Flight plan

British Airways' Group treasurer, George Stinnes, talks to Alexander Campbell

British Airways (BA) has hit the headlines recently for its operational risk failures. The airline suffered badly from problems at London Heathrow's newly opened Terminal 5 and, earlier this year, a Boeing 777 airliner lost power on approach to the same airport. But the airline is equally exposed to financial risk - in particular, its fuel costs mean it has huge exposure to high and volatile oil prices.

Financial risk is the responsibility of the airline's group treasurer, George Stinnes. He sees his job as one of delaying the inevitable: "Our philosophy is 'you can run, but you can't hide'. The way we view hedging in general is to reduce the volatility of the balance sheet and income statement. When you get rapid movements of any component, hedging - by smoothing it - gives you a chance to reduce other costs that might take a bit longer to adjust, so as to retain your profitability." The recent rises in the price of crude oil would have hit BA's bottom line hard, if not for the airline's ability to compensate by cutting distribution costs (money paid to intermediaries such as travel agents), Stinnes adds.

With crude oil spot prices hitting $115.41 a barrel on April 22, hedging BA's 2-billion-gallon annual fuel purchase is a key issue for Stinnes and his risk management team. "We hedge out as much as two years or more, but we operate on a declining basis - our fuel hedging programme is 70% covered for the next two quarters, decreasing to 60%, 50%, and then in the year beyond it's a bit less. We tend to have 60% hedged on a rolling basis."

The plan has not worked perfectly this year, he admits: "We went into this financial year carrying more cover than last year, but because price movements were so violent, our costs will still be significantly higher. We started our plan this year expecting the $85-a-barrel range, and so we expected £450 million higher fuel costs - as oil is now in the $115 range, clearly that doesn't hold true."

The market for jet fuel derivatives is too small for BA to hedge its purchases out to two years without taking unacceptable liquidity risk, Stinnes explains. As a result, it hedges using jet fuel derivatives out to three or four months, then uses either gasoil - a more liquid petroleum product - or crude oil as a proxy hedge. This can expose airlines to basis risk - indeed, a recent breakdown of the correlation between gasoline and jet fuel prices caused heavy losses for some airlines that had used gasoline as a hedge.

More hedging is not necessarily better - the 'right' level of hedging is one that doesn't run the risk of putting BA at a significant price disadvantage to its peers. Consequently, BA and its rivals tend to hedge at roughly the same levels, Stinnes says: "If none of our competitors had any hedging, we wouldn't want to put on any hedging either. You could have a huge price advantage - or a huge disadvantage."

BA's other main risk management tool is its huge cash reserve. It keeps between £1.8 billion and £2 billion on hand - equivalent to 20% of its annual turnover. Since the terrorist attacks of September 11, BA has been keenly aware of the speed with which liquidity can dry up. "You can, if things go badly, use up quite a bit of cash quite quickly," Stinnes says. As such, the company keeps its cash reserve in highly liquid conservative investments such as deposits and gilts, with strict counterparty risk limits on both its investments and its hedge book. The treasury team must also ensure BA's capital expenditure is covered by commitments for at least two to three years in advance - the airline has a total of $3.4 billion in commitments covering its aircraft purchases over the next five years, for example.

BA's multinational revenues and costs expose it to foreign exchange risk - fuel is bought in dollars, most salaries are paid in sterling and aircraft are purchased either in dollars or euros. The key is to balance borrowing against revenues in each currency, so the risks of forex fluctuations net out, says Stinnes. "If we have euro loans outstanding, the good thing is we also have a steady flow of euros coming in, so we know we can generate the euros from the operation to repay borrowing - so we don't have to register the forex exposure," Stinnes explains.

- Alexander Campbell

BIOGRAPHY: GEORGE STINNES

2006: Group treasurer, BA

2000: Head of investor relations, BA

1990: Pilot, BA

1985: Corporate finance, mergers and acquisitions, Wood Gundy (now CIBC).