In an interview yesterday, Cathay Pacific chief executive Tony Tyler said the Company plans to spend cash to unwind all their fuel hedging contracts when their contracts are back to the break-even point (the point when the contracts are not making money or losing money and it should be at an oil price between $60-$80). The Company has experienced its first loss in 2008 since the Asian crisis, due to their failed fuel hedging strategy and the dramatic decrease in passengers (particularly in business class and first class).
From reading their annual result announcement, I believe that their hedging strategy involves buying a call and selling a put (a zero cost or very low cost collar). The premium from selling of the put is to offset the cost of buying a call. Currently their puts are costing them billions of dollars. Unwinding the contracts at this moment doesn’t make sense as this would be very costly. When oil price goes back up to $60-$70 (assuming it will happen), then buying new puts to offset the currently shorted puts will be less expensive.
The management is basically taking a view that there will be a time shortly in the future that oil price will go back up to $60-$70 and then it may then go back down to below $50 (otherwise they would not close their the shorted puts). But then what happens if oil never goes back up to $60? Then Cathay Pacific will continue to suffer losses till 2011! This is wishful thinking from Cathay’s management that they can end their hedging contracts very soon.
