Special report

Airlines risk management

Introduction

All treasurers whose companies consume raw materials to provide

services or products must think about commodity price risk. But few
have seen challenges such as airlines have faced since the start of the
Covid-19 pandemic.

Accustomed to steady passenger growth, and under pressure to

tightly manage expenses amid the shift to low-cost travel, airline
finance teams are keenly aware of the risk of fuel price increases. Do
they pass on such increases to customers, and risk a decline in sales?
Or do they buy hedging contracts to insulate customers (and thereby
shareholders) from oil price fluctuations?

In the US, the three largest carriers decided some years ago that fuel
hedging wasn’t worth the trouble, and shunned it. In Europe and Asia,
airlines took the opposite route. They habitually hedged most of their
fuel consumption using forward contracts – a derivative that pays out
if fuel prices rise, but incurs a symmetric downside if prices fall.

That didn’t matter when an Opec price war pushed down the price of
crude oil at the start of 2O2O. Under hedge accounting rules, the loss
on the derivative could be matched against the reduced fuel expense
and removed from the income statement.

Then came the pandemic, and everything went wrong. Flights were
cancelled as countries shut their borders and instituted lockdowns.
The loss-making derivative could no longer be offset because fuel was
no longer being purchased. Under accounting rules, the hedges were
suddenly ‘ineffective’.

The result was billions of losses, and an eventual shakeup of

airline risk management practices. EuroFinance has covered these
developments step by step. It was our independent reporting that
first identified the hedging ineffectiveness problem in April 2O2O, and
predicted the eventual losses. The prediction would be vindicated in
the following months, as documented in further articles.

This year, airline treasurers are learning lessons and thinking about
things in a new way. Even as flight volumes recover and oil prices tick
back upwards, most have not returned to the 9O% forward contract
hedge ratios of old. Increasingly option strategies are being deployed,
with a focus on the economic risk-reward proposition, rather than an
accounting result.

Some are looking at new ideas, such as hedging ticket prices rather
than fuel costs. And the growing concern over climate change
is prompting increasing use of carbon hedges in Europe where
emissions are regulated. The rest of the world is likely to follow suit.

2
Contents

Covid-19 puts airline hedge strategies

under new focus 4

European airlines may quit fuel hedging

after $4.66 billion in losses 7

Asia Pacific airlines hit by $3.2 billion

fuel hedging losses 1O

Airline hedging travels new route 13

Airlines in a quandary over hedging

as fuel price rises 17

EuroFinance Newsroom, Thought

Leadership and Awards 21

3
Covid-19 puts airline hedge
strategies under new focus

An OPEC-Russia oil price war and

Covid-19 brought oil prices to historic
lows, while flights have ground to a
halt. That has created a fuel hedge
headache for airlines.

By Nicholas Dunbar and Manpreet Singh

April 2Oth, 2O2O

In normal times, airlines worry about

increases in fuel costs affecting their bottom
line. Companies such as Ryanair, EasyJet,
Lufthansa, Air France and International Airlines Group are well known
for their extensive fuel hedging programmes.

That was before the Covid-19 pandemic grounded airline fleets

worldwide, at the same time as oil prices plunged almost two thirds.
This catastrophe was something which no airline was prepared for,
with underwater hedging contracts adding to liquidity pressures.
Absent a rebound in oil prices, hedging losses are likely to be realised
in the airlines’ financial results.

Even before the pandemic reduced the demand for oil, crude oil prices
plummeted from the high of $66 per barrel in 2O19 to sub $25 per
barrel in the first quarter of 2O2O due to talks between OPEC and
Russia breaking down which led to a ramp up in oil supply.

International Airlines Group, whose fleet includes British Airways and

Iberia, could be facing mark to market hedging losses as high as $3.2
billion. EuroFinance calculated this figure based on IAG’s disclosures
on 28 February that it had hedged 9O% of its 9.6 million tonne fuel
consumption for 2O2O, and subsequent moves in the oil futures curve.

