Moneyweb falls into the same trap that many others have stumbled over time and again. David Carte mis-titles SAA loses as oil price falls and makes the mistake worse with the subtitle “A hedge goes the wrong way”. Mr Carte doesn’t belabour the point in the article, but his perspective on hedging is clear. I’ll repeat my comments attached to the story below:
The article reflects a common misunderstanding of hedges. This comment doesn’t necessarily support hedging (since they are good arguments for and against hedging) but it attempts to point out why hedging is not “taking a view” and therefore must not be judged with the benefit of hindsight as to whether the commodity involved (oil in this case) increased or decreased in price.
It isn’t a question of getting the hedge “wrong”. SAA is exposed to the risk of high oil prices. In order to remove this risk, they can hedge against the cost of rising oil prices. This way they are free to concentrate on the operational aspects of running an airline, rather than trying to guess the oil price of tomorrow. In this case, the oil price decreased. The “loss” they have made on the hedge isn’t really a loss – it is offset by the lower cost of fuel for their operations. Similarly, if the oil price had increased, they would have made a profit on the hedge, which would have been offset by the higher cost of fuel in future. The final impact is that changes in oil prices don’t impact them as much as they would have without the hedge.
Now, there are other risks such as “basis risk” and, more broadly, trying to estimate their future fuel needs (i.e. what exposure they need to hedge) but these technical points don’t negate the position that hedging is not about getting it “right” or “wrong”. It is about not wanting to take a view on oil and thus removing the exposure in a company.
Hedging is risk management, it is not taking a view. Having said that, there have been examples of misuse of hedges through mistake, lack of understanding, or trying to use derivatives to take a punt and still calling it a “hedge”.
Appropriate timing for a follow-up to my follow-up on WAR and hedging future gold production. The world of financial risk, hedging, derivatives and risk management require careful analysis, strong technical skills and an understanding of some fairly complicated mathematical models in order to generate value. Throwing a few ideas around because they seem popular does not fit this bill.