5 million barrel reduction in output quotas last month.

Thursday's pessimistic IEA oil demand forecast could speed up OPEC's decision for another quick production cut.

“This will make the case for OPEC to cut at least a further 1 million barrels a day as they need the world to return to just-in-time supplies," said Olivier Jakob of Petromatrix in Switzerland.

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