Ryanair which last year hedged 9O% of its forecast 2O2O fuel
consumption may be sitting on mark-to-market losses as much as
$1.5 billion, according to calculations by EuroFinance based on its
financial disclosures. Its dollar hedge price per barrel is $83 which is
way above the current June oil futures price of $3O, creating a loss of
$53 per barrel.

4
Budget airline Easyjet may have lost $1.3 billion using a similar
calculation to Ryanair, while Air France KLM lost an estimated $8OO
million based on the swap or forward contracts in its hedging portfolio.
Most of the major European airlines had hedged above 6O% of their
anticipated fuel consumption before Covid-19 decimated their flight
schedules.

US airlines such as American Airlines, United Continental and Delta

Airlines which have shunned fuel hedging are in a better position
compared with pro-hedging airlines. The exception being Southwest
Airlines which hedged 59% of its 2O2O fuel consumption at $88.2 per
barrel.

Options versus forward contracts

The price at which Easyjet hedged its fuel consumption for 2O2O
at $89 per barrel is highest among major airlines, while Lufthansa
airlines have the lowest at $63.32 per barrel. However, the choice
of hedging instrument has a major impact the financial result, in
particular the use of forward contracts versus bought options, where
the mark to market loss is limited to the premium paid for the option.

5
So Ryanair which exclusively uses forwards may be on the hook for
$1.3 billion, and under the terms of the contracts may be required to
post this amount in collateral to counterparties. The use of forwards
by Easyjet explains why its losses on fuel hedging are also likely to
be high. But Lufthansa and Southwest Airlines, which favoured an
option-based strategy are likely to have taken a much smaller hit.

Lufthansa says it uses exclusively options in its fuel hedging. In a March

18 earnings call, CFO Ulrik Svensson said: “there is no commitment to
buy any fuel”. Along with Lufthansa, other airlines such as Southwest
Airlines follow a similar strategy while Air France uses a combination
of options and swaps for fuel hedging. In an SEC filing published on 5
March, Southwest said, “The Company’s fuel hedging portfolio allows
for full participation in declining market prices”.

Ryanair in its latest statement said that the airline will take a hit of
approximately €3OOm as an exceptional charge due to ineffectiveness
of its fuel hedges. Without commenting on its hedging, IAG said on
3O March it had extended a $1.4 billion undrawn credit facility for a
further year, as part of total cash and undrawn facilities of €9.4 billion.
On 6 April Easyjet said it had used a Covid Corporate Financing Facility
provided by the Bank of England to issue £6OO million of commercial
paper, while drawing down on an existing $5OO million revolving credit
facility, secured against aircraft assets.

IAG and Ryanair declined to comment on their hedging losses. Easyjet

and Air France KLM didn’t respond to requests for comment.

6
European airlines may quit fuel
hedging after $4.66 billion in
losses

Treasury teams at European airlines

are bracing for a shakeup as time-
honoured fuel hedging policies are
reviewed in the wake of pandemic-
related losses.

By Nicholas Dunbar & Manpreet Singh

December 1st, 2O2O

The airline sector has been upended by the

Covid-19 pandemic. When global demand
for flights collapsed, European carriers
found themselves hedged against millions of tonnes of unneeded fuel
purchases – at the same time as plummeting oil prices dragged the
contracts underwater.

As first reported by EuroFinance in April, European airlines such as

Ryanair, Air France, EasyJet and International Airlines Group faced
mark-to-market losses of up to $6.82 billion on these fuel hedges.
This estimation was based on the companies’ disclosure on fuel
hedging percentage and estimated fuel consumption for 2O2O.

Now, with passenger demand not predicted to fully recover for several
years, some $4.66 billion of the estimated losses have been realised,
according to EuroFinance analysis of the companies’ Q3 financial
disclosures. Some, like IAG and Lufthansa, have been so chastened by
the experience that they have stopped hedging completely – and may
never resume.

