00:00:00 Speaker 1: Hey, Odd Lots listeners, the Odd Lots tour continues and our next stop is in Chicago. 00:00:04 Speaker 2: That's right. Joe and I will be at the City Winery Chicago on October 15th for a live Odd Lots recording. Tickets are on sale now at Bloomberg.com forward slash Odd Lots. 00:00:15 Speaker 1: And of course, a special thank you to Barclays for supporting Odd Lots Live. 00:00:19 Speaker 2: So that's October 15th at City Winery in Chicago. Get your tickets now. 00:00:27 Speaker 1: Bloomberg Audio Studios. 00:00:29 Speaker 2: Podcasts, radio, news. Hello and welcome to another episode of the Odd Lots Podcast. I'm Traci Alloway. 00:00:47 Speaker 3: And I'm Joe Weisenthal. 00:00:48 Speaker 2: 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. 00:01:15 Speaker 3: I actually didn't know this. 00:01:16 Speaker 2: Yes. 00:01:17 Speaker 1: This is an industry thing that I didn't know that they have a reputation or a pattern of. 00:01:23 Speaker 2: 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. 00:01:42 Speaker 3: Because when you. 00:01:43 Speaker 2: 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. 00:02:03 Speaker 1: 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, they're usually jumping oil. 00:02:13 Speaker 3: There's something people talk about the airlines. 00:02:16 Speaker 1: And we've all said it. 00:02:17 Speaker 4: Right? 00:02:18 Speaker 1: This is what I'm fascinated by. All of these things that we talk about all of the time. 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. 00:02:52 Speaker 2: The other thing about fuel and airline costs. 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 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 surcharges. 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... Yeah, yeah. 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. 00:03:55 Speaker 3: Airline prices are very expensive these days. 00:03:57 Speaker 4: Yeah, they are. 00:03:58 Speaker 3: But bookings are really high, too. People are flying. 00:04:01 Speaker 1: And I keep seeing all these things, new TSA records, new global records. 00:04:05 Speaker 3: We are flying a lot in this world. 00:04:07 Speaker 1: 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 going to lose money. And then it's like, OK, well, here's my opportunity, et cetera. So I'm very curious about how it all works, how. 00:04:23 Speaker 3: It feeds through. 00:04:24 Speaker 1: And I'm just to a little bit of context, according to September 29th, back in February or March when the Iran war broke out, we were all staring at that Singapore jet fuel chart. 00:04:35 Speaker 2: Well, one of us was. I was staring at the Europe jet fuel versus Brent crack spread. That's the difference. 00:04:44 Speaker 1: Sorry. 00:04:45 Speaker 2: No, but it is true. 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 stock. 00:05:08 Speaker 3: Do you want me to pull up a ticker for you right now? 00:05:09 Speaker 2: 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 of years. Just don't zoom out. 00:05:29 Speaker 3: No, wait a second. It's not that bad. 00:05:31 Speaker 1: Look, look. 00:05:33 Speaker 3: It's actually like, I was expecting worse. 00:05:35 Speaker 1: 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. 00:05:42 Speaker 4: Yeah. 00:05:42 Speaker 2: So. 00:05:45 Speaker 2: 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 All Thoughts. 00:06:06 Speaker 4: Happy to be here. 00:06:07 Speaker 2: 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. 00:06:24 Speaker 4: That is a long story. And I'm going to pretty much put into a synopsis where I traded effects 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 I Came back to Singapore, joined NatWest, sent to London to sell government bonds, and then became a bond trader with a 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 J.P. Morgan for Asia, the head of commodities for them, basically asked me to join him. 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. well, the aviation industry and how technical it gets and how interesting it can get as well. It's a very interesting sector. 00:07:46 Speaker 1: 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? 00:07:54 Speaker 4: 2011 to 2013. Well, two and a half to nearly three years. 00:07:59 Speaker 3: Got it. 00:08:00 Speaker 1: 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? 00:08:12 Speaker 4: The actual title is vice president, treasury, and risk management. 00:08:17 Speaker 2: Okay. 00:08:17 Speaker 4: 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. 