Last year proved to be one of the most difficult years in aviation history. And issues were compounded for those airlines that had a 6 month-plus jet fuel swap hedge program in place. Why? Because of the onslaught of SARS-2 and the resulting double-whammy of falling oil prices (almost all hedges were fixed at much higher oil prices, prior to the pandemic) and then had little to no flight demand. These airlines added to their woes as those big hedge invoices rolled in at a time with little income to pay the bills. As a result, many teams tweaked, downsized or stopped their hedge programs. But now the challenging question is “when to hedge next” because jet prices have risen 75% since the end of last year as economies recover on the incredible vaccination rollouts and ESG-driven demand for commodities to build new ESG-networks and systems. So what can the airline C-suite do to ensure their decisions at this very unpredictable juncture in terms of fuel cost management? Onyx suggests a deep hedge review, starting with oil demand reduction (3-5% can be achieved with reduced onboard fuel weights) and then oil price exposure, policy and consider an alternative more efficient and dynamic approach, built and overseen by derivative trading and hedging experts.
It has always surprised the Onyx Advisory team that hedging airlines mainly EU and FE, and a handful of US carriers typically fix/hedge the fuel price on very long forward tenors or not at all, there is a more defined argument for a short-term hedge program, as laid out below.
The argument for a defined short-term hedge program in the scheduled airline industry:
- Fuel volatility
Fuel is a large and unpredictable cost for airlines if left unhedged, in fact between anywhere between 20-40% of operating costs on average over the last 20 years.
- Airline Booking Curve Hedge profile – hedging to the typical ‘expected’ seat sale horizon
The airlines that do hedge have until recently assumed the future will serve up the ‘expected’ in terms of future seat demand, the chosen routes will be perpetually served, and so arguing that jet fuel hedging should ideally cover some extended future horizon, which ended up being a 12–18-month horizon typically. COVID has clearly changed this perspective. Equally surprising is that some airlines choose not to hedge at all, but now they are now fully exposed to the volatility and uncertainty of oil price to serve up, uncontrolled, their final operating margin. For example, with seats sold 3 months ago, flown today the current reality of higher fuel prices; s, the airline’s margin will have been impacted negatively. Think about the last 12 months rally from 40 to 75 USD/bbl on Brent.
When we reviewed airline seat sales, the reality is airlines tend to only sell most of their seat capacity just 1-3 months in advance (the ‘booking curve’), and this is lower in the current climate. A true fuel hedge would aim to fix the airline’s service margin, that is coordinating to match seat sales tenors and oil price hedge tenors. This would sensibly be the de facto airline hedge position – the booking-curve hedge.
Design the basic program around the short-term service margin exposure – the booking curve hedge.
A Hedge program needs to be constructed carefully and with specialist risk management expertise. As stated already, the de facto position should be hedging the expected seat sale profile, moreover, any reduction or increase in that tenor should be considered dynamically with the limits of the policy, and weekly/daily reported to stay within the framework and allow for re-assessment. It is important to consider beyond the tenor and to also consider the hedge tools choice in this increasingly speculative position. Specifically, we mean the primary hedge tool of choice also needs to change from fixed price Swap to insurance-style Options, with premiums as a maximum loss. This is a dynamic approach, which needs to be embedded into the policy, is best taken with the support of derivative trading professionals that are involved and proven in their real-time trading, thus bring all-important trade acumen into the mix.
Onyx’s viewpoint - how Onyx has helped the aviation industry pre-2020:
To help combat the perpetual question of ‘hedge or not to hedge’ your airline can employ Onyx Advisory to review the overall policy or simply aspects of your oil and carbon hedging, for instance reducing cost or expansion of counterparties or enhancing trade timing. We use a collegiate approach to update the policy and other support areas, aiming to gain full stakeholder buy-in. We allow for market conditions and trade flexibility, keeping the dynamic markets perpetually under surveillance and so making trade decisions that protect but keep in mind the secondary risk impact. Our consultants advised the Boards of airlines to observe and hedge against the near term with swaps and to only use Options if hedging deviates from the ‘booking curve’. This was the mantra at Onyx far in advance of 2020. As result, the Boards at airlines that implemented this more dynamic hedge approach manage to preserve cash and reduce the cost of hedging to a finite amount whilst remaining fuel price sensitive – and so helping to significantly reduce one of the key hedge problems experienced by the more heavily hedged airlines during 2020 – unaffordable MTM losses.
If you want to benefit from Onyx’ hedging and deep oil derivative trading experience, then reach out via our website. Onyx is an exceptionally large volume market maker, trading forwards in daily volumes far beyond all other traders. We bring an innovative approach to managing commodity risk. As a result, our expertise in oil trading and hedging is an ideal match for airlines, and any hedger trader, that wishes to review and enhance performance. Learn the Onyx way. Our professional hedge consultants are regulated, qualified and bring deep physical and financial trade experience. Can your airline afford to not seek our advice?
Disclaimer:
This publication has been prepared by Onyx Capital Advisory Limited which is regulated by the Financial Conduct Authority. It is provided to our clients for information purposes only and any persons acting on information contained in this publication do so solely at their own risk. The information contained in this publication has been obtained from sources that we believe to be reliable but we do not represent or warrant that it is accurate or complete. The opinions in this publication are those of Onyx Capital Advisory Limited and may be subject to change. The information contained herein is provided as of the date indicated, may not be complete and, is subject to change, and no obligation is undertaken by Onyx Capital Advisory Limited to revise or update it. This publication is directed at eligible counterparties and professional customers as defined by the Financial Conduct Authority. Any kind of reproduction of this publication without written permission by the publisher is strictly prohibited. Onyx Capital Advisory Limited reserves the right to modify content or cancel publications without prior consent or notice. Other firms within the group may hold existing positions (long or short) in the investments described in the publication.