That’s the message from Steve Gunning, CEO of IAG, which owns
British Airways. In his Q3 investor call Gunning noted that “given what
we’ve experienced and endured this year, we are actually doing a sort
of fundamental review of that policy to see whether we need to learn
from 2O2O and take a different tack”.

Adding further on fuel hedges he said, “No, we’re not taking out
further hedges at this point”.

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The company at the end of Q3 reported a €1,599 million ($1,856
million) loss on over-hedging of which €33O million ($383 million)
came in the third quarter. CEO Gunning commented on this by
saying, “this (over-hedging) was driven by the fact that because we’ve
reduced our capacity plans going forward, we are effectively more
hedged or over-hedged than we were before”. The company has ‘de-
designated’ its rest of fuel hedges. An IAG spokeswoman declined to
comment on staff changes at the airline’s fuel management team.

Range options

IAG’s German rival Lufthansa posted €764 million ($886 million) fuel
over-hedging losses in Q3 and the company anticipates adding more
given the lower demand for flights in Q4. The airline also noted in its
investors call that it believes the effect of over hedging will ‘fade out’
in the first quarter of next year due to the fact that it had ‘stopped’ the
fuel hedging at the beginning of the crisis.

Lufthansa’s 2O19 annual report mentions that the company almost

exclusively used range options for its fuel hedging needs, a kind of
derivative where the cost of the bought call option on fuel is offset
by a put option sold to the counterparty. In December 2O19, these
contracts on a notional 6.2 million tonnes of fuel had a mark-to-
market value of just €8O million. The size of the over-hedging losses
which the company posted at the end of the Q3 may be the result of
settling in-the-money puts on fuel that was no longer required, as
well as the expiry of call options.

Lufthansa, which received €9 billion in state aid from the German

government this year, recently announced industry outsider Remco
Steenbergen as its new chief financial officer. It remains to be seen
how this former chocolate company CFO will take on fuel hedging
strategy. He will take charge on 1st Jan 2O21. According to sources
close to Lufthansa, there have already been changes at the airline’s
Hamburg-based fuel risk management team.

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Air France KLM which uses the combination of swaps and options has
posted a loss of €612 ($71O million) million at the end of Q3, of which
€112 ($13O million) is unsettled for the period Oct 2O2O to March 2O21.
The airline received a total €1O.4 billion in state aid from the French
and Dutch governments.

The Irish budget airline, Ryanair which uses forward hedging contracts
posted an ineffectiveness charge of €647.4 million ($751 million) at the
end of September 2O2O. The company has also reduced its fuel hedge
levels for next year to 4O% which in the past has been at a 9O% level.
Even though the company has suffered losses on over hedging of fuel
consumption, it is still committed to fuel hedging strategies.

The airline has settled 7O% of ineffectiveness hedges this fiscal year
and believes that it won’t have any further loss related to this in further
quarters. The company also recorded €153 million ($178 million)
ineffective hedges for the period from October 2O2O to March 2O21.

Unlike its Lufthansa and Air France KLM, Ryanair hasn’t received any
state aid. Rating agency Fitch has reaffirmed Ryanair’s rating at BBB
with a negative outlook. The company had issued a bond worth €85O
million and €4OO million equity in September 2O2O.

Another budget European Airline, EasyJet has posted a loss of £353

million ($458 million) for fuel hedge loss in its year ending September.
The company is currently hedged at 51% of its estimated fuel
consumption for the next year and 44% for FY 2O22. In fact, EasyJet
had increased its fuel hedging for FY2O22 from 35% to 44%.

However, the company has paused its additional hedging for the period
from April 2O2O to October 2O21 but it will continue for the latter
period as the company takes advantage of ‘low-price environment’.

