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Hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.
Joe, there's a topic that we've been wanting to do for a while.
Yes. Yes. And you would think it's kind of simple, but actually it's been really, really hard finding a perfect guest for this particular topic because it involves airlines. It involves a particular airline strategy. And airlines, having been a transportation correspondent for like a couple years way back in the day, airlines, they're weird about things. They're kind of secretive and they often don't want to talk about stuff.
I actually didn't know this. Like, um, this is an industry thing that I didn't know that they have a reputation or a pattern of.
There's like two things in the airline world that I always wanted to know or see, and we're going to talk about one of them today, which is fuel hedging and the sort of inner workings of airline fuel hedging. But the second one, I always wanted to see a completed aircraft contract, like an actual aircraft order that included the discounts that airlines would get, because when you see the announcement like Virgin Atlantic orders, I don't know, a certain number of planes from Boeing or Airbus, it's always at the list prices, so you never actually get a good feel for what they're actually paying for it. So I always wanted to see that. Never did in my transportation career, but at least I'm going to satisfy the fuel hedging urge right now.
I'm very excited about this episode because fuel hedging by airlines, you know, you hear about it all the time, or you hear, you know, every time there's a big price or usually jump in oil, there's something people talk about the airlines, and we've all said it, right? This is what I'm fascinated by. All of these things that we talk about all of the times. Oh, did they hedge their fuel? And then the conversation stops there, and they're like, oh, they did hedge their fuel, so okay, or they didn't hedge their fuel, so their stock is going down, whatever. But we all talk about it and have no idea actually what it means. And I'm very fascinated too by, okay, they have traders, right? And when we think of traders, we think of trading floors and all this stuff, but there's so much capital T trading activity happening on the corporate side that almost gets no coverage.
The other thing about fuel and airline cost. So fuel is, I think, the second biggest cost for airlines after labor, which makes sense, but it's also the most volatile cost. But people always imagine hedging as like, okay, airlines are worried about the price of oil going up, or to be more specific, the price of jet fuel going up, and so they want to lock in a certain cost so that they don't get caught out, you know, suddenly when prices spike, as they have been doing for jet fuel recently. But at the same time, there's always another lever that airlines pull when you see higher prices, higher oil prices, which is they raise fares or they raise fuel charges. So you can get this weird environment where you both lock in a certain price and oil starts to spike. Maybe the price you locked in is lower. And you can institute a fuel surcharge as well, because as we all know from doing these inflation episodes, if oil shortages or jet fuel shortages, everything else are in the news, customers aren't really going to complain that much if they see a big fuel surcharge on their bill.
Airline prices are very expensive these days.
But bookings are really high, too. People are flying. And I keep seeing all these things, new TSA records, new global records. We are flying a lot in this world. Of course, you know, if you hedged your oil and your competitor didn't, right, they're going to have to raise prices or if they're not, they're going to lose money. And then it's like, okay, well, here's my opportunity, etc. So I'm very curious about how it all works, how it feeds through. And just a little bit of context, we're recording this September 29th. Back in February or March when the Iran war broke out.
We were all staring at that Singapore jet fuel chart.
I was staring at the Europe jet fuel versus Brent crack spread. Okay.
You know, that's the difference. Sorry. No, but it is true, like this has been in the news, and of course with oil prices spiking again with the shortage of diesel, this has suddenly become a very relevant topic. And you're absolutely right that a smart hedging strategy can be a competitive advantage for airlines. Disclosure: my dad flew for Southwest for a long time. A lot of my inheritance is somewhat unfortunately still in Southwest.
No, I don't want to see it. I don't want to see it. But Southwest famously pioneered a certain hedging strategy that then got copied by everyone else with varying degrees of success. So it can be an enormously important factor for airlines. And I am so... Don't show it to me, Joe. I don't want to. Don't zoom out. It looks pretty good over like the past couple years. Just don't zoom out.
Tracy, wait a second. It's not that bad. Look. Look.
It's actually like I was expecting worse. For those who are just listening, I tilted my computer screen so Tracy could see the chart. It's not as bad as I expected the way you led into that.
Yeah. So I'm very happy to say that we finally found the perfect guest to talk about all of this. Someone who did actual fuel hedging strategy at a major carrier and also did it in an extremely interesting way. We're going to be speaking with David Kang. He is former group treasurer over at Qatar Airways and also an all-round oil expert. So, David, thank you so much for coming on Odd Lots.