00:08:29 Speaker 2: Who actually hedges? Because my understanding is that some of the U.S. carriers weren't as prevalent when it comes to hedging as they had been in the past. 00:08:38 Speaker 4: I think the U.S. carriers aren't as prevalent. It's because they got smacked in 2014 and 2015. So they realized, right, Delta recently, 2020, 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 to pass all the costs on to the customer. And 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? Take it. So in that aspect, that's when some of the U.S. carriers actually dropped out 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've got LPG at the top, then you've got gasoline, and then you've got NAFTA, and then after that you've got your mildews, jet kerosene, and then your gas oil, and then after that the fuel residue. So all these are products that come out 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 product, which is basically producer hedging because it's called revenue hedging. They've got revenue here because they're selling the product. They're also buying, so they're at risk. So they need to buy the crude. So the same thing happens with airlines. And airlines, what we do is, 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 three more million barrels and then added up. So we hedged, 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'd get 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. 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 at the bottom and hedging. But sometimes you have to look at the price really and start to think about it. And what's your probability when oil goes at triple digit? Because you use Brent as your proxy because the jet fuel market is too thin. Or the American carriers use heating oil as their proxy, not jet. Because like I said, the jet market is too thin. Northwest Europe, SIFJET, 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've got Glencore, Mercuria. The list goes on, right? VTOL. You'll also jet fuel to be online. Morgan Stanley was the two as well. I've dealt with Morgan Stanley, Goldman Sachs. I bought physical jet from them at certain locations around the planet. 00:13:21 Speaker 1: 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? 00:13:45 Speaker 4: Well, there's a swap. And the swap is 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 rate. So you would buy swaps. And when you buy swaps, it's symmetric. So, I mean, you could go up or go down and you could, you know, and if the price of all goes up, you're looking good because you've locked in your exposure and you've locked in your costs. But if it goes down, you bleed. So it's best to do swabs when I think oil is low and it's in the lower double digits, somewhere around $ 25, $ 35. It's not an issue to buy swabs. 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 elevated? So they'll try and do options. So they'll buy call options, but thing is you have to pay for that insurance. You have to pay a fee. You have to pay a premium. 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 all they can afford is zero cost color. And they can use that. So you can buy options. You can do zero cost colors and you can do swaps. These are pretty much plain vanilla. But the stuff that I used to structure for J.P. 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. 00:15:31 Speaker 2: So the idea is that we have banks that are actually selling target redemption notes for the purposes of fuel hedging to airlines. 00:15:39 Speaker 4: Okay. On the vanilla side, you do a zero cost collar with the airline. If I'm the bank, But on the back of it, I structure the note as a target redemption note. That means it's basically going to redeem in five months, 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 call options. That means I can basically pull the call options, but they're actually inside the money. It's like they're in the money. 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, a strangle. That means basically I sold both wings. I sold calls at the top above $ 120. I sold puts below $ 80. And wherever oil stayed in between, I would profit from that because The banks will be paying me the premium. 00:16:51 Speaker 2: 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, yeah, to, you know, mom and pop, someone betting on like a big move or lack thereof in the Kospies, something like that. I hadn't even thought for a second that it could be related to fuel. 00:17:08 Speaker 4: Yeah. 00:17:11 Speaker 2: 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, I guess, the direction of the price of jet fuel and the price of Brent? Because sometimes, you does change very fast and very quickly, as we saw earlier this year? 00:17:41 Speaker 4: It's a fair comment, right? I would say yes and no. So yes to the fact, right, that as an airline, what do we burn? We've been 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. If you cannot hedge in gent, then you're totally exposed, right? So for lack of a better proxy, 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 and heating oil in the United States is tighter than what you would get. I mean, just recently you had heating all versus TI go through a hundred dollars for the crack. Is it 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 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. But sometimes the market is 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, with their jet forecasts. So they move either something they understand better and it's more liquid, like gas, London gas oil, heating oil in the United States. 00:19:55 Speaker 1: I just pulled up a chart, speaking of charts, on the terminal. And it's very interesting because if I go back, 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. 00:20:33 Speaker 4: Is true, but when I buy Singapore Jet Fuel, except for the incumbent. 