Both EasyJet and Ryanair escaped the fate of fellow low cost carrier,
Norwegian Airlines which in November filed for bankruptcy protection
in Ireland. The company had limited hedging for 2O2O and paused
it for FY21. At the end of Q2, the company had recorded NOK 1O57
million ($12O million) in fuel hedge losses.

European airlines are now a long way from their comfortable position
two years ago when they hedged almost 6O-9O% of their estimated
fuel consumption in anticipation of rising fuel costs. In the future, they
may come to resemble US counterparts such as American Airlines,
United Airlines and Delta that quit their hedging habit several years ago.

9
Asia Pacific airlines hit by $3.2
billion fuel hedging losses

In the wake of Covid-19, airlines are

disclosing fuel hedging ineffectiveness
losses as flight cancellations mount up.

By Nicholas Dunbar & Manpreet Singh

January 26th, 2O21

The aviation sector has been particularly

hard hit by the pandemic, not least because
the long-standing practice of hedging
fuel purchases against a rise in oil prices
rebounded with a vengeance when oil prices
fell and passenger traffic plunged.

Analysing European airlines’ hedging policy in April 2O2O, EuroFinance

estimated that mark-to-market losses were $6.82 billion. A few
months later, the same airlines disclosed $4.66 billion in ineffective
fuel hedging losses.

Now a similar pattern has emerged in Asia, where airlines have

been punished due to ineffective hedging of fuel resulting from the
pandemic.

Singapore’s flag carrier, Singapore Airlines was the hardest hit in the
Asian market where it reported ineffective fuel hedging losses of
$71O million at the end of March 2O2O. Six months later, it posted its
interim financial results disclosing $563 million in additional surplus
fuel hedge losses. The airline in its financial results noted that “The
Group has paused fuel hedging activity since March 2O2O, given the
uncertain pace of recovery”.

Its rival in Asian airspace, Emirates Airlines also reported the loss of
AED 2,244 million ($6OO million) at the end of June 2O2O by its sole
shareholder, Investment Corporation of Dubai which in its interim
report mentioned the airline had reported fuel hedge losses.

Meanwhile, Australia’s Qantas Airways reported a $571 million loss

on its fully hedged fuel consumption at the year-end of June 2O2O.
The company noted that it took advantage of fuel hedging in the first
of its financial year while in the second half, pandemic and drop in
fuel prices resulted in hedge loss. In April 2O2O, the airline closed its
10
hedge position and reshifted to September 2O2O in outright options.
It also noted that “there are no margin call obligations on the Group’s
hedging”.

Hong Kong-based Cathay Pacific Airways reported a fuel hedging loss

of $2O7 million at the end of June 2O2O according to its six month
interim report. However, this is only a fraction of the hedging losses
that the airline is likely to have incurred. At the end of 2O19, Cathay
Pacific owned crude oil forward contracts with a notional amount of
28.9 million barrels, at prices ranging from $58 to $64 per barrel, and
maturities of up to two years.

At this reporting date, a decline of 5% in crude oil prices would result

in a loss of $8O million on the hedges, the airline said. Between
December 2O19 and January 2O2O, prices declined by 18%, implying a
loss of $288 million. During the same period, Cathay reduced its flights
by 96%.

Japanese opacity

In Japan, the country’s leading carriers haven’t publicly acknowledged

any fuel hedging losses, but analysis of annual reports implies
significant losses will have occurred. According to its annual report,
Japan Airlines saw a reduction in commodity swaps estimated at
a fair value of about $271 million at the end of March 2O2O while
ANA Holdings reported a “deferred loss on derivatives under hedge
accounting” of $134 million.

In an email response to EuroFinance, a Japan Airlines spokesman said

“the amount $271 million is simply the difference in valuation based
on our balance sheet and will not be a direct loss”, adding that the
company hedges 4O% of its fuel consumption and the company has
no plans to abandon this in 2O21.

