Comments On MAS Oil Hedging Losses

Posted yesterday: MAS Suffers A Whopping 640 Million In Fuel Hedging Losses!!!

Maverick said...

• It also restated accounts from last year. It's shareholder equity is totally wiped out, negative equity ...........! From plus 4.2 billion to minus 446 million.
  
  Is this "hedging"?
  
  Totally insane!

I am actually not surprised after been given the heads up from Ah Beng and also the article highlighted in the posting And What About MAS Oil Hedges?

On the Edge Financial Daily, MAS explains unrealised fuel MTM loss of RM3.38b (MTM losses were as what was highlighted in the earlier blog posting And What About MAS Oil Hedges? _

• MAS explains unrealised fuel MTM loss of RM3.38b
  Written by Joseph Chin
  Friday, 12 June 2009 20:04
  
  KUALA LUMPUR: Malaysian Airline System Bhd (MAS) reported an unrealised fuel mark-to-market (MTM) loss of RM3.38 billion for its first quarter ended March 31, 2009, triggered by the unprecedented collapse in fuel prices in late 2008 and early 2009.
  
  Explaining the MTM loss, it said on June 12 the net unrealised MTM position was mainly due to fuel hedging contracts with maturity over a three-year period up to Dec 31, 2011. However, it said the unrealised fuel MTM position would fluctuate subject to the movement in the fuel forward curve.
  
  “On a comparable basis, using fuel forward curve as at May 29, 2009, the unrealised fuel MTM loss has reduced by RM1.15 billion,” it said. MAS added total fuel volume hedged as at June 8, 2009 was 21.9 million barrels for the periods up to Dec 31, 2011.
  
  “As of March 31, 2009, MAS has hedged 47% of its fuel requirement at US$103 per barrel for the rest of 2009. The average hedged fuel prices for 2010 and 2011 range from US$90 per barrel to US$100 per barrel,” it added.
  
  The national carrier posted net loss of RM694.8 million in the first quarter ended March 31, 2009 compared with a profit of RM46.6 million a year ago. The net loss included derivative loss of RM557.0 million with the early adoption of financial reporting standards (FRS 139).
  
  In a statement to Bursa Malaysia, it said that it has applied and been granted a conditional waiver until Dec 31, 2009 from being categorised as an Affected Listed Issuer under PN 17 after it triggered the criteria under Paragraph 2.1 of PN 17 in relation to shareholders’ equity.
  
  “With an early adoption of FRS 139 and a net unrealised MTM loss on derivative financial instruments of RM3.32 billion, the group equity holders’ fund as at March 31, 2009 is negative RM458 million," it added.
  
  MAS also said the board had approved the early adoption of FRS 139 to allow MAS’ financial statements to be directly comparable to most major international airlines and to improve transparency of the financial statements.
  
  To recap, MAS said it adopted a competitive fuel hedging policy, whereby it strives to have similar fuel cost with its peer competitors. It gradually built its hedging portfolio throughout the year. Due to the unprecedented collapse in fuel prices in late 2008 and early 2009, these contracts were in MTM loss position.
  
  It said these were unrealised losses as the fuel hedging contracts would mature over a three-year period up to Dec 31, 2011. The unrealised MTM position would fluctuate based on the movement in the fuel forward curve. As at March 31, 2009, the unrealised fuel MTM loss was RM3.38 billion.
  
  MAS said that notwithstanding the voluntary early adoption of the new accounting standard and the net unrealised MTM position, the group's operations remained robust and the “going concern” assumption remains valid.
  
  In approving the early adoption of FRS139, the board has had taken into consideration :
  
  i) the group's cash balance remains strong, at RM3.77 billion as at 31 March 2009 including negotiable instrument of deposits;
  
  ii) on non-FRS139 basis, the group Equity Holders’ Fund will be at RM3.39 billion as at March 31, 2009; and
  
  iii) on FRS139 basis and using comparable fuel forward curve as at May 29, 2009, the group proforma equity holders’ fund would have been RM692 million as at March 31, 2009.
  
  “The reduction in the group equity holders’ fund does not trigger any default or cross default of its financial facilities,” it said.
  
  To improve its equity, MAS said it planned to gradually lock in the MTM gain when the opportunity arises (fuel forward curve moves upward) and deliver underlying operating profit.
  
  On the underlying performance, MAS said it would continue to fast track the implementation of its Business Transformation Plan (BTP 2), based on dynamic pricing, network optimisation, cost management and innovation.
  
  “The board of MAS is committed to these ongoing measures and strategies to cease or avoid triggering the PN17 criteria by Dec 31, 2009,” it added.
  
  As part of MAS’ enhancement in its risk management practices in relation to its fuel hedging policy, MAS will continue to selectively buy put options which will reduce the existing fuel hedging downside exposure. This will provide certain protection with respect to unrealised MTM exposure in the event the fuel price moves downward.
  
  On the conditional waiver from PN 17, MAS said Bursa set four conditions:
  
  Condition 1: The conditional waiver was only for unrealised MTM losses for fuel hedging contracts arising from the adoption of FRS 139. If MAS triggers the PN 17 criteria due to reasons other than the above (e.g. realised losses from hedging contracts), the above conditional waiver will not apply;
  
  Condition 2: MAS must ensure full compliance with FRS 139 in recognising and measuring all the financial assets, financial liabilities and certain contracts to buy or sell non-financial items as stipulated in FRS 139 in all its financial statements issued in the financial year 2009;
  
  Condition 3: MAS is to take all necessary measures to cease or avoid triggering the PN 17 criteria by Dec 31, 2009. If MAS triggers or continues to trigger the PN 17 criteria after the expiry of the conditional waiver (Dec 31, 2009), MAS would be required to fully comply with PN 17 requirements;
  
  Condition 4: MAS must take the following disclosures in its quarterly report(s):
  
  i) a Proforma balance sheet position in its quarterly report (“QR”) ended 31 March 2009, showing shareholders’ equity based on MTM valuation of the fuel hedging contracts as at 29 May 2009 under the FRS 139 reporting principles;
  
  ii) a Proforma balance sheet position without FRS 139 in all its QRs for financial year 2009;
  iii) total realised and unrealised losses due to fuel hedging contracts under FRS 139 for financial year to-date in all its QRs for financial year 2009; and
  
  iv) the status of the measures as referred to in Condition 3 above in all its QRs for financial year 2009.
  
