Weak Asian jet fuel outlook sees airlines ease up on hedging

Weakness in Asian prices of jet fuel in the fourth quarter, normally a peak demand period, looks set to persist through 2012 on a dip in air travel caused by Europe's debt crisis, which could tip the world economy into recession.

The bleak outlook is prompting airlines to throttle back on hedging plans, with most just sticking to current volumes. For oil refineries, less income from processing a barrel of crude into jet fuel may force them to switch to more profitable fuels, such as diesel.

"Most airlines have adopted similar strategies as they did in mid-2011, with regard to hedging," said Shukor Yusof, a Standard & Poor's analyst in Singapore. "They will keep monitoring the markets and adjust their requirements within 5 to 10 per cent of their fuel needs for the next 12 months."

For example, Air France is looking to hedge about 52 per cent of its fuel costs for the first quarter, sticking to its strategy of last year.

Cathay Pacific aims for hedging coverage of at least 20 to 30 per cent for the next 12 to 18 months, depending on prices, a company spokeswoman said. Hedging by Hong Kong's flagship carrier for the 2010-11 financial year was estimated around 35 to 40 per cent, and 50 per cent for the year prior.

Jet fuel prices relative to diesel are usually at their strongest in the first and fourth quarters of the year, typically spurting as much as 50 per cent, when holiday air travel picks up and winter demand for heating fuel kerosene, a product similar to jet fuel, increases.

But there has been no such rise so far in 2012 as a weaker economic outlook pushes people to cut back on vacations and travel. Asia's jet fuel market looks for support to Europe, where any spike in air travel demand draws fuel from Asia.

Jet fuel prices rose nearly 19 per cent over the January to October period last year, while diesel prices gained almost 18 per cent. In contrast, from November to last month, jet prices gained just 0.77 per cent compared with 2.89 per cent for diesel.

International air traffic shrank 1.5 per cent in November from October, and has grown just 0.5 per cent since May, the International Air Transport Association said in a December report.

Europe's passenger market has slowed sharply, with 4.9 per cent annual growth in November, just half the figure of 9.5 per cent for the first 11 months of 2011, the airline body added.

Airlines worldwide face losses of more than $8 billion this year if Europe's politicians fail to tackle the region's debt crisis, said IATA, which groups 240 of the best-known airlines, carrying 84 per cent of global traffic.

"With the weak demand, refineries are already minimising jet yield and yet the prices are still down. I don't see an upside for the product any time soon," said a Singapore-based trader.

Refineries can adjust the cracking process to vary yields of jet fuel, kerosene and gasoil in line with the margins achieved for each product.

Gains in Asian jet fuel prices have stayed persistently lower than those of lower quality diesel since late December, with jet prices often slipping below diesel rates by 90 cents to more than $2 a barrel.

"If you look at the supply side in Asia, apart from Japan, no country is running at a lower capacity," said Alex Yap, a consultant at Facts Global Energy.

Japan's crude refining is now running at 87.8 per cent of capacity, about 0.8 per cent lower than last year after the March 11 earthquake and tsunami shut some refineries. China and India, on the other hand, plan to process more crude, with a spate of new refineries starting production.

"Chinese refineries are running at high capacity rates. Demand-wise, it's been weak in Europe and there has been a lack of any kind of pull from the market there," Yap said.

Diesel demand remains strong in Asia, driven by rising vehicle sales, especially in giant economies India and China. In India, vehicle sales grew 30 per cent in the fiscal year to March 2011, while in China, they rose 5.2 per cent last year.

This has created an inverse relationship between the prices of the two products which may trigger a shift in supply as Asian refiners start to produce more diesel and less jet fuel, responding to the cost considerations.

Asian refining margins for jet fuel slipped below those of diesel, and have stayed that way for ten straight sessions since January 16, Reuters data showed.

For most of the period from January 2010 to early December 2011, jet fuel margins had been about $1 to $2 a barrel higher than those of diesel. But on January 31 this year, diesel cracks were $18.63 a barrel above Dubai quotes, compared with $17.53 a barrel for jet fuel cracks.

The physical regrade - the difference between jet fuel and gasoil cargo prices - has stayed below minus 90 cents a barrel since late December, indicating jet fuel is weaker than gasoil.

Over the period from October 2010 to January 31, the strength in jet fuel was evident, with the regrade ranging from a premium of 40 cents to $2.85 a barrel, Reuters data showed.

The same scenario holds in the financially settled derivatives market, which usually takes its cue from physical demand and supply. Here regrade prices peaked last February 22, at $3.20 a barrel, after an upward trend in the first quarter of last year from January 4.

Since January this year, prompt regrade tanked within the first week to minus $1.37 a barrel, with the peak at minus two cents on January 25.

The only source of hope for the jet fuel market is Asian demand, led by countries such as Vietnam and India, where stronger economic growth and rising affluence is giving a fillip to air travel, helping to stall further slides in prices.

Energy consultancy Wood Mackenzie in Singapore expects demand for the fuel in Asia to grow up to 4.5 per cent this year over 2011, to 1.5 million barrels per day.

"The jet fuel and gasoil spread has narrowed, but we are expecting jet fuel to bounce back later this year," said consultancy analyst Sushant Gupta.

"That's mainly on growth of jet fuel demand from developing economies like Vietnam and India."

Besides Asia, the Olympic Games set to run in London from July to August this year could also boost demand for jet fuel as air travel pick ups, a trader based in Thailand said, which would also help to stem the slide.

But such spikes may not be enough to fuel a recovery this year, a source with a Singapore refiner said.

"If Europe's economy continues to remain weak, I don't think there will be much of a recovery for jet fuel," the source said.