00:20:39 Speaker 3: Wait, say that again? 00:20:41 Speaker 1: Can you explain what is, when I look at, tell me about this chart that we always pull up. 00:20:45 Speaker 3: Is it not that meaningful? 00:20:46 Speaker 2: Stop saying we, Joe. 00:20:48 Speaker 3: Sorry, that I. 00:20:49 Speaker 1: 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. 00:20:58 Speaker 4: 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. Everybody else does not. 00:21:45 Speaker 2: 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? 00:22:06 Speaker 4: 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 uh you know the 2026 war between iran and the us and israel a lot of times right it's 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 level as it moves up so you're making money and you've locked in your costs 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. The surcharge doesn't go through P & L, but the hedge goes through P & L. So then if the hedge goes up, 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 the market's still going up, the economy's 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 while you can. But at the same time, you've got to be very aware and situationally aware that, like I said, it's like a refinery. Your ticket is the product. In that product, you have the ticket price. Now, nobody tells you what the ticket price is, but right now, I'll tell you, because of the fuel surcharge, the ticket price is probably 25% of the ticket charge. 00:24:16 Speaker 1: And that's true. You would say that would just be generally true globally, on average, right now. 00:24:22 Speaker 4: Pretty much. 00:24:23 Speaker 1: Anyone who 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? 00:24:45 Speaker 4: 44%. 00:24:46 Speaker 3: Did you say 44%? 00:24:47 Speaker 4: 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. 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. Wow. 00:25:40 Speaker 2: So you mentioned having to get creative, and this is actually the way you came to this particular program. But you published a paper all about a particular hedging strategy that you undertook while you were at Qatar. Why don't you, just to begin with, explain to us the problem that you were trying to solve for your employer here? 00:26:01 Speaker 4: I'll just run this anecdote for you, just a little story. I'll keep it very short, right? But basically, our hedge book was down. a very decent amount of money, something like $ 280 million. So that's when I came on board and I had this hedge book and we were down $ 280 million. And as I was learning about the airline, because I come from a trading background, I'm not a corporate guy. So I have to learn how to be a corporate person. I have to learn about what the treasury is about and what the hedge book has and how I can add value. And in that time that I was trying to learn and add value, we were down to, we were at one point down $ 360 million. And so the CEO calls the CFO and I up to his office to chat with us. And basically he says to the CFO, Daniel Ho, when he says, Dan, why are we down $ 360 million? And I had just come on board, right? And I'm the group treasurer. And he, you know, do you know what a hospital pass is? Basically you pass the ball and you know, everybody's running for it and everybody can see you're going to get the ball and you get smacked. So that was me. So I got the hospital pass from Daniel and I talked to the CEO and I said, look, right. You know, chief, when oil goes up, right. We make money on swaps, right. You know, we lose money in the physical because we don't pay more, but we float in our exposure. And then when oil comes down, yes, we're losing on the hedge book, but jet fuel comes down as well. And when jet fuel comes down, we're making on the physical. And he said, look, you are losing on the hedge book. You're also losing on revenue management because, right, if oil is coming down, that means the probability is at that time when I was at Qatar Airways, the probability is that the global economy is not doing too hot. So it's not doing too hot, right? we will not be able to have people sitting in their seats. We cannot fill up the plane. So the aircraft is not going to take off. If the aircraft doesn't take off, we have fuel that we haven't burned. So we're losing money. We're losing money on revenue on the ticket, and we're losing money on the hedge book. And that was a double whammy. So the CEO was very, it was tough. He said, David, you're the group treasurer. I do not want to see you read any more on the balance sheet, do you understand? So that's when I came away from that meeting with him, with this now awareness that I actually had to do something where it's either we come out flat or make some money, but no red. So that's one of the reasons why I did what I had to do and get creative. 