We are so glad to have finally found you. Thank you so much for staying up late from Singapore. Why don't you just go ahead and tell us who you are and why I just described you as a general oil market expert in addition to being the former group treasurer of Qatar.
That is a long story and I'm going to pretty much put it into a synopsis. Where I traded FX in Toronto. I traded interest rates in New York. 425 Lexington was the building I was in for a Canadian bank, which is just down the road from you.
And came back to Singapore, joined NatWest, sent to London to sell government bonds, and then became a bond trader with the Japanese trading house and lost my job in the 1998 Asian financial crisis. So then became an oil broker and did that for about six, seven years. In 2006, my buddy who was the MD of JP Morgan for Asia, the head of commodities for them, basically asked me to join him on the desk. And so then I moved from becoming an oil broker to a structurer. And then I went to Sumitomo, the Japanese trading house, and became the head of trading for Asian products. And it's just gone from there. And I've worked in the coal industry. I've worked in the LNG industry. So I'm pretty much an energy man all in. But I think working for Qatar Airways, I learned a lot about the aviation industry and how technical it gets and how interesting it can get as well. It's a very interesting sector.
We love airline episodes. Our listeners love airline episodes. So extremely excited about that. Just real quickly, what were the years you were at Qatar?
2011 to 2013. Well, two and a half to, yeah, nearly three years.
Got it. So former group treasurer, what is the basic expectation of that role within the airline? What is the obligation of the treasurer to do for the company?
Actual title is vice president, treasury and risk management.
So basically I do the treasury and I do the risk management for all financial products of the airline. So I protect the airline financially. That's what a treasurer does.
So who actually hedges? Because my understanding is that some of the US carriers weren't as prevalent when it comes to hedging as they had been in the past.
I think the US carriers aren't as prevalent. It's because, right, they got smacked in 2014 and 2015. So they realized, right, Delta recently, 2020, right, lost nearly over a billion dollars. So they were still hedging as well. But most of the American carriers, especially the small ones, especially the smaller airlines, they just put everything into the surcharge. So we pass all the cost on to the customer that's built into the ticket. Now, you will never see a ticket that tells you the percentage of your surcharge. It will just tell you it's a fuel surcharge and then that's it. And some of them even have done away with that. They say that's a ticket price. You pay it and you fly. Then that's it. Don't worry about the fuel. You want to get somewhere, we take you. So in that aspect, that's when some of the US carriers actually dropped out, right, because they don't have a hedge book big enough, or rather they don't have a balance sheet big enough to maybe take on these risks of hedging. And that's what the international carriers do have, is they have a balance sheet and they have a hedge book that's big enough, plus they have a revenue book that's big enough as well. And that's why they can charge the surcharge at the same time as they're hedging the fuel on the consumption side.
So think of an airline, very similar to an oil refinery. Okay, so what does an oil refinery do? It takes in crude, sends it to this crude distillation unit, the CDU, and all of that comes out on the other side of the products, right? So you got LPG at the top. Then you got gasoline, and then you got naphtha, and then after that, you've got your middle distillate. This is jet kerosene, and then your gas oil, and then after that, the fuel residue. So all these are products that come up from crude. So what does a refinery do? They sell the crack. That's the difference between the product and the underlying crude. That's a spread. So they sell the crack. So they sell the product, right? Which is basically all right, producer hedging because it's called revenue hedging. They've got revenue here because they're selling the product. They're also buying. All right. So they're at risk. So you need to buy the crude. So the same thing happens with an airline. And airlines, what we do is, I mean, I had to get creative for a number of reasons which I won't go into, but because of those reasons we had to sit down and really think about how hedging is going to be because we had a 6.6 billion balance sheet and we were consuming, the first year of consumption was something like anywhere from 24 to 27 million barrels. The next year was added another three more million barrels and then added. So we hedged, we look at the, we look, we forecast out to three years. One of the reasons why we did that was because we were accepting 1.5 aircraft a month and basically we were planning new routes probably once every two months. We begin a new route. So we could schedule all this. We knew what was coming in. We knew the planes that were coming in. So our consumption was going up at a steady rate, right? So we understood what we were doing. And so we also saw that the world was, you know, was looking good. People were trying to fly again. And so, you know, we started buying all at the bottom and hedging. Sometimes you have to look at the price freely and start to think about it and what's your probability when oil is at triple digit because you use Brent as your proxy because jet fuel market is too thin or the American carriers use heating oil as their proxy.
