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Hedging blamed for airlines' losses

HEDGING, a tool used by airlines to stabilize jet fuel costs, has been blamed as the culprit behind huge losses for China's biggest airlines.

Its three largest carriers reported 2008 losses totaling 28 billion yuan (US$4.09 billion), almost half of which was attributed to fuel hedging.

Air China lost 7.5 billion yuan on fuel-hedging contracts, and China Eastern Airlines said wrong-way bets on hedging dragged its revenue down 6.4 billion yuan. China Southern Airlines bucked the trend, however, reporting a profit of US$6.28 million after ending its hedging last June.

"The more you hedge, the more you lose when betting the wrong way," said Theo Panagiotoulias, American Airlines vice president for Asia-Pacific. He said hedging should be used as a tool to stabilize exposure to rising fuel prices, not a gambling devise in hopes of making bigger profit.

Indeed, the revenue fiasco for some Chinese airlines has triggered discussions about the advisability of fuel hedging.

A hedge is a financial contract that allows investors to lock in certain prices as insurance against the possibility that the spot price will rise. If the price does rise, the hedger gets a payoff that cushions the blow of higher prices.

Last year, global crude oil plummeted from a record US$147 a barrel to as low as US$34, leaving many airlines committed to paying far more than spot prices for fuel. That came after a year when many airlines benefited from hedging as oil prices were on the upswing. Jet fuel prices normally track the price of crude.

China Eastern earned 586 million yuan from hedging in 2007, which encouraged the carrier to hedge 36 percent of its fuel purchases last year. Air China, which operates the largest international network of any Chinese carrier, set an upper limit of 50 percent on its hedging.

Hedging by Chinese airlines involves fuel purchases only for overseas flights, since domestic fuel prices are fixed by the government.

The problem with hedging any commodity is the acumen needed to manage the risks and correctly anticipate future prices movements, analysts said.

Foreign carriers are very cautious about fuel hedging and keep their exposure to about 20 percent.

"We hedged no more than 30 percent of fuel and usually signed three-month contracts, not like some carriers that signed one-year or even three-year contracts," Panagiotoulias said.

Savings for carrier

American Airlines saved US$380 million on fuel expenses last year by hedging, he said.

Still, despite the bad hedging bets, industry analysts said they are confident about the performance of China's airline industry this year because the market may have hit its bottom.

In the first quarter of this year, Air China posted a net income of 880 million yuan after reducing paper losses on fuel hedging by 990 million yuan.

"The rising oil price will help the carriers cut hedging losses, and the aviation industry is expected to recover this year," said Yao Jun, an analyst with Merchants Securities Co.

Oil prices in recent weeks have hovered around US$50 or lower, enabling carriers to reduce fuel costs.


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