The Malaysian Insider

SINGAPORE, Oct 26 — Is the global airline industry headed for a new crisis even as the current one seems to be coming to an end?

It may be early days yet, but there are ominous signs indicating that the global aviation industry, which has been in crisis mode for the past 18 months as a result of the global economic slump, could be hit on a second front: soaring fuel price.

This fear has become all the more real after a sharp pop-up in the December oil futures price, which shot through the US$80 per barrel mark last week as a drop in gasoline stocks triggered a rally in crude oil. The result has been an uptick in jet kerosene price.

This is despite the fact that demand has barely picked up in an industry which has cut back capacity and services amid the travel demand slump of the past year.

The rise in crude oil prices has pushed up the price of jet kerosene by more than 10 per cent over the past month to US$85 pbl — its highest levels in nearly a year. Though this is still some 6 per cent below October 2008 levels, there is very real concern that it could hit US$100 pbl by the end of the first quarter of 2010, if not earlier.

Cathay Pacific's unrealised fuel-hedging losses stood at HK$7.6 billion as at the end of last year, while its partner Air China slumped to its first loss since its 2004 listing after losing 7.47 billion yuan on wrong-way bets on fuel prices.

And if that happens, it would deliver a serious blow to an industry which is grappling with overcapacity, slumping yields and cut-throat competition.

The irony is that the threat of rising fuel costs is coming amid a slump in fuel demand.

According to the latest data from the US Air Transport Association, fuel consumption by its 13-member carriers was down 10.8 per cent in August 2009. Though the average price they paid was US$2.01 per gallon, a 43.2 per cent decrease year-on-year, this was 5 per cent above average market prices.

So why is fuel heading higher in a sluggish demand environment?

The problem stems largely from the unprecedented weakness in the US dollar. A flight to better yielding offshore assets, especially equities, has driven the greenback to new 14-month lows lately. And every time the greenback dips, resource prices rise.

But while demand globally has fallen, demand from parts of the booming Asia Pacific could accelerate the recovery in fuel price, says the Sydney-based Centre for Asia Pacific Aviation.

It noted that Chinese consumption has been swelling, driven by very strong domestic passenger demand, and Chinese producers increased aviation fuel refining by 10 per cent during the first half of this year. And while jet fuel price in India has been falling recently, demand is poised to rise on the back of rising traffic demand.

Yet, it may be too early to sound the alarm, say some industry analysts. Prices, while rising, are still way below the levels of mid-2008.

But most industry players fear that things could quickly spin out of control for an industry already facing a collective loss of US$11 billion this year if jet kerosene price shoots past the US$100 pbl level.

This is because many airlines around the world have deliberately “under-hedged” after their disastrous hedging losses of the past year. With the exception of the American carriers whose balance sheets were too weak for hedging, the drop in the price of jet fuel from a record US$181.85 a barrel in July last year to a low of US$46.05 in March this year worked against airlines which locked in fuel-hedging contracts at higher prices than those in the spot market.

Singapore Airlines, for example, made a S$543 million (RM1.3 billion) loss on fuel hedging in the quarter ended March, including a S$112 million deficit from early termination of some contracts before maturity.

It was even worse for other players like Cathay Pacific and the Chinese carriers.

Cathay's unrealised fuel-hedging losses stood at HK$7.6 billion (RM3.3 billion) as at the end of last year, while its partner Air China slumped to its first loss since its 2004 listing after losing 7.47 billion yuan (RM3.6 billion) on wrong-way bets on fuel prices.

Although most would have wound down these positions by now, or at least will have lower imputed losses as fuel price rises against their high hedges, the experience of the past year would have prompted many airlines, especially in Asia, to take a very conservative line on hedging.

After hedging 60 per cent of their fuel needs in 2008, airlines have hedged only 30 per cent this year. But low spot price has meant total fuel bill is now 25 per cent of expenses, compared to 32 per cent last year. This year's total fuel bill for this year is estimated to be US$115 billion.

No one is projecting fuel prices to surge out of control, yet.

But if fuel prices do continue their recent uptrend, many of these carriers would be dangerously exposed on a second front even as they battle poor demand and yield squeeze.

And ironically, while airlines were able to claw back a significant portion of their higher fuel bill via aggressive fuel surcharges in 2007 and 2008 when the economic conditions were strong, this option has become tougher amid the current fragile economic climate, soft demand and cut-throat competitive environment. — Business Times Singapore