How Airlines Actually Hedge Higher Fuel Prices

Odd Lots

This episode dissects the complex world of airline fuel hedging through an interview with David Kang, former group treasurer at Qatar Airways. He explains how carriers manage extreme jet fuel volatility using financial

Key takeaways

• David Kang served as group treasurer at Qatar Airways from 2011 to 2013, where jet fuel consumed roughly 44% of operating costs.
• Airlines hedge using Brent crude or heating oil because the physical jet fuel market is too thin and heavily influenced by a few major trading houses.

Main topics

• Airline fuel hedging mechanics
• Brent crude and heating oil as jet fuel proxies

Notable quotes

"The word hedging is a bit of a misnomer. It's actually a view. It's actually a trade."

Conclusion

The episode reveals that successful corporate hedging requires treating financial risk management as

Transcript preview

Speaker 3 (0:00) There are some market stories where you want every detail. Joe and I have made quite a few podcasts on that basis. But sometimes you've only got 10 minutes and just want to know what's moving markets, fast. That's the Barclays Brief podcast. Every week, experts from Barclays Markets and Research get you up to speed on what's happening and what to watch next. Concise, focused, and brief. Search Barclays Brief wherever you get your podcasts. Speaker 5 (0:26) Hi, I'm Carol Masser with a helpful tip to keep you plugged in throughout the market day. Subscribe to the Stock Movers report from Bloomberg. These are short audio episodes, five minutes or less, delivered right to your podcast feed. Stock Movers fills you in on the day's winners and losers on Wall Street and tells you about the news and data that's driving those gains and losses. Why spend all day watching tickers scroll across your screen? Subscribe to Stock Movers today on Apple, Spotify, or anywhere else you listen. Speaker 4 (0:55) Hey, Odd Lots listeners, the Odd Lots tour continues and our next stop is in Chicago. Speaker 3 (0:59) That's right. Joe and I will be at the City Winery Chicago on October 15th for a live Odd Lots recording. Tickets are on sale now at Bloomberg.com forward slash Odd Lots. And Speaker 4 (1:10) of course, a special thank you to Barclays for supporting Odd Lots Live. Speaker 3 (1:14) So that's October 15th at City Winery in Chicago. Get your tickets now. Speaker 5 (1:22) Bloomberg Audio Studios. Podcasts. Radio. News. Speaker 3 (1:38) Hello and welcome to another episode of the Odd Lots Podcast. I'm Traci Allaway. And Speaker 4 (1:42) I'm Joe Weisenthal. Joe, Speaker 3 (1:44) there's a topic that we've been wanting to do for a while. Speaker 4 (1:46) Yes, yes. Speaker 7 (1:47) And you would think it's kind of simple, but actually it's been really, really hard finding a perfect guest for this particular topic because it involves airlines. It involves a particular airline strategy. And airlines, having been a transportation correspondent for like a couple years, way back in the day, airlines... They're weird about things. They're kind of secretive and they often don't want to talk about stuff. I Speaker 4 (2:10) actually didn't know this. Yes. This is an industry thing that I didn't know that they have a reputation or a pattern of. Speaker 7 (2:18) There's like two things in the airline world that I always wanted to know or see. And we're going to talk about one of them today, which is fuel hedging and the sort of inner workings of airline fuel hedging. But the second one, I always wanted to see a completed aircraft contract, like an actual aircraft order that included the discounts that airlines would get. Because when you see the announcement like Virgin Atlantic orders, I don't know, a certain number of planes from Boeing or Airbus, it's always at the list prices. So you never actually get a good feel for what they're actually paying for it. So I always wanted to see that. Never did in my transportation career. But at least I'm going to satisfy the fuel hedging urge right now. Speaker 4 (2:58) I'm very excited about this episode because fuel hedging by airlines, you know, you hear about it all the time or you hear, you know, every time there's Speaker 1 (3:07) a Speaker 4 (3:07) big price or usually jump in oil, there's something people talk about the airlines. And we've all said it, right? This is what I'm fascinated by. All of these things that we talk about all of the time. So did they hedge their fuel? And then the conversation stops there. And they're like, oh, they did hedge their fuel. So, OK. Or they didn't hedge their fuel. So their stock is going down, whatever. But. We all talk about it and have no idea actually what it means. And I'm very fascinated, too, by, OK, they have traders, right? And when we think of traders, we think of trading floors and all this stuff. But there is so much capital T trading activity happening on