Industry public affairs consultant Andy Cooper explains why it’s too simplistic to expect reduced fuel costs to result in lower holiday prices for consumers
The recent significant reductions in the oil price, together with fluctuations in the currency market have brought the whole question of hedging in the travel industry into sharp focus.
Within the past week, there have been two news items in relation to the oil price which have brought this issue to life.
Firstly, chief secretary to the Treasury, Danny Alexander was quoted as saying that the oil price reduction should result in a number of products, including package holidays, falling in price.
There are rumours that Treasury may have written to the big operators, almost to demand this.
That demand fails to recognise that tour operators and their associated airlines will have agreed contractual seat rates for Summer 2015 already, and will probably have hedged their risk by pre-buying some or all of their fuel requirements.
In a further development, Monarch chief executive, Andrew Swaffield was quoted as saying that Monarch’s slightly challenging financial position had meant that they had not hedged their fuel risk, and as a result, they were seeing a windfall from the fall in fuel prices.
These two news items got me thinking about how well understood hedging may be, as well as some of the challenges that are created by hedging.
The core principle of hedging is actually pretty simply.
It’s about agreeing a price now for a commodity which will be delivered at a future date, and then addressing that agreement in a financial instrument.
Normally the seller of the commodity will want some form of security from the buyer, which limits the ability of businesses to enter into hedging arrangements – many companies will not have the spare cash to commit as security.
Within our industry hedging contracts are mainly used in relation to fuel and currency.
The main benefit for the buyer is that at a time when commodities may be subject to wild price fluctuations, the buyer benefits from price certainty.
The disadvantage is that if the price of the commodity falls between the time of the hedge contract and the time at which the commodity is due to be delivered, the buyer may be paying too much for their currency or fuel.
Fuel is an interesting case in point.
There are effectively two variables in relation to the fuel price, as all fuel is bought and sold in dollars.
Therefore, the amount that an airline or other business has to pay for their fuel can be affected by any changes in either the fuel price or by the pound to dollar exchange rate.
At the moment, while fuel is getting cheaper, the Dollar is strengthening against the Pound, so the overall reduction in cost is nothing like as great as the net fall in the fuel cost.
Similarly, the Euro has struggled against most currencies in the past year, which means that if an operator has committed to buy their Euros in advance, they may be paying more than they would if they simply relied on the spot rate.
Looking at the annual reports of the big operators, de-risking their businesses by hedging their fuel and currency is important to them, and as a result, more than 90% of their fuel and currency requirements for both Winter 14/15 and Summer 15 have already been hedged.
As a result, those operators, as well as a number of airlines are unable to get any great benefit from the fuel price falls, and therefore have nothing to pass on to their customers.
Where the customer will start to see the benefit should be in future seasons – so after the end of Summer 15.
Assuming that the operators choose to hedge for those seasons (of which more below), the prices at which they will hedge will more closely reflect today’s prices, which should result in cost savings for holidays.
In the short term, the main benefit for holidaymakers will arise if they choose to travel to countries whose currencies are weak against the Pound, as the money in their wallets will go further in resort, enabling people to eat and drink more cheaply – not much use for those purchasing All Inclusive holidays though.
Similarly, customers buying unhedged products can also win – buying or paying direct for accommodation in destinations with weak currencies will give benefits.
Some airline seats may also be cheaper for similar reasons. Is this going to encourage customers to book direct, and not with tour operators? This has to be a real risk.
At the same time, the strength of the dollar is going to make any dollar denominated destinations, or any country with a currency whose exchange rate tracks the dollar, suddenly become more expensive.
This could impact on the plans of VisitUSA to encourage more British tourists, as well as impact arrivals in the Caribbean.
At a time when the benefits of the reduction in Air Passenger Duty are about to materialise, this could be a bit of a blow for those destinations.
Again, because tour operators are hedged for their currency, package products will be less adversely affected.
Also, woe betide anyone who had planned a ski holiday to Switzerland this Winter – the decision of the Swiss National Bank to remove their currrency’s linkage to the Euro has had a massive impact on the strength of the Swiss Franc.
The next problem that those who do hedge their currency or fuel have to face is determine the right time to make those hedging contracts for future seasons.
If we are being honest, there is not a lot of science about hedging, whatever the experts will tell you.
In general, the rates at which fuel or currency is sold for future seasons is generally fixed at or about the rate at which they are being sold today.
As a result, if an operator buys their fuel today, and there is a further 20% cut in the price, the operator fails to get the benefit of the price cut.
However, if the price starts to increase, and you are not hedged, then this can make a massive difference to the profitability of the operator.
Historically, the timing of the hedging has been to coincide with brochure costing – so the operator has some certainty as to the prices at which they will be selling, and is able to lock in those prices.
However, the other big variable is customer demand. If customers are buying later, would the operator do better to wait to make their hedging decision to coincide with the peak demand period?
What is clear from this is that there is no easy answer – and that in practice, the topic of hedging is a bit of a black art. It is a good means of de-risking a business, but may come at a cost.
What should be clear is that saying that holiday prices should track changes in fuel and currency rates is both simplistic and naïve – but, sadly, we can expect nothing less from our politicians.