Byline: Gideon Spanier
HEDGING is a mug's game, the cynics say. Trying to hedge your bets on the direction of fuel prices, interest rates or currency movements can sometimes make the best brains look like fools. But if the volatility of the past two years has proven anything, it is that for most businesses prudent hedging is a lot smarter than doing nothing.
With so many companies loaded with debt, attention has focused on interest rates, which have caught out some firms spectacularly -- pubs group Mitchells & Butlers lost [pounds sterling]500 million when it hedged the wrong way as rates fell. M& B's chief executive Tim Clarke paid the ultimate price by quitting last week.
But while interest rate hedging by corporates is commonplace -- indeed a requirement when banks are lending large amounts of cash -- currency hedging and, increasingly, energy hedging could be as important. Banks rarely make demands for firms to hedge such exposure despite it being potentially a bigger liability than interest rates.
Experts such as risk management consultancy JC Rathbone warn some companies may have left themselves dangerously exposed. The last two years when the oil price trebled to $147, dived by 70%, and then jumped by half, have shown it is vital for firms to protect themselves against such gyrations.
The airline industry knows all about fuel, of course, as this has long been one of its biggest outgoings -- well over 30% of expenditure in some years. Howard Wheeldon, senior strategist at BGC Partners, says energy hedging began in earnest 20 years ago around the time of the first Gulf War: "The rate at which it is now used, particularly by airlines that have shareholders, has grown out of all proportion in the last four years. Share-holderhave wanted a reduction in risk and if an airline is properly hedged, they [shareholders] can see a better way forward for earnings. They tend to forget the implications for cashflow."
Typically, an airline might hedge or forward-buy 50%-70% of its jet-fuel kerosene needs. But the impact on the balance sheet can be dramatic.
British Airways' results last week revealed a [pounds sterling]988 million hit to its reserves on "marked-to market movement on fuel and currency hedges" and changes in foreign debt.
BA's fuel bill shot up 44% to nearly [pounds sterling]3 billion, as the airline swung to a [pounds sterling]401 million loss in the year to March. The results suggest that, after declaring a [pounds sterling]329 million profit from hedging against rising fuel costs between April and September 2008, it suffered as kerosene then dived by two-thirds from $1400 per metric tonne in July. The fact that kerosene is traded in US dollars was another headache when sterling dived 30% after last summer.
Meanwhile, Virgin Atlantic, which is privately held by Sir Richard Branson and Singapore Airlines, indicated this week it kept its fuel bill to around [pounds sterling]1 billion -- saving as much as [pounds sterling]400 million last year -- with what it calls "prudent" hedging. Virgin posted a pre-tax profit of [pounds sterling]68 million and credits its in-house fuel-buying team for buying as much as two years in advance from 2006.
Others, such as Ryanair, have admitted they have suffered by not always buying ahead -- or by locking in prices at the wrong time, before they plunged. Luck plays a small part, of course, but experience and risk management are key.
Paul Newman, managing director of broker Icap Energy, says: "In any environment where the underlying commodity price or financial risk is high and volatile, and where operating margins are increasingly narrow, getting the hedging strategy right can be the difference between profit and loss. …