European firms’ shield against strong euro, oil price

July 30, 2007 - 0:0

PARIS (AFP) -- European companies confronting a double hit from the rise of the euro and of oil prices are turning increasingly to financial markets to stabilize costs and revenues.

With the euro setting near daily records against the yen and the dollar, big European companies such as aerospace giant EADS or luxury goods group LVMH have seen a surge in the prices of their exported products in local currencies on world markets. The rise of the euro can also crimp profit figures on foreign markets when they are reported in euros. At the same time oil rates are coming close to the record peaks of last summer, when they shot past 78 dollars a barrel. The latest trend has posed particular problems in the transport sector, notably in the fuel-hungry civil aviation sector. Oil is one of several raw materials vital to many companies to have risen sharply as a cost in the last two years. Vulnerable firms are now trying to cover their exposure through two types of financial instruments, the “forward contract” and the “option” on the so-called “futures” markets. Using a forward contract, a company attempts to avoid sharp surges in the price of oil or in a particular currency by making commitments over a fixed period of time. For example, a company might use a forward contract to buy a certain quantity of oil one year hence at 65 dollars a barrel. In fact the firm would buy the oil at the going market price, with the financial intermediary with whom the contract was signed absorbing the difference if the price exceeds 65 dollars a barrel. If the price is less than 65 dollars, the company would reimburse the seller of the contract. Options, the second instrument available to companies, can be exercised or not whenever the price hits a certain level, thereby smoothing out the effect of extreme movements. In the 2006-2007 fiscal year “85 percent of our oil consumption has been covered at an average price of 52 dollars a barrel, although the average price for the period is around 65 dollars,” said Air France finance director Philippe Calavia. He pointed to the U.S. carrier Southwest, which just after the start of the war in Iraq in March 2003 made a bet on a long-term spurt in oil prices. “They were covered over a period of three or four years at a price between 25 and 35 dollars a barrel and had an advantage over their competitors.” Oil producers too sometimes make use of the same technique. “Producers now have a tendency to cover themselves in order to be sure that over the next 10 months they will be able to sell at a price approaching current levels,” explained Frederic Lassere of Societe Generale. “Companies that consume oil, on the other hand, usually wait until the end of the summer -- and the end of the ‘driving season’ in the United States, a yearly consumption peak -- before buying oil.” While most airlines, using forward contracts and options, have been able to absorb the impact of higher oil prices, European multinationals have a harder time responding to the strength of the euro. “When you are a company like Airbus, a euro that is worth 1.38 dollars can pose a problem,” said one trader. “But the real issue is to know if the euro is going to continue to rise over the years. If you have structural costs in euros and your revenues come only from exports, you would eventually ask yourself if it weren't wiser to produce in the United States.