  The conditional waiver granted by Bursa was after taking into consideration of, amongst others, the following factors:
  
  i) high volatility of the underlying assets (i.e. fuel) hedged by MAS which is subject to MTM valuation giving rise to fluctuations in the group equity holders’ fund.
  
  In this regard, it is noted that the group equity holders’ fund was negative for the quarter ended March 31, 2009 based on the pricing of fuel price at the material period but positive based on the comparative fuel forward curve as at May 29, 2009; and that the MTM losses of the group’s fuel hedging contracts are unrealised losses.

Couple of things.

From what I see from below shot of MAS balance sheet taken from its earnings notes last night, cash balances should be around 3.4 billion. Not sure how 3.7 billion was mentioned.

Cash in the piggy bank is a lot - no doubt.

But if you look at the below, you can clearly see that MAS was in a MUCH STRONGER position last year. And some of the critical mindset would quickly highlight this as deterioration.

And the loans increased too.

From Business Times : MAS fuel hedge losses 'on paper' for now

• ... MAS' negative equity was attributed to unrealised mark-to-market losses from its derivative contracts, which will now be recognised on its balance sheet.
  
  "Effective January 1 2009, the fair value of our fuel hedges amounting to a charge of RM3.8 billion will be recognised in our balance sheet," MAS executive director and chief financial officer Tengku Azmil Zahruddin told reporters at a briefing in Kelana Jaya yesterday.
  
  However, these are unrealised fuel mark-to-market as the hedges are contractual arrangements over the next three years to 2011.
  
  "There will be no impact to the P&L (profit and loss) as they are effectively 'paper losses' and will only be realised when the contracts mature over the next three years. The amount realised depends on the actual oil prices then," Tengku Azmil said.
  
  Since March 31 this year, oil prices have increased more than 35 per cent. Thus, as of May 29, MAS stands to benefit from a hedging gain of RM1.1 billion in the second quarter results.
  
  "This could mean that MAS' quarter one RM695 million net loss will be fully reversed by the RM1.1 billion," managing director and chief executive officer Datuk Seri Idris Jala said.
  
  MAS adopted FRS 139 in its current fiscal year, ahead of the accounting standard's mandatory adoption in Malaysia from January 1 next year.
  
  Prior to adopting FRS 139, MAS did not include any mark-to-market gains or losses in its results, whether profit and loss or the balance sheet.
  
  "What we will do is, as the oil contracts mature, we will account for them as they mature. Last time, the 2010 or 2011 (fuel hedging) contracts were just ignored," Tengku Azmil added.

If my understanding is correct, these oil contracts aren't 'as bad' as it is appears.

The contract just priced to what to the market price and as per the prices at 31st March 2009, the hedging losses were massive and mind-boggling. The size of the hedging position were simply massive.

And also, if my understanding is correct, if these contracts were used soley by MAS in its operations, MAS loses by having 'higher' cost and 'higher' cost in such a challenging industry is simply not an ideal business practice.

So in my flawed opinion I do not think MAS position today is as bad as it appears.

It's marked to market and the 'market prices' has improved substantially since 31st March 2009.

But... but.... but..... buttttt.....

Back to the issue of its oil hedging.

Back in May 2008. MAS embarked on its ELF programme or Everyday Low Far sales campaign and the following was one article, MAS MD stands up for low-fare programme.

Me?

I was extremely puzzled.

For me it was not Star Wars But Air Wars!

Why?

For me, the business economics and fundamentals then made it extremely insane for MAS and AirAsia to be embarking on a pricing war. Remember oil then was above US$100.00 then. And the signs were already there that the global markets were going to collapse.

And yet both of these airlines went on a price war!

Now if my reasoning is not flawed, it appears now that MAS armed itself with a huge war chest by buying tons and tons of oil contracts at US100 per barrel to compete in this price war!

I just could not understand.

One small country, two airlines, both competing against each other!

Why?

Was there ever a need to do so?

The following is another article from a news clip from Business Times (sorry no links) back in May 2008 commenting a bit on the pricing 'war'.

• No subsidy given to MAS: Minister
  
  Published: 2008/05/17
  
  TRANSPORT Minister Datuk Ong Tee Keat said yesterday that the government does not provide Malaysia Airlines (MAS) a RM400 million yearly subsidy for some of its international routes.
  
  AirAsia Bhd chief executive officer Datuk Tony Fernandes had said that MAS receives the subsidy for flights to Los Angeles, Paris and New York.
  
  Ong also said that the current price war between MAS and AirAsia was healthy competition which would benefit the nation.

Healthy competition?

Well, if my reasoning is not flawed, it appears that MAS is hurting because it took on huge oil contracts when oil was above US100.00 to compete in this 'healthy competion'!

And as I am writing this, how ironic the balance sheet comes to mind again. As per the balance sheet statement from MAS reported yesterday, (See the tables posted earlier) MAS as per March 2008 did have a very impressive balance sheet. Cash balances were over rm4 billion then!