January 11th, 2009China Eastern Loses Fuel Hedge Gamble
A year ago airline CEO’s were routinely invited to appear on CNBC’s Fast Money and Mad Money shows. The one question they were always asked was their level of fuel hedging. CNBC commentators praised Southwest Airlines for its decision to hedge fuel by locking in at such a low cost. But CNBC commentators never discussed the possibility of those hedges going wrong. And in most cases, they are.
From Marketwatch, China Eastern just reported fuel hedging losses of $906 million. Hedges are very common in multi-national companies, but when it comes down to it, they are a gamble. And those gambles can work against you too!
China Eastern Airlines said Sunday it suffered a fair value loss of 6.2 billion yuan ($906 million) on fuel hedges last year and that operations have been affected by deteriorating business conditions since the second half, warning it would report a “significant loss” for 2008. The Shanghai-based airline said losses were accumulated under an “industry-wide crisis.” It said its aviation-fuel hedges ballooned into losses after crude oil prices fell sharply.
January 12th, 2009 at 1:32 am
It isn’t pure gambling… Airlines want to predict the future, and they’re willing to pay some money to insure against bad futures. I’m sure China Eastern lost a ton of money, but they probably saved just as much buying their un-hedged oil.
That said, I always wondered why none of the commentators ever asked southwest “Why are you so much more hedged than your competitors, and wouldn’t you be in really bad shape if the hedges had gone wrong?” Seems the news prefered to paint them as brilliant savy business men. Right….
January 12th, 2009 at 3:50 am
Exactly right. And those “predictions” cost a lot of money to make. Corporate hedging probably started out as a way to remove SOME of the commodity price volatility from the bottom line. But I really have to believe that in Southwest’s case it went beyond a simple volatility reduction hedge and into the gambling state. In the summer of 2008, CNBC painted Southwest as genius’s that saw the oil rise coming – their gamble paid off. But now even Southwest must be suffering from having locked in so much of their oil prices at $125-$150.
Incidentally, Tupperware does NOT hedge one bit, yet they have very big foreign currency exposure that puts a lot of volatility into their bottom line. Cramer interviewed the CEO on Mad Money way back and the response was that in the long run hedging ALWAYS costs you more money than just taking the volatility as it comes. Cramer agreed, and then probably prepared his “Praise Southwest” show immediately afterward to “hedge” his own bets.