FACTBOX-JAL losses offer some lessons on hedging

Feb 10 (Reuters) - Japan Airlines Corp 9205.T filed for
bankruptcy under the weight of $25.4 billion of losses, of
which $441 million was attributed to hedging mostly on forward
Brent crude oil contracts.

The hefty losses, in an environment where most airlines are
recovering, suggested the Japanese carrier had raised the
volume of its hedges when oil was at its peak and into forward
positions of beyond 12 months.

This left it over-exposed when prices collapsed.

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* AT RISK

- JAL's bankruptcy triggered a credit event in which 10 of
its 12 main counterparties, mostly international and Japanese
investment banks, risked losing 80 percent of the hedging
losses. [ID:nSGE60I077]

- Mitsubishi Corp's (6331.T) global derivatives unit,
Petro-Diamond Risk Management, lost more than $250 million for
the fiscal year to March 31 due to JAL's bankruptcy.
Petro-Diamond had said last October it would cease its
risk-management operations globally.

- Two other Japanese firms, Mitsui & Co and Sumitomo Corp
(8053.T), would book losses of more than $10 million each.

* IMPACT

- But its overall impact on oil and financial markets was
limited, unlike the collapse of Lehman Brothers two years ago,
which forced counterparties to use exchange clearing facilities
on mutual fears over creditworthiness.

- Most banks have also mitigated losses from those
positions taken when crude was at record highs, allowing them
to continue taking on hedging positions for airlines and not
curb credit like they did during the depth of the financial
crisis.

- But hedging losses of the past two years thinned
liquidity in the jet fuel and diesel markets, particularly at
the back end of the swaps curve, as airlines cut back on
hedging too far forward, though some have returned this year,
brokers said.

- Before 2008, investment banks routinely engage in
activity at the back of the distillates curve, hedging volumes
from their airline customer flows and their own proprietary
positions.

"Most of the banks are not too worried about the potential
losses -- it will be a pinch more than a knockout blow like it
was when Lehman went under as the amounts are not that big in
the current environment of regular nine-figure losses," an
investment banker said.

* OVERHEDGED

- Investment bankers and traders said it was likely that
JAL increased its forward hedges, like most other airlines,
when oil prices neared the above-$140 peak in a contango
market.

Worse, the Japanese carrier could not average down its
losses by buying Brent when prices fell below $40, as it had
reached the upper limits of the volumes it is allowed to hedge.

The 40 billion yen losses were on a mark-to-market basis --
prices where the hedges were placed versus prevailing Brent
crude values at $75.00-$83.00 a barrel in the week when it
filed for bankruptcy.

- At the time when the hedges were placed, as it is now,
the Brent market was in contango, meaning some of the forward
hedges could have been purchased at prices as high as $200 a
barrel.

* STUBBORN RESISTANCE

- Bankers said when prices started rising towards $100 a
barrel at end-2007, most airlines held stubbornly to limited
hedging, believing prices would retreat.

- But when crude soared above $100 and with forecasts for
$200, the price of physical jet fuel became a crippling burden.

Many then went to the other extreme, raising their hedging
volumes to up to 70-80 percent of fuel consumption and extended
their contracts as far forward as 24-36 months.

- They got caught again when oil plunged to below $40 by
end-December 2008, leaving many airlines deep in losses.

- What worsened matters was that the hedging positions
taken were too far forward to be mitigated by savings on
physical fuel costs for some airlines, which have also used up
the maximum volumes they were allowed to hedge, traders and
bankers said.
(Reporting by Yaw Yan Chong; Editing by Ramthan Hussain)