Airlines face major financial threat: hedged fuel contracts

Qantas is amongst many global airlines that have to face the added twist of yet another financial threat. This one would have come anyway, regardless of the virus problem, it’s just adding another major headache on top.

As the virus spread OPEC (Organisation of Petroelum Exporting Countries), was in the middle of one of its meetings when the cartel, based in Vienna, but whose members are mostly Middle Eastern countries, Venezuela, Nigeria, and Indonesia, started discussing crude oil prices.

The United Kingdom – still a major crude producer, the US – now a net exporter, and Norway don’t take part. Russia, who’s oil production is close to that of Saudi Arabia, attends as a contributing guest.

The virus was slashing already lowering demand, and a production cut is usually agreed to keep the price of crude oil higher. Saudi Arabia and Russia wouldn’t agree to a proportional cut – their economies are dependent on oil prices and exports.

Russia didn’t want to cut output and loose market share, and the Saudis were adamant they weren’t loosing market share to let Russia keep its production. So the two fell out, the Saudis increased production of oil nobody wants to slash the price, but keep their market share. Oil prices plunged and the world is running out of space to store the unwanted crude oil.

Airlines were horrified, more than would normally be the case. Around 60% of them buy their aviation gas as far as a year or more in advance, usually around 6 months. They agreed to pay around $50 per barrel and suddenly the price is down to little more than $19. They’re committed to having to pay nearly three times the price for their aviation gas than if they hadn’t hedged.

Hedging is designed to reduce the risk of sharp rises, nobody saw such a massive collapse to levels not seen since the late 1980’s.

If you’re competing on ticket prices against an airline that doesn’t hedge, you’re either in massive loss making territory if you price match, or you loose customers keeping ticket prices higher, it’s a no win scenario.

And it’s worse than that, because you contracted to take delivery of a certain predicted quantity of gas at that price and you have no income from the virus grounding your fleet.

Quite how airlines who hedged are going to get themselves out of this is yet to be ascertained. Suppliers may relent – or risk loosing their clients, but some may not care and hold the airlines to their contracts, especially if a vast profit is to be made.