the corporate side that almost gets no coverage. The Speaker 7 (3:47) other thing about fuel and airline costs. So fuel is, I think, the. second biggest cost for airlines after labor, which makes sense. But it's also the most volatile cost. But people always imagine hedging as like, okay, airlines are worried about the price of oil going up, or to be more specific, the price of jet fuel going up. And so they want to lock in a certain cost so that they don't get caught out, you know, suddenly when prices spike, as they have been doing for jet fuel recently. But At the same time, there's always another lever that airlines pull when you see higher prices, higher oil prices, which is they raise fares or they raise fuel surcharges. So you can get this weird environment where you both lock in a certain price and oil starts to spike. Maybe the price you locked in is lower. And you can institute a fuel surcharge as well, because as we all know from doing these inflation episodes, if oil shortages. Yeah, yeah. jet fuel shortages, everything else are in the news, customers aren't really going to complain that much if they see a big fuel surcharge on their bill. Speaker 4 (4:50) Airline prices are very expensive these days. Yeah, they are. But bookings are really high, too. People are flying. And I keep seeing all these things, new TSA records, new global records. We are flying a lot in this world. Of course, you know, if you hedged your oil and your competitor didn't, right, they're going to have to raise prices. Or if they're not going to lose money. And then it's like, OK, well, here's my opportunity, et cetera. So I'm very curious about how it all works, how it feeds through. And I'm just to a little bit of context, recording this September 29th. Back in February or March, when the Iran war broke out, we were all staring at that Singapore jet fuel chart. Well, Speaker 7 (5:30) one of us was. Speaker 4 (5:32) I was Speaker 7 (5:33) staring at the Europe jet fuel versus Brent crack spread. You know, that's the difference. Sorry. No, but it is true. Like this has been in the news. And of course, with oil prices spiking again with the shortage of diesel, this has suddenly become a very relevant topic. And you're absolutely right that a smart hedging strategy can be a competitive advantage for airlines. Disclosure. My dad flew for Southwest for a long time. A lot of my inheritance is somewhat unfortunately still in Southwest stock. You Speaker 4 (6:04) want me Speaker 7 (6:04) to pull up a ticker for you Speaker 4 (6:05) right now? No, I Speaker 7 (6:05) don't want to see it. I don't want to see it. But Southwest famously pioneered a certain hedging strategy that then got copied by everyone else with varying degrees of success. So it can be an enormously important factor for airlines. And I am so... Don't show it to me, Joe. I don't want to. Don't zoom out. It looks pretty good over like the past couple of years. Just don't zoom out. Speaker 4 (6:24) No, wait a second. It's not that bad. Look, look. It's actually like I was expecting worse. For those who are just listening, I tilted my computer screen so Tracy could see the chart. It's not as bad as I expected. The way you the way you led into that. Speaker 7 (6:38) Yeah. So. I'm very happy to say that we finally found the perfect guest to talk about all of this. Someone who did actual fuel hedging strategy at a major carrier and also did it in an extremely interesting way. We're going to be speaking with David Kang. He is former group treasurer over at Qatar Airways and also an all-round oil expert. So David, thank you so much for coming on All Thoughts. Speaker 2 (7:01) Happy to be here. Speaker 7 (7:02) We are so glad to have finally found you. Thank you so much for staying up late from Singapore. Why don't you just go ahead and tell us who you are and why I just described you as a general oil market expert, in addition to being the former group treasurer of Qatar? Speaker 8 (7:19) That is a long story. And I'm going to pretty much put into a synopsis where I traded effects in Toronto. I traded interest rates in New York. 425 Lexington was the building I was in for a Canadian bank, which is just down the road from you. Speaker 1 (7:37) And Speaker 8 (7:37) came back to Singapore, joined NatWest, sent to London to sell government bonds, and then became a bond trader with a Japanese trading house and lost my job in the 1998 Asian financial crisis. So then became an oil broker and did that for about six, seven years. And in 2006, my buddy, who was the MD of J.P. Morgan for Asia, the head of commodities Speaker 6 (8:05) for them, basically asked me to join him on the desk. And so then I moved from becoming an oil broker to a structurer. And then I went to Sumitomo, the Japanese trading house, and became the head of Speaker 8 (8:17) trading for Asian products. And it's just gone from there. And I've