Not jet, because jet, say the jet market is too thin. Northwest Europe, SIF jet, that's a very thin market now. So, you know, you cannot use these instruments to help you hedge, right? You have to go and use Brent as your proxy where it's liquid and there are people at both sides of the table for Brent. I mean, if you go to a table, right, where there are airlines, they're the only buyers of jet fuel. So you've got a ton of, like, refineries saying, yeah, I've got jet fuel for you. I, you know, Glencore, Vitol, the list goes on, right? Vitol, you'll all sell jet fuel to the airline. Morgan Stanley too, as well. I dealt with Morgan Stanley, Goldman Sachs. I bought physical jet from them at certain locations around the planet.
Okay. So there are these various entities that you can trade with. Let's start with what is the most plain vanilla thing? The sort of modal trade, perhaps, so to speak, of how I imagine there are all sorts of complex ways, complexifiers, etc. But what is the sort of core, most common trade that one would do? How does it, walk us through the steps of it.
Well, there's a swap, and the swap's actually a derivative of your futures market. So from your futures market, you can tell what the swap rate is, right, two months out. So this is your swap rate for April. It takes into account May and June for the futures. Okay?
And that's your April swap, right?
So you would buy swaps. And when you buy swaps, it's symmetric. So, I mean, it could go up, it could go down, and you could, you know, and if the price of oil goes up, you're looking good because you've locked in your exposure and you've locked in your cost. But if it goes down, you bleed. So it's best to do swaps when I think oil is low and it's, you know, in the lower double digits, somewhere around $25, $35. It's not an issue to buy swaps. But as it gets, as it moves further up around 70 to $80, I think everybody starts to think about that risk going up because how long will oil stay still elevated? So they'll try and do options. So they'll buy call options, but the thing is you have to pay for that insurance. You have to pay a fee. You have to pay a premium, right? So some airlines are, for lack of a better term, too cheap to pay for their calls. So they fund it all right by selling puts. So that's how they can afford a zero-cost collar and they can use that. So you can buy options, you can do zero-cost collars, and you can do swaps. These are pretty much plain vanilla. But the stuff that I used to structure for JP Morgan was a target redemption note, and then you have a vanilla side on the option and you have the exotic side. So that's where it gets a little bit more complicated.
So the idea is that we have banks that are actually selling target redemption notes for the purposes of fuel hedging to airlines.
Okay. On the vanilla side, you do a zero-cost call with the airline, if I'm the bank. But on the back of it, I structure the note as in the target redemption note. That means it's basically going to redeem in five months or redeem in one year or redeem in two years. So off the back of that, on the exotic side, I can get you a better rate where you can buy the oil and I can get you a better rate for your option, your call options. That means I can basically pull the call options, but they're actually inside the at-the-money. It's like they're in-the-money call options that I can sell to you, but with this exotic behind that. And so a lot of these exotics, they're called extendables. Some of them are just like selling, like what I did. All right, a strangle. That means basically I sold both wings. I sold calls at the top, you know, above 120 bucks. I sold puts below 80 bucks, right? And wherever oil stayed in between, I would profit from that because the banks would be paying me the premium.
It's so funny because I'm so used to thinking about those sorts of notes and structured products in Asia as being sold to, like, mom and pop, someone betting on, like, a big move or lack thereof in the Kospi, something like that. I hadn't even thought for a second that it could be related to fuel.
David, can I just ask, you said something really interesting earlier, which is that most of the fuel hedging is done via Brent trades as opposed to jet fuel because the actual jet fuel trading market is so thin. Does that mean that airlines end up being exposed to big differences between the, I guess, the direction of the price of jet fuel and the price of Brent? Because sometimes, you know, that difference does change very fast and very quickly, as we saw earlier this year.
It's a fair comment, right? I would say yes and no. So yes to the fact, right, that we as an airline, what do we burn? We burn Jet A1. So basically, we're exposed to the jet fuel market. We should hedge with jet, but the jet market's too thin. So that's why we use the Brent market. Now, for lack of a better term, again, it's better to have a hedge on than no hedge at all. You cannot hedge in jet, right? Then you're totally exposed, right? So for lack of a better proxy, right? People use Brent because it's the international carrier. Some airlines use, like in the United States, some of them use WTI, West Texas Intermediate. Some of them, or most of them, use heating oil because it's very close. So the heating oil spread between the jet heating oil in the United States is tighter than what you would get. I mean, just recently, right, you had heating oil versus WTI go through $100 for the crack at like $107. That's like insane amounts of money, right? It's 230 bucks per barrel while crude is trading at 110. And then Brent's trading at nearly $120. And you know, in metric tons, you've got probably like a 74 to $75 crack of gas oil in Europe. I'm not sure where the jet market is in Europe because it's so hard to pin down. There's no real open market for it. There are agencies like Argus or Platts and they will print a number, but you know, the numbers that they print sometimes have no offer on the back of that and there's a bid and then they just up it and they assume that there's an offer. Or sometimes the market's offered and there's no bid and then they just pick a number. So it's very arbitrary. So that's the reason why most people don't trust these agencies, right, with their jet forecasts. So they move either to something they understand better and it's more liquid, like London gas oil, heating oil in the United States.