However, observers believe that the airline will ultimately have to

accept that the hedges are no longer effective. According to Japan
Airlines published figures, passenger traffic has declined by 71% since

11
the end of 2O19, and the number of flights by 32%. The majority of
reduction has been in international flights, or long-haul flights which
use the greatest amount of fuel.

ANA Holdings has also shied away from reporting a hedge

ineffectiveness loss in its current financial year. According to the
company, it only hedges against domestic fuel costs with a three-
year window, while its international operations are covered by fuel
surcharges. As a result, approximately 3O percent of ANA’s overall
total fuel consumption was hedged.

Responding to EuroFinance, an ANA spokeswoman conceded that

fuel price declines have impacted the company but “For competitive
reasons, we cannot disclose the specific amount”. She added, “After
the decline in demand and downsizing of our network operations
levels, we decided to stop hedging immediately and therefore our
valuation losses are improving with the gradual rise in the fuel market”.

As for Indian subcontinent airlines such as Indigo, SpiceJet, GoAir

and Vistara (Tata and Singapore Airlines alliance) these had no fuel
hedges and this could prompt them to be better placed in the market
rather than airline companies who hedge their fuel. Similarly, Turkish
Airlines does not engage in fuel hedging but does hedge its foreign
exchange risk.

Meanwhile, a new initiative has emerged which might better meet

airline risk management requirements post-Covid. Skytra which is a
wholly-owned subsidiary of plane manufacturer Airbus, has obtained
the approval from UK’s Financial Conduct Authority (FCA) to be a
regulated benchmark administrator for its Air Travel Price Indices.
These indices will allow the air travel industry to hedge air travel
pricing on different international routes. It has also selected Nasdaq to
provide technology for its new air price derivatives.

12
Airline hedging travels new
route

As airlines start returning to the

skies, their treasurers are updating
risk management strategies after
the $1trn industry’s 2O2O crisis. The
new formula: less fuel hedging, more
revenue protection.

By Julian Lewis
March 9th, 2O21

As airlines start to move on from their 2O2O crisis, they are changing
hedging strategies significantly. Having suffered badly when lockdown
and derivatives left them long of a commodity no longer required,
treasurers are approaching fuel risk management more cautiously.
At the same time, the $1trn industry is looking to benefit from a novel
revenue hedge.

With the Airbus venture Skytra now authorised by UK regulators,

carriers who have long struggled with almost 9O% of revenues being
booked 9O days or fewer before take-off are relishing the prospect of
protecting their flight yields.

The big question, though: will corporate buyers of air travel take the
other side of the trade?

Annus horribilis

Although some airlines suffered even greater losses on their hedge

portfolios in the 2OO8 global financial crisis, 2O2O challenged their
risk management as never before. They faced an unprecedented
combination of operational shutdown, the need to unwind derivatives
in a one-way market and oil futures trading at negative prices for the
first time.

They ended up reporting enormous ineffective hedge losses. These

reached $4.7 billion in Europe and $3.2 billion in Asia.

Airlines had to scale back their hedging strategies aggressively. Air

France suspended its programme, which was based on covering 6O%
of the nearest three quarters’ exposure, 5O% of the next-nearest’s and

13
 down in 1O% steps. Finnair reduced the lower bound of its permitted
hedged exposure to zero from 1O%.

While treasurers insist 2O2O’s uniqueness means the experience doesn’t

invalidate hedging’s long-term value, they acknowledge its difficulties.

“While you cannot look only at one year, last year was terrible, for sure
– something no one predicted,” comments Bruno Lecerf, Director of
Financing & Treasury at Air France, which reported a €221m decline in
the fair value of its fuel hedges in 2O2O. He stresses, though, that the
portfolio is significantly less in the red now after oil’s recovery this year
and some hedges having matured.

“The underlying commodity exposure didn’t materialise. That’s a tail

risk, really,” judges Christine Rovelli, Group Treasurer & Head of M&A
at Finnair, where the fair value of its commodity derivatives fell by
€29.4m in 2O2O.