worked in the coal industry. I've worked in the LNG industry. So I'm pretty much an energy man, all in. But I think working for Qatar Airways, Speaker 6 (8:32) I learned a lot about the aviation industry and how technical it gets and how interesting it can get as well. It's a very interesting sector. We Speaker 4 (8:42) love airline episodes. Our listeners love airline episodes. So extremely excited about that. Just real quickly, what were the years you were at Qatar? Speaker 2 (8:50) 2011 to 2013. Well, two and a half to... Nearly three years. Speaker 4 (8:54) Got it. So former group treasurer, what is the basic expectation of that role within the airline? What is the obligation of the treasurer to do for the company? Speaker 8 (9:07) My actual title is vice president, treasury and risk management. Okay. So basically I do the treasury and I do the risk management for all financial products of the airline. So I protect the airline financially. That's what a treasurer does. Speaker 7 (9:23) So who actually hedges? Because my understanding is that some of the U.S. carriers weren't as prevalent when it comes to hedging as they had been in the past. Speaker 8 (9:33) I think the U.S. carriers aren't as prevalent. It's because they got smacked in 2014 and 2015. So they realized, right, Delta recently, 2020, lost nearly over a billion dollars. So they were still hedging as well. But most of the marine carriers, especially the small ones, especially the smaller airlines, they just put everything into the surcharge to pass all the costs on to the customer. And Speaker 2 (10:00) that's built into the ticket. Now, you will never see a ticket that tells you the percentage of your surcharge. Speaker 8 (10:06) It Speaker 2 (10:07) will just tell you it's a fuel surcharge. And Speaker 6 (10:10) then that's it. And some of them even have done away with that. Speaker 8 (10:12) They say that's a ticket price. You pay it and you fly. then that's it. Don't worry about Speaker 2 (10:17) the fuel. You want to get somewhere, they'll take you. So in that aspect, that's when some of the US carriers actually dropped out, right? Because they don't have a hedge book big enough, or rather they don't have a balance sheet big enough to maybe take on these risks of hedging. Speaker 8 (10:34) And that's what the international carriers do have, is they have a balance sheet Speaker 4 (10:38) and Speaker 8 (10:39) they have a hedge book that's big enough. Plus, we have a revenue book that's big enough as well. And that's why they can charge the surcharge at the same time as they're hedging the fuel on the consumption side. So think Speaker 2 (10:52) of an airline, very similar to an oil refinery. Okay, so what does an oil refinery do? It takes in crude, sends it to this crude distillation unit, the CDU, and all of that comes out on the other side of the products, right? So you've got LPG at the top, then you've got gasoline, and then you've got NAFTA. And then after that, you've got your mildew, this is jet kerosene, and then your gas oil, and then after that, the fuel residue. So all these are products that come out from crude. So what does a refinery do? They sell the crack. That's the difference between the product and the underlying crude. That's a spread. So they sell Speaker 6 (11:30) the crack. So they sell the product, right, which is basically, all right, producer hedging because it's called revenue hedging. They've got revenue here because they're selling the product. They're also buying, so they're at risk. So they need to buy the Speaker 8 (11:43) crude. Speaker 2 (11:44) So the same thing happens with airlines. And airlines, what we do is, I mean, I had to get creative for a number of reasons, which I won't go into. But because of those reasons, we had to sit down and really think about how hedging is going to be. We had a 6.6 million balance sheet and we were consuming the first year of consumption was something like anywhere from 24 to 27 million barrels. The next year was added three more million barrels and then added another. So we forecast out to three years. One of the reasons why we did that was because we were accepting 1.5 aircraft a month. And basically we were planning new routes, probably. Once every two months, we'd get a new route. So we could schedule all this. We knew what was coming in. We knew the planes that were coming in. So our consumption was going up at a steady rate. So we understood what we were doing. And so we also saw that the world was looking good. People were trying to fly again. And so we started buying at the bottom and hedging. But sometimes you have to look at the price really and sunset. starts to think about it and what's your probability when what was a triple digit because you use brent as your proxy because jet fuel market is too thin or the american carriers use heating oil as their proxy not jet because jet like