This month we speak to Alex Harris, Virgin Atlantic’s Group Treasurer, about the effects that fuel price increases had on the airline industry in 2005, and discuss the strategies employed by Virgin Atlantic to manage FX and commodity risks.
Virgin Atlantic is the UK’s second largest long haul airline, carrying over 4 million passengers each year.
Could you give me some background information about Virgin Atlantic?
Since it was founded in 1984, Virgin Atlantic Airways has become Britain’s second largest carrier, serving the world’s major cities. Now based at London’s Gatwick and Heathrow airports, it operates long haul services to twenty-five destinations worldwide as far apart as Las Vegas, Mumbai, Sydney and Shanghai.
Virgin Atlantic has enjoyed huge popularity, winning top business, consumer and trade awards from around the world. The airline has pioneered a range of innovations setting new standards of service, which its competitors have subsequently sought to follow. Despite Virgin Atlantic’s growth, the service still remains customer driven with an emphasis on value for money, quality, fun and innovation.
What is your role at Virgin Atlantic?
At Virgin Atlantic, our main priorities in Treasury and Fuel management are with foreign exchange risk, interest rate risk, liquidity, fuel and operational management. As a result, a significant amount of our time and attention is spent in supporting these objectives through developing, promoting and managing our strategies to minimise our exposure to these core areas. As a result of the relatively large cash reserves of the business, we spend a considerable amount of time guiding and shaping our global cash management strategy while ensuring sufficiency of liquidity and enhancement of value to meet our business requirements and strategic goals.
The Virgin Atlantic culture promotes cross-business working groups – as a result Treasury often gets involved in a wide range of projects. Maintaining and enhancing our presence with our business partners both internally and externally is an important aspect of the role.
How is the treasury structured?
Treasury operations are centralised and managed out of our head office in Crawley. It is staffed by a small team of six people, supported by the finance teams in each of our outstations. The team is split into the traditional roles of front, middle and back office. However, due to the small size of the department and the Virgin Atlantic culture, team members have the opportunity to get involved in a broader range of tasks, responsibilities and experiences than would ordinarily be the case.
As a UK-based business operating in sterling and dealing with USD, what sort of exposures do you encounter?
As an airline business operating globally, we are exposed to many risks, be they related to passenger safety and security, environmental, political, economic or technological.
In recent years, the airline industry has experienced the effects of a wide range of shocks: 9/11, the Iraq War, SARS, the tsunami, and the ongoing threat of avian flue, and most recently the massive increases in global fuel prices.
We do have a significant exposure to the USD. Sterling is our functional currency but we operate in an industry that is fundamentally a USD based business. Our primary capital costs (aircrafts) and a material part of our operating costs (fuel and maintenance) are traded in USD.
So how do you manage these exposures?
Clearly we are unable to proactively manage some of the unexpected shocks such as 9/11. However, the business has positioned itself, and continues to position itself, to be able to react rapidly and effectively to such events. There are some risks, such as FX, interest rate and commodity prices, that we can proactively manage.
We have in place structured planning and budgetary processes to identify and quantify currency, interest and commodity exposures. We have board approved policies to hedge and manage the identified exposures and these policies are reviewed regularly.
We have a Treasury Risk Committee (TRC) that approves hedging strategies within the policy guidelines and there is a board sub committee, which considers recommended changes or temporary departures from the hedging policy. The hedging policy extends out three years; its purpose is to provide an acceptable level of protection against adverse movements, whilst allowing a degree of participation in favourable movements.
Treasury seeks to add value through choice and timing of hedging strategies (within policy guidelines). Treasury regularly reports to the TRC and the board on exposures, cover, positions and structures taken.
How is commodity risk managed at Virgin Atlantic?
Commodity risk is managed in a similar manner to FX risk. The board approved hedging policy has the same three-year tenor as the FX policy. The Fuel Hedging Committee (FHC) reviews and approves proposals from the Head of Fuel Management.
A difference between FX and Fuel hedging is in the products that Fuel is able to utilise in its hedging strategies. Fuel is able to hedge using different products at different points along the tenor of its permitted range using a combination of jet fuel, gas, heating oil, and crude oil. As with Treasury, Fuel regularly reports to the FHC and the board.
Oil prices rose dramatically in 2005 – what impact did this have?
The dramatic increase in physical fuel prices during the latter part of 2004 and 2005 had a significant impact on operating cost. Fuel represents a relatively large percentage of our operating costs. Any increase in price has a material impact on our bottom line. This impact was partly mitigated by earlier hedging and the introduction of a fuel surcharge.
How have the events of 2005 affected your strategy?
The dramatic increase in fuel prices coupled with the Buncefield oil depot disaster in the latter part of the year heightened our attention to the management of fuel and the erosive effect that fuel cost can have on the bottom line.
Our strategy has not changed significantly, but it has raised the profile of operational fuel management. Hedging has now become more focused and much more time consuming as we seek to manage this increasingly more expensive commodity in a timely and efficient manner, to take advantage of hedging opportunities as they occur.
Would you say that hedging policies are consistent throughout the industry?
No, I think they vary quite significantly. Some companies have stated that they do not hedge at all; others restrict their hedging to a year or less, whilst others hedge out to five years and beyond.
Ultimately a company’s hedging policy is determined by their risk philosophy and this will vary from company to company and between industries.
Looking at treasury more generally, what sort of projects are you working on at the moment?
We are in the midst of restructuring our global cash management arrangements. This includes the reduction of the number of our partner banks and bank accounts globally. This will improve our liquidity management through better pooling and cash concentration processes, coupled with improved balance reporting information, and a reduction in banking costs.
We are also finalising a new Treasury Management System implementation, which we started last year. One of the key deliveries includes STP into our ERP system. We are planning further enhancements to our TMS over the course of the year to improve its reporting and risk modelling capabilities.