As the oil price plunged and banks stepped away, the difficulty of
finding bids exacerbated the situation. Some carriers took as long as
two quarters to fully unwind their positions.

Cautious comeback

Now, though, with the industry set to resume much of its flight
schedules, many hedges now expired or unwound and oil back at pre-
pandemic prices, airlines are cautiously returning to hedging.

Their strategies are different this time round, though. Finnair has
moved to what Rovelli describes as a much more agile approach that
features regular review of its programme every other month and
more dialogue with the audit committee and senior management.

In light of its financial situation Air France expects to pursue a “less

Christine Rovelli ambitious” approach. This is likely to feature shorter tenors, lower
Group Treasurer & Head of M&A, hedge ratios and, in consequence, a smaller portfolio. To reduce
Finnair downside risk, the carrier (already an active hedger through zero-cost
collars) also expects to increase its use of options.

Counterparty risk appetite is also still notably limited. Even financial

institutions that have returned to oil derivatives are reluctant to trade
maturities much beyond 12 months.

Treasurer enthusiasm

Against this background, airline treasurers are unsurprisingly

enthusiastic about the prospect of managing their revenue risk
through derivatives on Skytra’s new price indices.

“The concept is great. It will be fantastic once the liquidity is there

to allow us to trade the instruments,” says Rovelli. The prospect of
lowering ticket price volatility – always high, even before the pandemic
– is attractive, while Skytra’s “massive trove of historical data” will aid
gaining auditor approval for hedges under IFRS 9.

14
“It is the first time since a long time that we’ve seen something so
inspiring in terms of risk management,” adds Lecerf. He regards Skytra
as potentially “a breakthrough for the industry”.

Airline appetite for the new indices seems assured. The big
uncertainty is over major travel buyers’ appetite to use Skytra.

“To ensure a robust, true marketplace, we need to find willing

counterparties to animate the market”, comments Lecerf. In
view of the lower risk appetite for hedging instruments, he fears
counterparties may be in limited supply at first.

It doesn’t help that airlines’ credit ratings declined badly last year. After
the industry added over $2OObn in debt, fewer than 15% of carriers
now carry investment-grade ratings and 6O% have fallen into the
speculative category.

Collateralisation through credit support annexes (CSAs) could address

the ratings disparity with counterparties, though this requires cash
or cash-equivalents at a time when the industry is struggling. Some
carriers also refuse to use CSAs.

In the longer term, reducing earnings volatility and financing costs

by hedging revenues with Skytra products should help raise airlines’
ratings again. A recent white paper by Toulouse Business School
professor Regis Huc suggests that an overall one notch rise in ratings
could save the industry up to $8bn a year.

Skytra itself is confident in the outlook for both corporate and financial
participation. “The first wave of counterparties will be multi-national
corporates and investors,” CEO Mark Howarth affirms.

The venture anticipates the greatest initial demand being on regional

routes. It foresees long-haul markets taking longer to regain volume
after the pandemic.

15
Readying for take-off

Skytra expects derivatives on its indices to begin trading in H2 this

year. Forwards/futures, swaps and options are all likely to feature.

These derivatives will eventually trade both over-the-counter and

on-exchange, though confirming a listed venue has been delayed
to next year. “In the longer term we see OTC being used for
larger block trades or customised settlement, and listed being for
continuous trading in smaller sizes,” Howarth suggests.

If Skytra derivatives attract the anticipated two-way flow between

ticket buyers and airlines, hedge funds and other financial players
are likely to be attracted into trading them too – just as they do the
Baltic Exchange Dry freight benchmark.

Skytra sees strong prospects of participation. “A diverse set of

investors will be healthy for liquidity,” Howarth believes.

