Cathay Pacific Seen Posting Wider Fuel-Hedge Loss as Oil Drops

Crude oil’s plunge to the cheapest level in more than a decade helped the global airline industry boost profit forecasts. One airline that hasn’t fully benefited is Cathay Pacific Airways Ltd.

The marquee Hong Kong airline reported an unrealized fuel-hedging loss of HK$7.42 billion ($954 million) as of end-June -- and oil prices have slumped a further 42 percent since then. The company may announce March 9 that its hedging losses last year ballooned to HK$8.4 billion, according to the median in a Bloomberg News survey of three analysts.

Asia’s biggest international carrier hedged much of its fuel requirements at prices higher than those prevailing in the spot market, causing it to report losses from the contracts. Oil’s sudden drop and airlines’ hedging losses are a replay of events in 2008 and 2009, when Cathay, Chinese carriers and Singapore Airlines Ltd. all reported millions of dollars in losses because of those contracts.

“The turbulence in the oil market is affecting Cathay more than its competitors,” said Shukor Yusof, founder of independent aviation consultancy Endau Analytics in Malaysia. “Hedging sometimes brings about a certain degree of Volatility ."

Being Prudent

Global airline earnings are set to increase 10 percent to a record $36.3 billion in 2016, helped by cheap fuel and a growing U.S. economy, the International Air Transport Association said in December. For 2015, their profit is expected to have nearly doubled to $33 billion, from $17.4 billion a year earlier. Some airlines haven’t benefited fully from the lower oil prices because of their hedging, IATA Chief Executive Officer Tony Tyler said last month.

When spot market oil prices fall below the levels at which an airline has hedged, the carrier must book paper losses. Airlines also must pay charges if they want to unwind contracts prematurely.

Cathay Pacific Chief Executive Officer Ivan Chu has vowed to persevere with the strategy. The airline said last August it hedged 63 percent of its needs for 2015 at an average Brent oil price of $91 a barrel. For this year, the airline has hedged 60 percent of its needs at an average price of $85 a barrel.

In an e-mailed response to Bloomberg, Cathay Pacific said the company doesn’t speculate on fuel prices, but hedges to protect against the possibility of fuel prices rising. "We will continue to monitor the fuel prices movement closely, and take a prudent approach to risk," the company said.

Brent crude oil declined 35% in 2015 to end the year at $37.28 in London, and was trading at $36.72 on Thursday.

Rising Profits

Cathay may post net income of HK$5.53 billion for 2015, according to the average of 14 analyst estimates compiled by Bloomberg. That’s an increase from the HK$3.15 billion profit a year earlier. The airline carried 7.9 percent more passengers.

Shares of Cathay gained 1.2 percent Thursday to HK$13.48 in Hong Kong. The stock has dropped 22 percent in the past 12 months, compared with a 19 percent decline in the Hang Seng Index.

When oil prices plunge, carriers that don’t hedge benefit the most. Airlines in mainland China don’t hedge fuel, gaining every time the commodity declines.

“It’s a battle between those who hedge and those who don’t hedge,” said K. Ajith, an analyst at UOB Kay Hian Pte. in Singapore, who rates the Hong Kong carrier’s shares as hold. “Cathay’s cost base is unfortunately higher, and their competition knows that."

--With assistance from Clement Tan To contact the reporter on this story: Kyunghee Park in Singapore at kpark3@bloomberg.net. To contact the editors responsible for this story: Anand Krishnamoorthy at anandk@bloomberg.net, Michael S. Arnold

By: Kyunghee Park

©2016 Bloomberg News