00:29:07 Speaker 2: So this actually reminds me one of the first things that I learned as an airline correspondent, which was someone who had been in the business for a very long time as an airline consultant, basically told me that it's very much like running a grocery business in the sense that you have these fixed perishable costs. And if you don't sell everything right away or fill up the capacity of the airplane and all those costs, you eat them, right? It's like, you know, I don't know, you have like 10 bags of lettuce. Cauliflower, yeah. If you don't sell it on that day, you lose all that money. And so I always thought of airlines and air travel as this very perishable industry, even though one big part of the expense is very, I guess, fixed cost in the form of aircraft. But you have to get people in the plane- At a particular price on a certain day. Otherwise, you just lose money. 00:30:01 Speaker 4: Right. 00:30:01 Speaker 1: I guess the idea is airline capacity is not something that you can hold in inventory. 00:30:07 Speaker 4: Right. 00:30:08 Speaker 2: Exactly. 00:30:08 Speaker 4: Yeah. 00:30:09 Speaker 1: It's super interesting, and I hadn't really thought about it that way. So, okay, your boss comes to you and says, stop losing money. I guess every boss of every trader everywhere would like to say that. 00:30:21 Speaker 4: Do better. 00:30:22 Speaker 1: Now you have your suddenly stop losing money thing. mandate in this environment what do you do after. 00:30:29 Speaker 4: That i sat down with my deputy treasurer and uh you know talked about it and looked at it from many different angles and you know then of course me coming from an oil trading background i look at a refinery and i see that they're a consumer and they're a producer and so i said look as an airline we have to produce something we're producing a seat for you to sit on to get you from point a to point b so we're producing that seat But what's in that seat? What goes on? So we kept on extrapolating until the point where we got the ticket. And then in the ticket, you have your fuel surcharge. And we ran correlations between the fuel surcharge and Brent. And the correlations came back around 75%, which is significant. And of course, for our hedge fund, and we buy the swap, right, we're 88% hedged, about 88% correlated with Jet. So the fuel surcharge is 75% correlated with Jet, and our Brent is 87% or 85% correlated with Brent. So we use Brent as the proxy, and in the surcharge, right, we now knew there was a correlation there. So that we can hedge. That is a product. That is something we sell. So in that ticket, we have a product and we have revenue and that's where you do revenue hedging. So you have consumption hedging and you have revenue hedging. So that's how we came, you know, we really extrapolate out the curve. We, you know, we sat down for a couple of weeks and really brainstormed and we came up with this. And from there, we went to the revenue management department, talked to Ankur Vandiver, who was the senior VP at that time of revenue management and his right-hand man, Sven Larsen. And we talked about this and even they didn't realize, right, that they were actually, they actually were long oil. I actually said, you know, you're long oil. That's how you get your revenue, right? Because you've built that long oil. 00:32:38 Speaker 2: Through the surcharge, right? Yes. Wait, so the basic idea was that because the airline was in fact long oil, because you could charge higher prices when oil prices went up. that you could use that to buy a certain option strategy that would have been riskier without the extra operating revenue. Is that what you mean? 00:33:04 Speaker 4: Absolutely. All right. So what happens is now we're long fuel on one side on the ticket. We're short fuel because to fly the plane or to fly the aircraft, you need jet fuel to take off. So we're short fuel on one side, but long fuel on the other side. So now... What do we think about? We think about doing like a producer hitch. And that's one of the reasons why we did the strangle where we sold calls. Now, uh, when we sold calls, they're not naked because right. They had the surcharge in there protecting that call. So yes, if we got, if the calls got taken out or, you know, they were exercised. Yes. A surcharge would take care of that call of those calls that we sold. So we're protected there. Now, on the downside, we've sold puts. Now, if the oil goes down and we're selling puts, it's good for us anyway. So yes, we'll eat some loss on the puts, but the thing is we're going to be buying cheaper jet because it's going down in price. So this whole strangle or this strategy, there was no, for lack of a better word, nudity to it. There were no naked parts to it. And we covered all bases. We looked only at direction, not so much. We didn't take a view of where oil was going to go. What we did was, right, we understood that there would be a price mean reversion. It was holding at a hundred bucks. It would do that for five months and we would come away either flat, slightly losing a little bit of money or making a decent amount. And we kind of got lucky. 00:34:50 Speaker 2: It had to stay within a certain band, right? 00:34:53 Speaker 4: Correct. 