Caijing reports how listed Chinese airlines Air China (BBerg:0753 HK), China Eastern Airlines (NYSE:CEA), and China Southern Airlines (NYSE:ZNH) have had wild swings in both the profits and losses of their fuel ‘hedging’ positions.
Caijing: Some SOEs suffered huge losses on overseas hedging contracts last year. The decline in crude prices saw the value of airlines’ fuel derivatives contracts shrink substantially. This prompted a government investigation into their hedging activities in February 2009.
However, with crude prices rebounding this year, the fair value of airlines’ derivatives holdings has risen.
In the first half, China Eastern booked an unrealized profit of 2.79 billion yuan related to changes in the fair value of fuel derivatives. Air China posted a 1.45 billion yuan profit for the same period.
To see just how wild these ‘hedging’ swings have been , look no further than China Eastern’s most recent 20-F SEC filing, emphasis added:
China Eastern 20-F: Aircraft fuel expenses increased by 22.3% from RMB15,117 million in 2007 to RMB18,488 million in 2008. This increase was primarily due to a substantial increase in the average price of aviation fuel. In 2008, we consumed a total of approximately 2.4 million tonnes of aviation fuel, representing a decrease of 5.5% compared to 2007. Although our weighted average fuel price per tonne in 2008 increased substantially by approximately 28% from 2007, our aircraft fuel expenses accounted for 32.5% of our total operating expenses in 2008, as compared to 35.2% in 2007. Aircraft fuel expenses accounted for 32.5% of our total operating expenses in 2008, as compared to 35.2% in 2007.
Changes in fair value of financial derivatives resulted in a loss of RMB6,401 million, compared to an income of RMB84 million during the same period in 2007. The difference was mainly due to sharp fluctuations in international oil prices in 2008, which plunged rapidly after reaching a historical high in July 2008… As of December 31, 2008, the loss of fair value in our aviation fuel hedging contracts had contributed to the loss of our Company in the amount of approximately RMB6,256 million.
Clearly their hedging is pretty poor. In the same period that higher fuel prices increase their costs, the hedges for fuel prices lose money at the same time. Just another example of how investors think they own one type of investment exposure when in actuality they simply owned a giant commodities speculator.
Chinese regulators are trying to crack down on Chinese companies’ improper derivatives exposure, but they clearly have a long way to go.