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Chinese airlines benefit as oil prices fall to six-month low

Wednesday, August 5, 2015 - 08:58
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Air China, China Eastern Airlines and other Chinese carriers are expected to benefit the most after oil prices in London fell below US$50 a barrel on Monday to their lowest closing price in more than six months.

[SINGAPORE] After many airlines were burned because of slumping fuel prices in 2008 and 2009, Chinese carriers stopped hedging their fuel purchases - even when prices soared above US$100 a barrel. Now they're having the last laugh.

Air China, China Eastern Airlines and other Chinese carriers are expected to benefit the most after oil prices in London fell below US$50 a barrel on Monday to their lowest closing price in more than six months. On Tuesday, Brent crude futures for September settlement inched up to US$49.99.

More airlines in Asia are looking to reduce the amount of fuel they buy under hedges, or at least sign shorter hedging contracts, according to Malayan Banking Bhd. Fuel costs are the biggest expense for Asian carriers, accounting for about 40 per cent of the total.

"Hedges have come off," said Mohshin Aziz, an analyst at Malayan Banking in Kuala Lumpur. "A lot of airlines have decided not to hedge, or to hedge less." Lessons of 2008 Air China, China Eastern and China Southern Airlines, the country's three biggest carriers, all said they don't hedge on fuel purchases. They're expecting first-half net income to jump - by as much as 743 per cent in the case of Air China.

In 2008, when crude prices plunged more than 50 per cent, hedges that locked in fuel at higher prices pushed Cathay Pacific Airways into its first annual loss in more than a decade. Air China and China Eastern also reported paper losses from fuel hedging in 2008.

Chinese airlines "haven't hedged for a long time after they suffered a big loss during the 2008-2009 financial crisis, and they've been very restrained since," said Geoffrey Cheng, a Hong Kong-based analyst at BOCOM International Holdings Co. "As a result, they're benefiting now." AirAsia, South-east Asia's biggest budget carrier, and its AirAsia X unit have gone completely unhedged for 2016, according to group chief executive officer Tony Fernandes. About 50 per cent of AirAsia's fuel needs for this year are hedged.

"Nice to wake up and see Brent below US$50," Mr Fernandes tweeted on Tuesday. "That's a magical number for us in the airline business." Some Asian airlines have continued hedging despite the decline in fuel prices.

Singapore Airlines, South-east Asia's biggest carrier, said last month that its savings from lower fuel prices were partially offset by hedging losses and a stronger US dollar in the quarter ended in June.

Before hedging, Singapore Air's fuel costs dropped 33 per cent because of lower prices. With almost 60 per cent of its fuel requirements for the quarter hedged at an average of US$110 per barrel, the carrier lost S$263 million on its hedges.

Singapore Air said it had hedged 55 per cent of its jet fuel needs for the July-September quarter at an average price of US$104 a barrel. Jet fuel closed at US$60.06 a barrel yesterday in Singapore, according to data compiled by Bloomberg, the lowest level since the prices were first compiled in July 2011.

Cathay will give an update on its hedging strategies when it announces first-half earnings on Aug 19, the carrier said in an e-mailed response on Tuesday.

In March, after Cathay announced it lost HK$911 million (S$162.3 million) from fuel hedges last year, the carrier said it still considered it prudent to hedge against a steep rise in fuel prices - though it hoped to lock in future hedges at lower levels.

Hedging is an important part of the airline's risk management, chief executive officer Ivan Chu told Bloomberg TV at the time.

Malaysia Airlines has no hedges in place but would like to have some - if it could afford to, chief executive officer Christoph Mueller said on Tuesday at a conference in Sydney.

"It's less speculative" to have hedges in place, Mr Mueller said. "A fuel hedge does not come for free, and our financial means are quite constrained right now." The airline, which was taken private last year by Malaysian sovereign wealth fund Khazanah Nasional, is undergoing a restructuring after it lost two planes in disasters last year.

For now, at least, airlines that haven't hedged will report lower costs. They're also expected to benefit as lower oil prices have led carriers to reduce fuel surcharges, making air travel more affordable.

Travel demand in the Asia Pacific region has increased more than 6 per cent this year, outpacing the annual average of 4.2 per cent, according to Malayan Banking's Mr Mohshin.

"For airlines, anything below US$80, life is good," Mr Mohshin said. "Below US$50, there's no need to think. Everyone makes money."

BLOOMBERG

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