Chinese Airlines Hit by Dispute Over Hedging

A dispute with international banks has cost Chinese airlines dearly as they have been flying for much of the past year without insurance against surging oil prices.

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Profits at two of the country’s biggest airlines have fallen sharply as a result, providing an example of how too much risk aversion in Beijing’s management of the economy can itself be risky.

Three years ago the Chinese government barred airlines from buying crude future contracts – an essential form of protection against rising fuel costs.

This hardline stance was based on the view that the airlines had been duped by western bankers when they suffered big losses in 2008 after the value of their crude futures collapsed alongside the price of oil during the global financial crisis.

Airlines sought to claw back some of their losses from the banks, alleging that they had been “maliciously” sold hedging products which were overly complex.

Since then the airlines have let their existing hedging arrangement expire and have not entered any new ones, according to financial statements published this week by Air China and China Eastern Airlines .

“All the contracts signed in past years were settled by 31 December 2011,” China Eastern disclosed in its full-year results.

Air China said: “As at 31 December 2011, the fuel derivative contracts of the company all expired, and no new position has been established.”

That lack of protection against oil prices has made them extremely vulnerable.

Air China’s jet fuel costs were Rmb34.7 billion last year, accounting for nearly 38 percent of overall expenses. Its hedging positions – holdovers from before the ban – allowed it to recoup a mere 0.2 per cent of those costs. Typically, airlines try to hedge about a third of their fuel bills.

Air China’s 2011 profits fell 38.8 percent to Rmb7.5 billion ($1.2 billion), worse than expected.

China Eastern’s profits last year were down 9.1 per cent to Rmb4.9bn and it posted a loss in the fourth quarter.

“As an airline, rising crude costs are what we most dislike seeing,” Liu Shaoyong, China Eastern chairman, told the Financial Times.

Regulators have not announced a change in their futures policy, but Mr Liu said that they were beginning to row back from a blanket prohibition on hedging.

“They have given us permission to buy hedging contracts for jet fuel. These will be about 20 per cent of our overall [fuel cost]. We are now looking for appropriate market opportunities,” Mr Liu said, adding that they had yet to enter any new contracts.

China’s state-owned companies used to be allowed to trade futures on global markets relatively freely, under the supervision of the country’s securities regulator. After the airlines’ losses in 2008, the Assets Supervision and Administration Commission took over the job of policing derivatives trading by state-owned firms.

A very conservative agency, it quickly clamped down, ordering companies to exit risky contracts and to report their futures positions every quarter.

That, in turn, has made the airlines more cautious.

Fan Cheng, executive director of Air China, said last August that his airline had received permission to resume hedging, but that oil prices were “too volatile”.

“We’ll wait for better timing,” he said. Brent crude prices have since risen about a fifth.