Presented by Abhishek Shrivastava Goa Institute of Management (2011-2013)

Increasing Fuel prices Regularly. Increasing Volatility and Unpredictability (35,138) Equity prices negatively correlated to fuel Reduces Cash flow Volatility prices.

The value is positively related to 2008 CRISIS hedging of future jet fuel requirements. CONSTANT TREND TILL 2002 (Allayannis and Weston (2001)), Average hedging premium for airlines is likely in the range of 5% - 10%.
US Iraq War

Crude pricesairline firm 1987-2012

i n c r e a s i n g

Does hedging effect firm value

by Carter, David A & Rogers, Daniel

Hedging helps airline deflect higher jet fuel cost

by Austin, Mary Clair

State of Airline fuel hedging & Risk Mgmt.

by Markets Energy Advisors

South West Airline Case Study

Heating Oil highly correlated as compared to Crude oil

Check the Spread

H e a t i n g
O i L

Regression Statistics

Regression Statistics

Multiple R R Square Adjusted R Square Standard Error Observations

0.995551255 0.991122301 0.991047067 2.320424029 120

Multiple R R Square Adjusted R Square Standard Error Observations

0.984191 0.968632 0.968366 4.361743 120

R e c o m m e n d e d

 The fuel prices will continue to show upward trend with

Normal volatility between Quarters. The trend is expected to be same as period of Dec 2008-Sep 2012.(Normal Period after Crisis starts Settling). Analysis However, the fuel prices can see some unexpected large volatility in case of US-IRAN TENSION, Euro Zone breakdown
QUARTERLY PRICES 1-Dec-12 1-Mar-13 1-Jun-13 1-Sep-13 1-Dec-13 1-Mar-14 1-Jun-14 1-Sep-14 1-Dec-14 1-Mar-15 1-Jun-15 1-Sep-15 CAGR 2010 1437 2009 1428 MAX PRICE 112.490303 115.253643 119.398653 123.543663 127.688673 131.833684 131.833684 140.123704 144.268714 148.413724 152.558734 156.703744 MIN PRICE 82.8027273 84.8367879 87.8878788 90.9389697 93.9900606 97.0411515 97.0411515 103.143333 106.194424 109.245515 112.296606 115.347697 AVERAGE PRICE EXPECTED 97.17845118 100.6734007 104.1683502 107.6632997 111.1582492 111.1582492 118.1481481 121.6430976 125.1380471 128.6329966 132.1279461 135.6228956

QUARTER AVERAGE MAX MIN 1-Dec-12 116.396 164.4208 84.97505 B 1-Mar-13 121.432 171.8563 88.81785 r 1-Jun-13 126.468 179.2919 121.432 e 1-Sep-13 131.504 186.7274 126.468 n t 1-Dec-13 136.54 194.163 131.504 1-Mar-14 141.576 201.5985 136.54 C 1-Jun-14 146.612 209.0341 141.576 r 1-Sep-14 151.648 216.4696 146.612 u 1-Dec-14 156.684 223.9052 151.648 d 1-Mar-15 161.72 231.3407 156.684 e 1-Jun-15 166.756 238.7763 161.72 1-Sep-15 171.792 246.2118 166.756 IN GALLONS FUEL CONSUMPTION 2011 1,764

H e a t i n g O I L

FUEL CONSUMPTION IN GALLONS

T R E N D A N A L Y S I S . F O R E C A S T I N G

Expected Normal trend in Aviation Ind.

2012 2013 2014 2015 11.14% 1960.576 2179.059 2421.888 2691.779

R o l l o n PRICE RANGE/Barrel (As Forecasted) $82 to $119 Fuel Exposure to Hedging 10%-20% YEAR REMARK Increasing US-Iran, Euro Zone may Fuel this a n d Q u a r t e r l y R e v i e w P r e f e r r e d

FIRST HALF 2013

Downside risk less

$95-$110
$110-$120 $87-$100, $120-$127 $105-$115 $110-$125 $125-$135

Approx. 60%
Approx. 2010% 40% 60% Over 50% Over 40%

FIRST HALF 2013

FIRST HALF 2013 SECOND HALF 2013 SECOND HALF 2013 2014 2015

Prices are expected to be stable

Upside movement expected less Predictability less, Predictability less Predictability less Predictability less

Heavy Hedgi ng may take atoll

2013
Hedge complete that is 2179 gallons as forecasted consumption

2014
Hedge approx .50% that is minimum of 1250 gallons of fuel consumption expected

2015
Hedge over 40% ,minimum of 1350 gallons as per expected consumption

HEDGING INSTRUMENT

Recomme nded (YES/NO)

PRICE (Heatin g Oil/B

REMARK

Flat vanilla Jet fuel Swap NYMEX heating oil calendar Swap Differential Swap
Call options(OTC)

YES YES

$95$110 $95$110 $95$110 -

Short term, recommended for first half 2013 Short term,recommneded for first half 2013 Not required, Basis risk already Mitigated
Usually settled monthly, hence suitable to Business model of Low Cost airlines Can be avoided,as Premium is high and generally used for cross hedging, which is already avoided by Here by using Heating Oil

NO
YES

R E C O M M E N D E D S T R A T E G Y

Call Options(Exchange Futures)

NO

Assumption: Client is a Low cost airline

HEDGING INSTRUMENT

RECOMME NDED (YES/NO)

PRICE (Heating Oil/B)

REMARK

Zero Cost Collar

YES

80 put,156 call (long term),Short term (80 put,120 call)

$95-$110 (Short term)

Suits to Business model, no upfront cost if restructured accordingly, recommended for short/long both
Not suitable for Low cost airline. Daily settlement helps in risk mitigation and effective risk management, which is critical to importance to low cost airlines Both can be Short/long term

Premium Collar Forwards

NO YES

R E C O M M E N D D E D
S T R A T E G Y

Futures

YES

$95-$110

Assumption: Client is a Low cost airline

Hedging recommended,Fuel prices are expected be continue upward Trend. Hedging will increase Firm Value and also return in Stock Market

Use Heating oil instead Crude Oil for Hedging to reduce Basis risk.

Hedge for full exposure to fuel in first 6-12 months. Avoid heavy exposure in next two years. Same strategy can be implemented in every Quarter Review. Hedge short term with Jet Fuel swap, Heating oil Swap and call options in price range-(95-110). Use zero collar (80 put,160 call) and Futures for long term.Downside risk in short term can be mitigated by Zero Collar Company must continually monitor and adjust its hedge portfolio at least Quarterly.Hedge committee and long term contracts with Oil companies and official hedging policy recommended

R E C O M M E N D A T I O N S

 Collar

pay off

Swap

Mechanism

References