00:34:54 Speaker 3: Okay, okay. 00:34:55 Speaker 1: So this is very interesting. I guess from the perspective of any... You know, again, I think in our heads, someone hears the word trader, and they think someone at their computer trying to make money, right? And every day you're trying to get more cash, etc. However you want to do it. How much then... of the job of the trader in any corporation, not the speculator, but the someone who's using the markets for their own business needs, how much then is the job to actually identify the natural trade of the corporation? So what you discovered or what you were able to clarify is that because of the ticket charge, Qatar Airlines was structurally long-branded. So that allowed you to create this sort of position without a view. So how much is the job of anyone in your seat, either today or at a different airline, or maybe even a different company who is in a trading capacity to truly understand the business so that they understand, you know, what is the company's sort of, I guess, natural exposure or natural direction to any given market? 00:36:13 Speaker 4: I've only worked for an airline in a corporate sense, so I can only talk about that. But what I can say is that the word hedging is a bit of a misnomer. 00:36:23 Speaker 3: Okay. 00:36:24 Speaker 4: It's actually a view, right? It's actually a trade. And it's a good word that you said that, you know, these traders in the corporate, they don't call themselves traders because, right, that sends compliance into a fit because they believe that hedging is is good for them. So compliance goes ballistic. And they'll say, no, no, we're not trading. We're hedging. So what do we hedge? We're a consumer. We have to buy whatever we're consuming in order to lock that price in. If we're a producer, we've got to sell to make sure we lock in our revenue that we made at the top. So the word trading is not very well accepted at corporates. They don't believe in it. And auditors don't like it either. But I think if I can find that little bit of a tweak where I can get something as a product and the product is linked to the underlying risk that I have, which is exposure to jet fuel, I'm sure in another company you can find links like that. And then you can put on hedges that will protect you. It's like the food market. It's perishable. It's got to be within one day. I'm sure that somebody's going to be able to find out that with certain techniques they can prolong that. And by prolonging that, now they're long vegetables. They're not short. Something in that vein. 00:37:51 Speaker 2: I just want to hear the sort of stories of how much money you made from this particular hedge and what happened at Qatar Airways when this was unveiled to your management. 00:38:05 Speaker 4: Okay. It was $ 130 million. And actually that year our revenue side lost 65. So if not for my hedge, we would have lost money. But on top of that, because of my hedge, right. Going out the curve, we may have lost that money at that time, but because of that hedge and making money, I was able to give the revenue department the ability to cut fares. So Qatar Airways used to be a follower. They'd follow EK, sometimes even EY, right? So EK is Emirates, EY is Etihad. So they're always a follower. And when Emirates cut, then they cut fares, right? When Emirates put up the fares, they put up their fares. But I worked with Ankur and I gave him advantage, first mover advantage, and he took advantage of that. And he cut fares by 20% and then we led the market, right? And sorry to say, bums on seats. We sold. I mean, you know, we had every plane that was nearly 80 to 90% full. So we were able to give them that ability and they were able to make use of it. So I think as with anything that you do in life, you always try to add value to that food chain. 00:39:37 Speaker 2: Since you brought up the other Middle Eastern airlines, I'm going to ask what is a potentially sensitive question, but I'm sure a lot of people will be wondering about this. There are many sensitive questions I could ask when it comes to the Middle Eastern airlines, but this one in particular, the UAE, Qatar, a lot of those regions are supposedly not drowning in oil, but they have a lot of oil. Why the need to source jet fuel externally in the first place? Why couldn't, you know, these countries subsidize, subsidize? I'm using air quotes here for those watching on video. Why couldn't they subsidize their airlines with, I don't know, exchanging Brent with a refinery down in wherever for a lower price jet fuel for their airlines? 00:40:26 Speaker 4: I think with the airline industry, because you have a hub. And then you have your spokes, right? So you fly all over the world, but everybody flies through the Middle East. Now, we can only take so much jet fuel on one aircraft and we go long haul. We've got to fill up on the other side. So, I mean, it's the other side who basically commands the price. So it's not us, right? 00:40:52 Speaker 2: I see. 00:40:52 Speaker 4: So, yes, I mean, you know, with Qatar Petroleum, right? Okay, just... It's not the most pleasant of experiences dealing with QP because they had a subsidiary named Wokod, W-O-K-Q-O-D, Wokod. And they used to sell us jet fuel at 3.65 a gallon. And when we fly to Dubai and lift jet from Dubai, Chevron's selling it at 295 a gallon. So we were getting screwed 70% by our own national petroleum company. 00:41:29 Speaker 2: That's amazing. 