DO NOT WRITE OFF THE NEED FOR A GOOD FUEL HEDGE POLICY

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By TESTCustomwebLP TESTCustomwebLP November 4, 2010 14:38

DO NOT WRITE OFF THE NEED FOR A GOOD FUEL HEDGE POLICY

Analysts predict oil prices to rise to $100 per barrel (/bbl) in 2012. Although prices have hovered around $75-85/bbl during the past 12 months, analysts expect a return to the price of oil tracking supply and demand fundamentals now that concerns over the economic recovery and any potential double dips are fading in several regions, especially the Asia Pacific region.

In a recent survey by Energy Risk magazine, some 14 oil analysts said they expect oil prices to average $85.36/bbl for the New York Mercantile Exchange’s (Nymex) light, sweet crude contract (WTI) in 2011 and $83.47/bbl for the Intercontinental Exchange’s (ICE) Brent contract. Prices averaged out at $93.92/bbl for WTI in 2012 and $92.25/bbl for Brent. At the end of October, WTI was trading around $82.32/bbl and Brent was trading around $82/bbl.

Although several analysts expect to see spikes of £100 a barrel by the end of the year, while demand from OECD and non-OECD countries remains muted this high level will be unsustainable until the end of 2011 when analysts expect demand to increase significantly.

Global demand for oil is projected to reach 86.6 million b/d in 2010 and 87.9 million b/d in 2011, according to the International Energy Agency (IEA) oil market report for September 2010. The figures show demand is reducing as the world continues to recover from the economic crisis however demand for oil in China continues to increase by 9% in 2010 and 4.3% in 2011. Demand in non-OECD Asia countries looks likely to continue unabated and will be the major contributor to the $100/bbl barrier being breached towards the end of 2012.

So should airlines look to more hedging now? Austrian Airlines thinks not. “In 2008, you had the feeling that some of the major players in Europe were under the impression that fuel hedging can somehow miraculously take the risk away from pricing and fuel prices,” says Wolfgang Henle, vice president of controlling and risk management at Austrian Airlines in a video interview with Energy Risk magazine. “Some companies, such as Air France, had to pay high for this misconception and if you overlook risk coupling, which I think they did, hedging can put you at more risk on what you had before, when you were not hedged.”

While it is true that fuel hedging carries it own risks, some airlines have reaped the benefits significantly – Southwest and easyJet to name a few. However, with such volatility in the oil price lately, airlines have been reluctant to take a punt in such an uncertain market.

At this point we should mention that the predictions of analysts are all based on the premise that economic recovery, while fragile, is happening and the spectre of a double dip has abated, but that is not entirely true as the markets have yet to feel the full impact of the US commercial subprime problems and as the foreclosure scandal runs its course. Equally in the UK and Europe inflation will force up interest rates, which may collapse the UK housing market. While austerity measures announced by many governments have already led to more unemployment and increase the potential for loan and mortgage defaults. We have not yet seen the full tail of the economic crisis so taking a bet on oil rising over $100/bbl in a little over a year, could be more risky than it seems.

When it comes to fuel hedging, airlines really are, for the most part, amateurs. The best example of this is Ryanair’s total mess of a fuel hedge policy over the past five years. Fuel hedging is a long term business; you cannot hedge when the market is on the floor, so you wait until the beginning of the cycle and obtain a long term fuel hedge that should see your savings curve increase as the economic cycle runs its course. The one thing airlines would like is fuel hedge insurance, a risk management policy that will kick in if the hedge starts to under perform due to oil price collapses down the line, this could be funded in part by savings throughout the course of the hedge. It is this area airlines should be looking at. A fuel hedge allows an airline to plan ahead, for that alone it is worthwhile, it is now time for airlines to explore the options…the clock is ticking.

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By TESTCustomwebLP TESTCustomwebLP November 4, 2010 14:38
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