Emirates saves $1bn by hedging fuel costs

Emirates has saved more than a billion dollars by hedging its fuel costs, a senior executive said yesterday.

“Hedging or risk management, as we call it, has helped Emirates reduce costs by more than $1 billion (Dh3.67bn) since 2000,” Gary Chapman, Emirates’ President for Group Services and Dnata, told Emirates Business in an interview.

Emirates saved $197 million on fuel costs in financial year 2006-2007 alone, according to the airline’s annual report. “This year, I’d expect it to exceed what we saved last year. However, I cannot reveal the exact projections for as we will be publishing our annual results in April,” said Chapman.

Fuel hedging is a practice often employed by airlines whereby they make advance purchases of fuel at a fixed price for future delivery in order to protect against the shock of price rises. Airlines continue to suffer from high jet fuel prices.

And hedging is often seen as a solution to minimise the problem. With oil flirting with the $100 per barrel mark, Emirates is expecting fuel to account for at least 40 per cent of its costs in the current financial year ending March 31, Chapman said. Last year, fuel accounted for 29 per cent of its overall costs.

“I would suspect our spend on fuel this year will be about 30 per cent more than last year’s,” Chapman said. It will be a combination of higher fuel prices and more fuel consumption.

“Of this, while 15 per cent will be accounted for by additional consumption as we have got more airplanes coming in, the other 15 per cent will be driven by higher oil prices,” he said.

Drawing a contrast, Chapman said that Emirates’s annual report for 2002-2003 showed fuel accounting for just 11 per cent of the airline’s costs. “That should give you an idea how dramatically the price of fuel has increased.”

Abu Dhabi-based Etihad Airways, meanwhile, says its fuel costs represent about a third of the airline’s total costs. “The airline is hedged at 65 per cent in 2008 and 20 per cent in 2009. Without a hedging programme in place, Etihad’s costs would be far higher so being prudent and forward thinking is extremely beneficial to the company,” said Etihad Airways’ spokesperson.

Apart from hedging, Etihad also has a surcharge tagged on to the ticket price that rises or falls depending on the cost of aviation fuel, something that most airlines have in place.

Emirates has hedging transactions all the way up to 2011, Chapman said.

There are not many other carriers in the Gulf that have adopted a hedging strategy. Examples include Bahrain’s Gulf Air and Kuwait’s Jazeera Airways.

“All airlines that hedged their fuel have benefited, just like Emirates. But only the wealthiest airlines can afford this as it is an expensive process. It essentially means contracting for fuel at a given price and volume in the future – it is a bet, and only the richest airlines can play this game,” says Addison Schonland, a California-based aviation analyst with Innovation Analysis Group.

“Other regional airlines should of course hedge their fuel costs, but can they afford it? What happens when the airline is state-owned and benefits from cheap local fuel anyway? Maybe then hedging is less urgent. But it is entirely rational and it should be done in any business,” he added.

Hedging has two main drawbacks, Schonland said: “Money tied up in a contract and the possibility that the bet on future price turns out to be wrong.”

“Many experts think oil has peaked. So anyone contracting now at higher prices will make a losing bet. And they will be tied to the contract – which is why nobody hedges 100 per cent of their fuel,” said Schonland.

Global success

Hedging is a common practice for a lot of airlines globally. A case in point Dallas-based low-fare carrier Southwest Airlines. The reason for Southwest’s rapidly increasing advantage over other big US airlines is its efficient hedging strategy.

It loaded up years ago on hedges against higher fuel prices. And with oil trading above $90 a barrel, most of the rest of the industry is facing a huge run-up in costs, while Southwest is not. The airline owns long-term contracts to buy most of its fuel at the equivalent of $51 a barrel through 2009, according to US media reports. The value of those hedges soared as oil raced above $90 and they are now worth more than $2 billion. Those gains will mostly be realised during the next two years.

The hedges have helped keep Southwest profitable – producing gains of $455 million in 2004, $892m in 2005, $675m in 2006 and $439m for the first nine months of 2007.

“Hedging has helped Southwest basically set fares. But as its old contracts have run out, Southwest has increased fares and the whole market’s prices have risen in sympathy. It is likely the same will happen at Emirates once its current hedging contracts run out,” says Addison Schonland.

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