fina3204 case airline hedging

The Hong Kong University of Science and Technology

FINA 3204: Derivative Securities Andrew Chiu

Derivative Securities FINA 3204

Fuel Hedging by

Hong Kong Listed Airlines

Andrew Chiu, PhD [email protected]

mailto:[email protected]



Cathay Pacific



“Even with the latest increase, the airline estimates that surcharges cover less than half of the increased cost of fuel. Soaring jet fuel prices are posing an enormous challenge to the aviation industry. Jet fuel costs now account for about half of the Cathay Pacific's net operating costs, compared with 39% a year ago.”

A Cathay Pacific spokesperson said, “There is a significant time lag of two to three months from the time we submit our fuel surcharge application to the CAD to the time the new surcharges become effective. For example, the supporting information we submitted earlier this month to the CAD was based on average jet fuel prices in May and June since the last review.

“Despite the recent drop in crude oil prices, jet fuel prices are still very expensive and higher than the levels when fuel surcharges were last adjusted two months ago.”

Press Release, Cathay Pacific, 25 July 2008

Fuel Surcharge as a Hedge



How is fuel hedged?

The simplest way of hedging is buying a swap, and following that, buying a call, says Lim. "The problem comes where you buy a call and sell a put," he says. "Collars were very common when WTI crude oil was $120-130 a barrel in summer 2008. You're selling a put to fund the call you're buying. If oil goes up, you profit because of the call, but if it goes down you get hit on the flip side because of the put.”

"If you'd done a simple call option, which was very expensive at the time (in mid-2008, because the expectation was that prices would rise), you would have lost the value of it (because the oil price dropped)," he adds, "but you wouldn't have had the downside risk.“

But Lim concedes it is getting increasingly difficult to analyse airlines' fuel-hedging positions, because "they won't tell you what the strike price is; they won't tell you how much they've got exposed; and they won't tell you what structure they are using".

Source: http://www.energyrisk.com/public/showPage.html?page=839641

Feb 12, 2009

http://www.energyrisk.com/public/showPage.html?page=839641



Clues from 2006 Financial Report



Jet Fuel & Crude Oil Relationship

http://www.iata.org/whatwedo/economics/fuel_monitor/price_development.htm

http://www.iata.org/whatwedo/economics/fuel_monitor/price_development.htm



Oil Swap

Cathay Pacific

Oil / Fuel Producer

Pay Fixed Oil Rate

Receive Market Rate based on Oil Index

Unlike a forward, no oil is transferred



Collar

Payoff

Crude Oil Price

Buy Call

Sell Put

Buy Jet Fuel

Collar



3-way Option

Payoff

Crude Oil Price

Buy Call

Sell Put

Buy Jet Fuel

Write Call

3-Way Option



ICE Brent Crude Oil Prices (2008 Jan - 2009 Mar)



Protective Call Option

Payoff

Crude Oil Price

Buy Call

Buy Jet Fuel

Proposed Strategy (Mar 18, 2009)



China Eastern Airlines



Hedging Losses

China Eastern Airlines Corp and other state enterprises involved in

derivative trading are being investigated by the National Audit

Office, indicating that Beijing is taking action to hefty losses incurred

in hedging activities by key enterprises. Officials from the watchdog

were at China Eastern for several days, in search of information on

hedging transactions that incurred 6.2 billion yuan (HK$7.04

billion) of unrealised losses for the Shanghai-based carrier, a

report by Shanghai's Eastern Morning Post said yesterday.

Source: South China Morning Post, Jan 14, 2009



Clues from 2006 Financial Statement



Buy 1 Call, Sell 2 Puts

Protective Call + Speculative Put

Payoff

Crude Oil Price

Buy 1 Call

Sell 2 Puts

Buy Jet Fuel

fina3204 case airline hedging

Documents

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fuel surcharges

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jet fuel costs

crude oil prices

average jet fuel prices