16
Airlines in a quandary over
hedging as fuel price rises

Airlines slashed their hedging by

almost a quarter, as measured by
average percentage of forecast fuel
purchases

By Anmol Karwal
June 15th, 2O21

For treasurers at global airlines, pandemic-

struck 2O2O was a “terrible” year for fuel
hedging. Travel demand plunged at the same time as oil prices,
resulting in an “over-hedged” derivatives position. Now as the global
economy emerges from the pandemic, crude oil prices have surged
to a two-year high and airlines across the world face the opposite
problem of being under-hedged.

Shift in Hedging policy

In normal times, treasurers can predict fuel consumption and hedge

against it, keeping price volatility out of their financial results with
the help of hedge accounting rules. But last year, they had derivative
contracts for which there was no corresponding purchase of jet
fuel, making the hedges ineffective under the rules. Their accounts
were cruelly exposed when Brent crude prices plunged in the first
half of 2O2O, resulting in European airlines including IAG, AirFrance,
Ryanair and Easyjet record $4.6 billion in losses. Meanwhile, ineffective
hedging losses at their Asia Pacific counterparts including Singapore
Airlines, Emirates, Qantas and Cathay Pacific stood at $3.2 billion.

Stung by the experience, airlines decided to overhaul their hedging

programmes. This resulted in an average drop of 24% in the hedging
exposure of these companies, according to their latest disclosures.

“We are reviewing our fuel hedging policy for the future. Clearly, given
the level of over-hedging that we have at the moment, we can take
a bit of time to do that.” said Steve Gunning, CFO at the International
Airlines Group (IAG), which owns British Airways and Iberia. The
company recorded a mark-to-market loss of €1,781 million ($2,159
million) during the year 2O2O, before benefiting from a €6O million
‘over-hedging gain’ in the first quarter.

17
The company mentioned in its Q4 2O2O disclosures that the policy
reduces the next year’s hedging from 9O% of the anticipated fuel
demand to only 6O% while encouraging a greater use of call options
instead of forward contracts or swaps.

“This revised policy is designed to give greater flexibility and to reduce

the negative impact of our hedge book when there is a significant
unexpected drop in demand or capacity and a material or sudden drop
in fuel prices” said IAG’s Gunning in a 7 May earnings call.

The Franco-Dutch carrier, Air France KLM also had a cautious approach
towards hedging as the company decided to hedge tenors of up to one
year instead of two years and reduce the maximum volume of hedged
portfolio to 5O% from 8O%, as a part of its new hedging strategy.

“The current situation forced us to rationally adjust the hedging strategy

by being more, more cautious and more modest in our ambitions for
the time being” said Frédéric Gagey, CFO at AirFrance KLM.

British low cost carrier EasyJet paused jet fuel hedging for a period
between April 2O2O to October 2O21 leading to a fall in its hedge ratio
to 65%, while Australia’s Qantas Airways is an odd one out as it still
continues to fully hedge its fuel consumption but with only options as
a hedging instrument.

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Overhedged Vs Underhedged

As oil prices rise sharply, it puts the airlines in a dilemma: If airlines

return to hedging, they may find themselves suffering losses once
more if prices fall again and fuel demand slumps. On the contrary, if
the rally in prices continues further then airlines will be exposed if they
remain under-hedged while demand for flights increases.

The German carrier, Lufthansa which reduced its fuel hedging

exposure to 65% is ready to absorb lower margins if prices continue
to rise after facing a €73O million ($885 million) loss on hedges. “We
have also adjusted the hedging structure so that we reduce the risk of
overhedging in case of a sharp drop in demand and participate more
in falling fuel prices. In turn, we will accept lower levels of protection in
the event of a moderate price increase.” said Remco Steenbergen, CFO
at Lufthansa in the Q4 2O2O earning call.

With flight volume so difficult to forecast, carriers are relying on

options which protect them from rising oil prices but given them the
right to purchase fuel at market prices if the fuel prices again fall
back. Even though they have a greater up-front cost as compared
to other hedging instruments, the new-found cautiousness in the
hedging strategies makes it suitable for airlines.

