Fuel hedges prove costly gamble for Asian airlines

By Felicia Loo - Analysis

SINGAPORE (Reuters) - Asia-Pacific airlines have clipped their fuel hedges to save on steep premium costs as oil slid to three-month lows, but they need to keep a consistent ratio to safeguard against volatile price swings.

A likely slowdown in global travel and ballooning fuel costs, which have more than offset a series of fare and fuel tax hikes and led to industry-wide losses in the second-quarter, have forced many airlines to scrap routes.

Some have even been threatened by insolvency.

To keep themselves above water, regional airlines must salvage any possible costs or seek to book higher profits by trimming hedges, betting on sustained price falls rather than a rebound to new highs, some analysts said.

"Hedging gives you the ability to fix costs and/or profit margins, but it typically takes away potential for windfall profits for favorable price movements," said Gerard Rigby of Fuel First Consulting in Sydney.

U.S. oil futures have deepened their losses to three-month lows below $120 a barrel this week from a record of $147.27 last month, but were still around a fifth costlier than the start of the year.

The cost of jet fuel JET-SIN jumped almost 70 percent over the past year to $144.00 a barrel in Singapore trading, though it came off the record of $181.65 a barrel reached last month.

But premiums in options are still high as volatility persists, said Rigby.

For example, the cost of ATM (At The Money) WTI Call dropped $2 a barrel to $17 a barrel but almost doubled from $9.50 in November for calendar 2009.

"Option premiums are a function of volatility and price levels, so evidently they have become more expensive," said Gerard Raynor of Societe Generale in Paris.

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

Some argue that airlines' attempt to overreach by making money in oil trading distracts them from their basic business.

"If they have bought calls, then they could just be losing the price of the premium. But at $17 per barrel, that is a lot to lose straight up. It is always the hardest question to answer for hedgers -- do they hedge now or wait for the market to dip?" said Rigby.

CONSISTENCY

But derivatives traders spoke against frequent changes to the hedge ratio to save on premium costs, and urged airlines to adopt a more consistent strategy by having a fixed quantity of hedges.