Much ink has been poured over the fuel hedging issues of Air Mauritius. Many have blamed the top management of Air Mauritius over “wrong” fuel hedging decisions. I am no fuel hedging expert but I wonder whether the decision to sign the hedging contract was “wrong” given the context at the time it was signed.

At that time the price of petrol reached about $150 per barrel from the usual $40 per barrel. Most of western media claimed that the increasing demand from developing countries were to “blame” for the increases in energy and food prices. The “experts” were predicting that the price would reach $200 at the start of this year.

This volatility in oil prices puts airlines at risk. Fuel hedging is a financial tool that can help stabilise the price of oil for the duration of the contract.

Wikipedia defines fuel hedging as:
A contractual tool used by some airlines to stabilize jet fuel costs. A fuel hedge contract commits an airline to paying a pre-determined price for future jet fuel purchases. Airlines enter into such contracts as a bet that future jet fuel prices will be higher than current prices or to reduce the turbulence of confronting future expenses of unknown size. If the price of jet fuel falls and the airline hedged for a higher price, the airline will be forced to pay an above-market rate for jet fuel.

Air Mauritius simply choose to believe the expert’s predictions that oil prices would go up and signed a hedging contract. Paying $105 per barrel is really a deal compared to $200 per barrel at predicted market prices. Frankly speaking had I been in the decision maker’s boots at that time and given the context, I would have taken the exact same decision. I would have signed the hedging contract.

Now that the oil prices have reached the same $40 per barrel as before, Air Mauritius is paying oil at a higher price than the actual price. Fine but still I fail to understand how they can be in a difficult situation as a result of this. Maybe an expert may help me understand this one.

My point is, when they signed the hedging contract they knew that they would pay $105 for the 2 years to come and this should have been budgeted for. They should know in advance where they are going to get the money to buy this oil. Would it be the lost of competitive advantage with airlines who chose not to go for a hedging contract? or is it more of the decrease in arrivals due to the financial crisis?

Anyway more airlines are facing the same fuel hedging issue as Air Mauritius. Examples are Air China, Southwest Airlines and Polish Airlines. I do not think I can blame top management of Air Mauritius on this particular issue. Maybe on other things like their hefty bonuses etc .. :S