Industrials

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

What's the best way to lose money on an insurance policy? Take out an insurance policy.

That may seem a flippant way of thinking about risk, but it reflects a hard truth: If the costs of protection run consistently ahead of its likely benefits, you may be better off switching insurers.

Airlines run on such thin margins that most take out some form of protection against a fuel bill that typically accounts for a quarter or more of operating costs. Some fuel hedges are better than others, though, and Cathay Pacific looks to have bought a dud.

The Hong Kong carrier lost a whopping HK$8.47 billion ($1.09 billion) on its hedge book during 2015, it said in annual results Wednesday -- more than the company spent maintaining its fleet of 201 planes. That follows a HK$911 million loss the previous year which barely offset the HK$985 million gain during 2013.

Heads I Win, Tails You Lose
Cathay underperformance in good times is exceeding its outperformance in bad times
Source: Company reports
Note: Based on adding fuel hedge losses to company's reported operating income

The idea of a fuel hedge is that by paying more when oil is cheap, you pay less when it's expensive. Trouble is, Cathay has managed to end up with fuel costs which exceed its competitors' at every stage of the cycle:

Fuel's Gold
Cathay Pacific's jet fuel costs have been higher than its competitors' throughout the cycle
Source: Bloomberg data
Note: ASK=available seat kilometer

Buying about $4 billion of jet fuel a year, Cathay isn't going to beat a commodities trader selling tens of billions, but it should be getting something in return. A fuel hedge that really made the difference between survival and bankruptcy would be unfeasibly expensive, so the best argument in favor of the practice is not that it raises profits directly but that it allows carriers to invest counter-cyclically.

When oil prices are high, there's a strong motivation for Airbus and Boeing to come up with fancy new fuel-efficient planes such as the 787 and A350 to help airlines reduce fuel bills. Early customers for such models get hefty discounts from the manufacturers and lock in years of reduced costs, but you can get to the front of the queue only if your capital spending program isn't being crippled by those high fuel costs.

Cathay could certainly do with some of that. Its fleet is the oldest among Asia-Pacific peers , a factor that helps explain the company's outsized fuel bill given that older planes tend to be less energy-efficient. Chief Executive Officer Ivan Chu has been taking steps to rectify that, with the first of 48 A350s scheduled for delivery in May and a further 21 Boeing 777-9Xs due to arrive from 2020.

This Year's Model
Cathay Pacific's aircraft tend to be older than its rivals' fleets.
Source: Bloomberg data
Note: Show last reported data in each calendar year. Companies have different reporting dates and frequencies.

It had better pay off. While those falling fuel costs have helped boost demand -- Cathay carried 2.5 million more passengers last year than in 2014, and the better-than-estimated annual result drove the shares up as much as 4.8 percent Wednesday afternoon -- the competition is fierce. Passenger yield, a measure of ticket prices, fell 11 percent to 59.6 Hong Kong cents per passenger, per kilometer in 2015, the lowest level since 2009. Cathay's mainland Chinese competitors have more modern fleets, lower staff costs and fewer barriers to expansion. They don't hedge their fuel bills, either.

Company directors are usually exhorted to be conservative, but in this case, Chu would do well to throw a little bit more caution to the wind and fix fuel prices over a shorter period than the current three to four years. Every cent spent maintaining a super-predictable fuel bill is a cent that could be better spent fending off the competition.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. This peer group was selected on the unscientific basis that all of them publish fleet age data and fuel cost-per-ASK figures.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net