Hedging Gains Favor at Hertz After Oil Drop Hurts Delta, Vitro

By Edward Klump

Jan. 8 (Bloomberg) -- Hertz Global Holdings Inc., the second-largest U.S. rental-car company, may lock in some of its energy costs after a record drop in crude prices burned airlines that sought to hedge the risks of rising oil prices.

Hertz, based in Park Ridge, New Jersey, wants to level out costs after rising fuel prices contributed to an 89 percent drop in third-quarter profit, spokesman Richard Broome said this week in a telephone interview. Hedging would protect the company should energy prices rebound after crude tumbled 68 percent in the second half of 2008. Futures contracts in New York show investors expect oil to rise 38 percent by December.

Hedging backfired for Delta Air Lines Inc., Cathay Pacific Airways Ltd. and Vitro SAB, which locked in prices when oil was rallying, inflating their costs as 2008 turned out to be the worst year for commodities markets in five decades. Crude futures, currently $105 below their high-water mark, advanced for six straight years before jumping to a record high in July.

“Not only was there buying on fear, but there was hedging on fear,” said Bruce Bullock, director of the Maguire Energy Institute at Southern Methodist University in Dallas.

Wrong-way bets were understandable as petroleum prices jumped, Bullock said. “You’re trying to make a decision and manage your risk, and you’ve got to weigh the probability that it’s going to go up versus the probability that it would go down,” he said. “If you put yourself in their position last summer it was like, OK, once burned, twice cautious.”

Air France, Delta

The turnabout in petroleum markets left fuel users such as Air France-KLM Group and Shenzhen Nanshan Power Co. holding unprofitable hedging contracts.

Delta, the world’s biggest air carrier, said in December that it may have to post $1 billion in collateral, or 15 percent of its cash, on jet-fuel hedges. Executives at Vitro, Mexico’s largest glassmaker, stepped down in November after making losing bets on derivatives. Alfa SAB, the world’s top maker of aluminum engine heads and blocks, said Dec. 15 that it had a $158 million loss on contracts tied to natural-gas prices.

Cathay Pacific, Hong Kong’s largest air carrier, said yesterday its paper losses from fuel-hedging almost tripled to HK$7.6 billion ($980 million) in two months. All Nippon Airways Co., Japan’s second-largest airline, may also suffer after hedging 75 percent of its fuel needs for the fiscal year starting April 1 at an average of $111.73 a barrel, according to Bloomberg News calculations based on the airline’s reports.

Price Bet

Southwest Airlines Co. posted a third-quarter loss, breaking a 17-year streak of profits, on wrong-way hedges. The low-fare carrier, based in Dallas, said Dec. 23 that it had to post $230 million in collateral to back contracts committing to purchase prices higher than market rates. The airline unwound most of its hedging contracts, which reduced collateral requirements for the fourth quarter by $600 million.

Southwest is only about 10 percent hedged on fuel each year through 2013, down from about 85 percent in the fourth quarter of 2008 and from 75 percent for 2009 previously, according to a Dec. 23 regulatory filing. Hedging has saved Southwest $4.4 billion since 1999, spokeswoman Beth Harbin said.

“They’re definitely saying they’re sure oil’s going to stay down for a while,” said Michael Derchin, an analyst at FTN Midwest Research Securities in New York.

Oil futures will average $60 a barrel this year as OPEC cuts output, according to the average of 31 analyst estimates compiled by Bloomberg. Crude fell below $43 yesterday after U.S. supplies increased more than analysts estimated, spurring the biggest drop in prices in more than seven years.

Rout in Commodities

The Standard & Poor’s GSCI Index of 24 commodity futures lost 47 percent last year, the most since its introduction in 1971. The Reuters/Jefferies CRB Index of 19 raw materials dropped 40 percent, the steepest plunge since 1957.

Delta will be “working off” hedging contracts that locked in prices above current market levels through the first part of 2009, President Ed Bastian told investors in a Dec. 9 presentation. The Atlanta-based company has reduced use of hedging on new fuel purchases.

Air France-KLM, Europe’s biggest airline, said in November that second-quarter profit dropped 96 percent as lower oil prices reduced the value of fuel hedges.

The Paris-based carrier pays the going market rate for fuel when oil sells between $70 and $120. The company pays fuel prices reflecting $70 oil when crude goes lower, and its costs are capped at $120 a barrel when it goes above that level. Oil futures reached $147.27 a barrel on July 11.

‘Eat Dirt’

Hedging losses for airlines will give way this year to gains from reduced capacity and lower fuel costs, said Robbert Van Batenburg, head of research at Louis Capital Markets in New York.

“They’re going to eat dirt in the fourth quarter, but that’s now behind us,” he said. “Inadvertently, they have postponed the great benefits that they should have seen from the collapse in energy prices.”

Mexico’s Vitro said Dec. 15 that it had $342 million of losses related to derivatives and that it closed out positions except for $22 million related to gas. That statement followed the November resignations of Chief Executive Officer Federico Sada and CFO Enrique Osorio, after the company made bad bets tied to currencies, interest rates and fuel.

The glassmaker used hedges to lock in gas at about $10.20 per million British thermal units for parts of 2008 and 2009, Osorio said in a September interview. Osorio said in July he boosted Vitro’s hedging to cover 85 percent of its needs for the rest of 2008, up from 40 percent in the first half of the year. New York gas futures, which touched $13.69 on July 2, dropped as low as $5.21 last month.

Contracts Disputed

SMU’s Bullock said hedging 20 percent or 30 percent of a company’s fuel costs is prudent. “If they bet the farm, if you will, and hedged 70, 80, 90 percent of their fuel needs, then that probably was not well advised,” he said.

Alfa, the maker of aluminum engine parts, said last month that it had $494 million of losses on derivatives related to exchange rates, interest rates, equity swaps and fuel futures as of Nov. 30.

In China, Shenzhen Nanshan Power and Goldman Sachs Group Inc. are in talks to resolve a dispute over hedging contracts, according to a Dec. 18 statement by the Chinese electricity producer. Shenzhen Nanshan Power is refusing to pay for losses on contracts signed in March, when oil prices were surging.

Some companies profited from oil’s decline. China Southern Airlines Co., Asia’s biggest air carrier by number of passengers, made $6.3 million from fuel hedging last year after closing all of its positions in September, a spokesman said on Jan. 5.

For Hertz, the idea behind hedging is to bring more certainty to the company’s expenses.

“We’re trying to control costs in every way we can, and fuel has been a major variability in costs for us,” Broome said.

To contact the reporter on this story: Edward Klump in Houston at eklump@bloomberg.net.