Europe airlines hedge against soaring fuel

LONDON (Reuters) - European airlines are hedging their fuel needs to protect against surging oil prices but their bets could go wrong if Chinese demand starts to slow after this summer's Olympics, pulling crude lower, analysts say.

Fuel accounts for more than a third of airlines' operating costs and companies fear even higher oil prices due to falling inventories and robust Asian demand.

China, the world's No. 2 energy user after the United States, has been scrambling for oil to stockpile before the Olympics, helping fuel a rise in prices to a record high of almost $140 a barrel on Monday.

"It's harder to hedge effectively by the day. The hedged book becomes the determining factor the way people look at the value of the company," said Marisa Thompson, an analyst from Morningstar in Chicago.

Fuel hedges -- financial products that give a buyer the right to buy fuel at a guaranteed price -- protect companies from price rises, but also boost their costs when prices fall.

"High oil prices is the number one enemy of airlines. Airlines are trying to minimize uncertainty and volatility," said Michael Waldron, an oil markets analyst at Lehman Brothers Holdings Inc.

Hedging becomes a tool for carriers to fend off soaring crude oil prices, which have doubled since last year.

But some experts argued airlines' attempt to overreach by making money in oil trading distracts them from their basic business.

"A ratable program works best -- carriers hedge rain or shine a fixed quantity. Keep it clean and nicely forward," said a derivatives trader, who declined to be named.

ON TENTERHOOKS

Air France-KLM has hedged 75 percent of its fuel needs for the 2008-2009 while British Airways has about 70 percent for March to June 2008 and Lufthansa locked in 85 percent for 2008.

Others have been more modest in fuel hedging.

Spanish airline Iberia has hedged 48 percent of its fuel costs for 2008. Ryanair, Europe's biggest low-cost carrier, has not hedged much of its fuel needs for the current year.

Ryanair's Chief Executive Michael O'Leary had said that some competitors would not be able to cope with persistent high oil prices and may go bust or be taken over by the dominant three European network carriers -- Lufthansa, Air France KLM and British Airways.

Airlines have said rising fuel costs will hit profits this year despite hedges, with some carriers looking to cut capacity and services to stem losses.

The International Air Transport Association has said the global airline industry may lose a record $6.1 billion this year.

While hedging could ease the suffering, it is not the ultimate solution, experts said.

Cutting capacity was a better strategy, and a sign of good management rather than weakness, Douglas O'Neill, transport analyst at Blue Oar Securities, told Reuters previously.

A WILD BET

A bet against oil prices has its risks for prices could go either direction.

Barclays Capital projected oil to rise to $150 this year while other banks were more bullish.

Goldman Sachs, the most active investment bank in energy markets and one of the first to point to triple-digit oil more than two years ago -- a once unthinkable level - expected oil to hit $150 this summer.

Morgan Stanley said crude oil may reach $150 by July 4.

But Lehman Brothers predicted oil prices to ease to $90 to $100 a barrel by the first quarter of 2009, due to slower growth in Chinese oil demand and rising global downstream capacity.

India's Reliance Industries Ltd will commission its new 580,000 barrels per day (bpd) oil refinery in September, with a focus on exports.

China expects to see an estimated 440,000 bpd of new refining capacity later this year versus 300,000 bpd of new capacity in 2007.

"This summer could see a potential for a spike in prices. It is bullish time but prices could turn around at the end of the year," said Lehman's Waldron.

(Additional reporting by Ben Harding in Madrid, John Bowker in London, Sami Torma in Helsiki, Angelika Gruber in Frankfurt and Jessica Mead in Paris; editing by William Hardy)