Kenya Airways Sh8,000 per barrel fuel pricing bet that flew off radar
By ROSELYNE OBALA and MOSES MICHIRA | August 8th 2015
Kenya Airways is purchasing fuel at Sh8,000 ($80) per barrel, about a quarter over the prevailing market prices in a pricing bet gone awry and partly responsible for its record loss.
This is first time the airline has divulged details of its fuel hedging contract which the management has repeatedly claimed were highly confidential.
A Senate select committee investigating the national carrier’s troubles, which reported a near Sh30 billion pretax loss last week, heard that the management did not anticipate the slump in fuel prices when they committed the airline to the existing hedging contract.
The committee chaired by Senator Anyang’ Nyong’o (Kisumu) grilled the airline’s management led by board Chairman Evanson Mwaniki, Managing Director Mbuvi Ngunze and Finance Director Alex Mbugua on why it contracted fuel instead of purchase on demand.
“This is a risk management strategy and it is an internationally acceptable practice. When there is volatility of cost it is irresponsible for any management not to contract fuel,” said Mbugua, in defence of their decision to contract fuel. He continued, “30 to 60 per cent of KQ’s operational cost is on fuel. We have not incurred any losses with the fuel hedging contract. In the last five years, we have saved Sh2.7 billion. The naked truth is that we must hedge. The Sh1.6 billion factored in the balance sheet as the fuel hedge loss has no impact on the Sh 5.7 billion loss accrued in the drop in all prices instead we have saved the airline Sh3.2 billion.”
Shell and Total are the airline’s fuel suppliers. “The board allowed implementation of the policy and we are within the approved limit.”
Senator Mutahi Kagwe (Nyeri) and Prof Nyong’o pressed on with the line of question, demanding to know how the loss came about. “Has the fuel hedging contributed positively to the growth in revenue of the airline or drop? Was the loss contributed to drop in oil prices per barrel and did the other airlines also incur losses,” questioned Kagwe. Senator Nyongo, Naisula Lesuuda (nominated) Hassan Omar (Mombasa) and Peter Mositet (Kajiado) expressed their reservations on the model, even as Mbugua reaffirmed that they had no option.
The hedging contract allows the airline to project its fuel costs, which make the single biggest item as the operating expenses, by entering an agreement with a counter-party to purchase fuel at a later date and at a fixed price. In the cases where the prices go higher than the bet amount, the counterparty would reimburse KQ the difference above the contract price. But in the contrary as is the present scenario of a crash in the oil prices internationally, KQ would pay its counterparty the difference between the contract price and the market rates.
Mbugua said that the airline had lost Sh1.6 billion in the financial year ended March 31, also the period that the firm reported the record operating losses. Mbugua told the committee that the airline had actually gained from the hedging contracts, estimated Sh2.7 billion, even though the firm announced a Sh5.8 billion in unrealized losses.
Costlier fuel compared to the prices paid by rival airlines means KQ cannot price its services competitively, in part explaining its outlying ticket prices. KQ’s management was also on the spot of leasing of flight and grounding of some of its fleets waiting to be sold.
The lawmakers faulted the purchase of four Special Purpose Vehicles (SPVs) in Bamuda, Carreabian and Cayman Highland, which the managers maintained has political and economic stability and offers low tax rates, which is paid in installment through guaranteeing consortium.
Ngunze revealed that 10 of its aircraft were grounded partly due to low business opportunities as they wait to be sold. “We have a fleet of 52 aircraft of which 10 are not operational. These aircraft have been grounded since May this year,” said Ngunze. However Kagwe questioned the rationale of grounding the aircraft after turning an offer from a South African Company to sale release at a cost of $322 million.
Mbugua confirmed that they had reached a deal before the board decided to cancel it and instead opted for an outright sale. “We are not working on a $189 million deal,” said Mbugua. Kenya Airways also said that four out of the grounded fleet have not been fully paid for. The firm is servicing loans at $1 million (Sh100 million) a month, out of a total loan of $100 million (Sh10 billion).
Senators took the airline management to task to explain the costing model embraced in its ticketing.
Kagwe illustrated how the airline had out priced itself out of market on a round trip ticket to London on British Airways at a cost of Sh180,000. KQ’s offer which Kagwe’s friend did not pick would cost Sh20,000 more. Frequent fliers have raised concerns about the cost of flying on the national carrier, and rather opted for the cheaper rivals including Ethiopian Airlines – which is wholly government owned.
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