00:41:29 Speaker 4: So, you know, when we took delivery of the 787s, the Dreamliners, we told the world that we were using them for training by going to Dubai and back, right, to train the crew. But actually we were going there. Literally we flew there on fumes, probably like, you know, we had like, Five tons or less, maybe four, three or four. We're flying there on fumes and literally we cannot circle Dubai airport once. We have to land straight away. And when we land, we can lift a hundred tons of fuel. 00:42:07 Speaker 2: You were tankering fuel from Dubai. 00:42:09 Speaker 4: Yes. Yes. And we were putting it in our own tanks at Doha international airport. And we had about storage capacity of about 9, 10 million gallons. So, you know, that's pretty decent. It will be a day's cover for the airline should we not get any jet fuel from anywhere else. We can still fly for a day. 00:42:31 Speaker 3: Interesting. 00:42:33 Speaker 1: Give us your sense right now. The people who are in your seat or equivalent seats elsewhere in the industry, give us an update of what they're dealing with right now, September 29th. between the ticker revenue side, which I assume is booming, and then the price of, you know, the surging price of oil and refined products? 00:42:52 Speaker 4: I think with respect to airlines or respect to. 00:42:57 Speaker 3: Yeah, with respect to airlines. 00:42:58 Speaker 1: What is the, what is the, how are they doing on the sort of fuel side these days? 00:43:03 Speaker 4: I think they're very wary of the consumption hedging, and they're mainly passing it through to the customer right now because they don't know what to do. Because, you know, a lot of airlines in 2020 lost a lot of money. Fuel hedging. Delta dropped over $ 1 billion. Let's just say a very highly ranked Asian airline basically lost nearly $ 2 billion. And, yeah, so, you know, it's not easy to work or to see what the geopolitics are bringing you. But what you can do is look, right? At the end of the day, it's a pass-through to the customer. So you use your ticket as your weapon of choice. And that's pretty much what I did as well. This pricing mechanism that I kind of thought up, I basically weaponized the revenue. 00:43:59 Speaker 2: Has anyone else used that structure since? 00:44:03 Speaker 4: You know something? I have no idea. But I was going to attend a treasury conference in Singapore to talk about what I had done And my CEO said, no, go, you're not talking at that treasury conference, right? Because we do not want to give our secrets away because nobody else is doing it. And one of the reasons why they're not doing it is because, again, it's the auditors, it's the sovereign wealth funds that probably own some of the airlines that are not, they don't feel it's kosher to sell oil because you're a consumer. I think it's a lack of understanding. for most people and a lack of understanding for most treasurers in their roles there that they cannot think like a horse with blinders. They cannot only see that basically by hedging the airline and keeping it safe, all you see is buying fuel. There's other aspects of the airline as well. And you've got to take all that into account and then cook up a strategy of your own and create something so that you can benefit from it. 00:45:13 Speaker 1: So I realize that this isn't strictly an airline question right now, but it's in the news. It is a refined products topic. There's all this talk and it could happen, this idea of, you know, we have this diesel crisis in the United States. Diesel prices are surging. It's possible that the U.S. is going to implement a ban on diesel exports. When you hear this, what do you think about? 00:45:40 Speaker 4: Okay, maybe it's not right for me to say this, but I think of taco. You know, trumpled chicken. 00:45:45 Speaker 3: Yeah, yeah, yeah. 00:45:47 Speaker 1: But specifically on this question of whether a country will ban the export of a refined product and how it ripples through markets. 00:45:56 Speaker 4: Well, Russia's done that, and China's done that somewhat, all right? But Russia's the second biggest diesel exporter on the planet. So a lot of diesel has been taken out of the whole complex. And honestly, right now, Europe's pretty short, and that's one of the reasons why London Gas Hall has just gone through the roof. Also, this export ban, a lot of it was rhetoric. So because of that rhetoric, you had diesel or heating oil in the U.S. come down instead of go up. Because a lot of the Gulf or Pad 3 in the United States is the kitchen. That's where all the refineries are. And so that's where all the product comes out of. New York Harbor, right, it's, you know, they don't have any access. They maybe have a small pipeline, but that's about it. For them, it's a seaborne trade for the Gulf to sell internally, right, to New York for their jet fuel or their diesel or their heating oil. So a lot of times what the East Coast does is they buy diesel from Europe. in order to make sure that they don't have, you know, a shortage at any one time. And so it now adds the point, right, that you've got the East Coast of the United States buying diesel and London Gas, all of course, is benefiting from that and heating oil is now taking a hit. And most of the heating oil, right, is going to Latin America anyway. So not very much is going to Europe, probably like 500,000 barrels per day. It's going to the ARA, 100,000 barrels a day to the UK and maybe 150,000 to the rest. Oh, sorry. ARA is Europe. So yeah, it's not, it's not super significant from the Gulf, but I think there's a US Gulf coast trade where, you know, they'll run an AfriMax or they'll run a, you know, long range two or maybe even a Panamax through the Panama Canal and they'll transport that product to Asia. So it's going from the U.S. Gulf Coast to Chubu in Tokyo or in Japan. 