IAG has highlighted a greater use of options in its new hedging

strategy while the fully-hedged Qantas using collars in order to reduce
costs of hedging. AirFrance also follows suit with 75% of its notional
fuel purchases being via options.

The rise of carbon hedging

As airlines reduce fuel hedging, they are ramping up their hedging

against carbon dioxide emissions, which is a key driver of climate
change.

Airlines in the European Union are subject to regulations on reducing

carbon emissions. They are granted CO2 allowances based on
historical performance and a CO2 efficiency benchmark. Every year
these allowances are surrendered by airlines equivalent to the amount
of CO2 they emitted in the preceding year.

With the pandemic causing a dramatic reduction in flights during

2O2O, the benchmark has been reset, creating a challenge for airlines.
Any shortage of allowances has to be purchased in the open market
or government auction, resulting in an added financial risk if the
airlines fall short. Airlines including Ryanair, Lufthansa, AirFrance and
Easyjet are increasingly hedging their future purchase of CO2 quotas
by using derivatives.

AirFrance for instance, purchased €133m of forward emissions

contracts as of December 2O2O, with 75% of the contracts with
a maturity of 1 year. Easyjet has contractual commitments to
purchase £22 million of Verified Emission Reductions, a carbon

19
offset exchanged in the voluntary or over-the-counter market for
carbon credits. While Ryanair didn’t disclose the notional amount of
carbon offset purchases but has hedged 4O% of its estimated carbon
exposure for calendar year 2O21.

Outside of Europe, the International Civil Aviation Organisation is

bringing in a global emissions standard which will eventually cover
other airlines too. The UK has already pledged to implement this
standard under UK law.

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EuroFinance Newsroom,
Thought Leadership and Awards

For over 3O years, EuroFinance has

been connecting and supporting
the the global treasury community
EuroFinance is the leading
global provider of treasury, cash
management and risk conferences,
training and research.

Thought leadership

We offer the market partnership

opportunities utilising our wealth of treasury and finance expertise in
providing editorial and content services that are based on the same
principle as our events - to provide the global corporate treasury
community with information and best practice that helps them do
their jobs better.

We publish white papers, case studies, interviews, articles, data

analysis & research that take the corporate treasurer’s perspective
as the starting point and amplify the messaging through our global
corporate treasury community, reaching over 8O,OOO senior
treasurers and into the world’s fortune 1,OOO companies.

Annual survey

Each year EuroFinance runs an annual survey to help us understand

the current issues impacting the global treasury community.
We can rely on open and honest feedback from our network and the
results of the survey helps treasurers identify “what’s next”.

It is conducted in March/April of each year at a pivotal time for the

global business and treasury operations.

The 2O21 survey, published in June 2O21, looked at understanding

changing priorities, digital transformation, treasury partners and
lessons learnt.

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EuroFinance awards

Our annual awards are the benchmark for treasury excellence judged
by EuroFinance’s editorial, research and production teams. This
independent accreditation serves as an industry-wide recognition of
the work undertaken by an organisation in the previous 12 months.

Treasury Excellence Awards

• Mastering strategic change

• Digital transformation / technology implementation

• Treasury management and process transformation

• Risk management and resilience

Treasury Innovation Award

Companies pitch their technological solutions and are judged against

a set of criteria with the overall winner announced at our flagship
EuroFinance event in September.

Treasury news

Our news content is based on the same principle behind our events –
providing the global corporate treasury community with information
and peer-to-peer knowledge sharing that helps them do their jobs
better.

Get the latest treasury news direct to your inbox every Wednesday.

Sign up here:  www.eurofinance.com/sign-up-newsletter

22
Celebrating 3O years
as the world’s leading
treasury event

International Treasury Management

Virtual Week
Monday September 27th - Friday October 1st 2O21

Register free now

www.eurofinance.com/virtualweek
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© EuroFinance Conferences Ltd. 2O21