I just pulled up a chart, speaking of charts, on the terminal, and it's very interesting because if I go back and normalize it to early February, so before the war started in March, basically Brent crude rose 50%. Singapore jet fuel rose over 100% or more than doubled during that time. I could imagine just start there, like at least for that period from, say, March to the middle of May, you could have been a well-hedged carrier hedging Brent and still bleeding a lot if what you're buying is Singapore jet fuel.
That is true. But well, I buy Singapore jet fuel except to the incumbent.
Wait, say that again. Wait, can you explain what is, when I look at, tell me about this chart that we always pull up. Is it not that meaningful?
Sorry. When I say we, I mean like all the people I talk with on the internet, not me and Tracy.
Tell me about this chart that I've been looking at in ignorance.
Singapore jet is a different animal because there are certain trading houses with certain oil majors that control that market very heavily because they know that the only buyers of this market are the airlines, right? And how would I put this nicely? Sometimes people talk to each other, okay? And they agree on something and then what they agreed on happens because all of them are looking the same way and are trading the same way. So it's not a very objective market. It's a very subjective market. And that's why, like I said, only the incumbent in Singapore actually does some jet fuel hedging. All right? Everybody else does not.
How much money can airlines actually make from raising just the fares and the fuel surcharges? Like, why even bother to hedge if in theory, I mean, I'm sure you have thoughts on the price elasticity of air travel. But if in theory I could just fully pass on the additional fuel cost to the customer, why do I need to hedge at all?
Hedging helps, like I said, when oil prices are low, because when oil prices are low, your fuel surcharge can't do anything. You cannot charge the person on the fuel, right? And your ticket price has to be low because oil is low. And usually when oil is low, usually the global economy is not doing well. It wasn't the case in 2014 and 2015, but most of the time in 1998, in 2008, in 2020, and right now, what we're seeing with the, you know, with the 2026 war between Iran and the US and Israel, a lot of times, right, it's something to do with the global economy and geopolitics. So what I would say is that hedging has its uses because it can protect you from a low as it moves up. So you're making money and you've locked in your cost. So that's where using swaps and calls and zero-cost calls work. Now at the same time, because oil is going up and it's part of what makes up an airline, you can charge the surcharge as well. So the airlines that want to make money can actually do that, right? The surcharge doesn't go through P&L, but the hedge goes through P&L. So then, right, if the hedge goes up, right, nobody sees the surcharge coming in. Nobody sees the revenue from there, but they see the revenue coming in from the hedge. So if you've done it well and you've bought and the market's still going up, economy is improving, everybody wants to travel, people are paying up, they don't really care right now how much the surcharge is, you can make twice as much money. But at the same time, right, you've got to be very aware and situationally aware, right, that like I said, it's like a refinery, right? Your ticket is the product. In that product, right, you have the ticket price. Now nobody tells you what the ticket price is, but right now I'll tell you, right, because of the fuel surcharge, the ticket price is probably 25% of the ticket charge.
And that's true. That would, you would say that would just be generally true globally on average right now. Anyone buys a ticket is 25%. Actually, you talked a little bit about the cost. So overall, when you say we talk about the cost of a flight or the cost of running an airline, is fuel basically 25% of the cost? Tracy mentioned that it was number two after labor. But for Qatar Airways, how significant was this one component for them?
Yes, I said 44%. That's the reason why I had to get creative. Wow. It was huge for us. I mean, you know, if you're like the rest of the world's airlines, right? So anywhere from 25, 30% of your cost is jet fuel, and then labor is a big cost. Yeah. But labor for us was a low cost, very low cost, right? Because we were getting a lot of crew and we were paying them decently, but not, you know, but prices would be better in Doha than it was back in their home country. So we had a lot of crew and, you know, cabin crew and flight tech as well from Eastern Europe, from Asia, and, you know, we kept the cost low on the labor side, but our cost, our exposure to the, you know, to the barrel, to jet fuel, right, was 44%. That's nearly half your expenses.