00:48:13 Speaker 2: Can't wait to heat my house in Connecticut this winter. David King, thank you so much for coming on OddLots. I should mention the paper if anyone wants further details. It's available on SSRN. It is Fuel hedging in the 21st century, what every airline can learn about proactively shaping revenue. Thanks so much, David. 00:48:34 Speaker 4: Thank you very much for having me. I appreciate it. 00:48:49 Speaker 2: Joe, I'm so glad we finally got someone to talk about fuel hedging in detail. I have to say, the story about Qatar Airways tankering oil from Dubai back to Doha is one of my now all-time favorite airline fuel stories. My top story, I've told this on the podcast before, but I think it's been years, was when Silverjet, the business class only carrier, sort of luxury airline carrier, when they were about to go out of business. their creditors cut credit lines for fuel spending. And so the CEO of the company was putting the entire fuel bill on his personal credit card. You hear about stories like this. The personal credit card. the rewards points were for British Airways miles. So he ended up with a bunch of BA miles. 00:49:40 Speaker 4: That's amazing. 00:49:41 Speaker 3: That's great. 00:49:43 Speaker 1: FedEx got its start too with a bunch of like the founder putting a bunch of the debt on his personal credit card. It's pretty wild. 00:49:51 Speaker 3: To think about. 00:49:52 Speaker 2: I thought that was great. 00:49:53 Speaker 1: I think the really interesting thing from that episode to me was I know, I guess it's interesting, and I'm not surprised. They don't like the term traders in the corporate context, but that's what they are. 00:50:05 Speaker 2: Right, you have to have a directional view. 00:50:07 Speaker 1: Selling calls and buying puts and all this stuff. But the idea is, again, like, you know, a trader in the typical environment is just seeking to max out P & L. And this idea that it's like, you don't have to take a directional view if you really understand the core idea I guess, structural position of the company already on the market. And the job is to balance that out. And you can understand how complex it gets because, you know, this idea that like, OK, the revenue could go up during times of higher oil prices, figuring out that sensitivity, how much you can pass through. You think of like an airline, of course, they're short oil, right? Of course, they're implicitly short oil. And that in certain environments, they could actually be implicitly long oil. And you have to really identify that exposure. I think that's really interesting. No, totally. 00:50:56 Speaker 2: I think this is an underappreciated aspect of the airline business, which is there is that other lever to pull. And it's sort of it reminds me of the bakery episode. 00:51:06 Speaker 3: Yeah. 00:51:06 Speaker 2: Remember where we were talking about how a baker in Chicago increases his prices when the cost of eggs goes up because everyone sees it in the news. There's a lot of elasticity, I guess, baked in. to prices for airfares when you're having a big oil shock. But on the other hand, if we, you know, evolve into actual physical shortages, which is a possibility, I guess we'll see what happens then. 00:51:31 Speaker 1: When I just right now think about the airline industry seems to encapsulate so many things with the economy right now, which is that like the cost of everything is going up. And also people are flying like crazy. I mean, the numbers are really huge. And so it's like, At least if we were to only look at the airline industry, we're like, the global economy, the. 00:51:53 Speaker 3: Economy is hot. 00:51:54 Speaker 1: People look at these sticker prices. They complain about how they know prices are going up, and yet total travel just keeps going up. 00:52:04 Speaker 3: It does not seem to have dented activity at all. This is a hot economy. 00:52:09 Speaker 2: All right, shall we leave it there? 00:52:09 Speaker 3: Let's leave it there. 00:52:10 Speaker 2: This has been another episode of the All Thoughts Podcast. I'm Traci Allaway. You can follow me at Traci Allaway. 00:52:16 Speaker 1: And I'm Joe Wiesenthal. You can follow me at The Stalwart. Follow our producers, Carmen Rodriguez at Carmen Irma, Dashiell Bennett at Dashbot, Cale Brooks at Cale Brooks, and Kevin Lozano at Kevin Lloyd Lozano. And for more OddLots content, go to Bloomberg.com slash OddLots. We have a daily newsletter and all of our episodes. 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