Case Analysis : 2012 Fuel Hedging at JetBlue

Airways

Submitted by:
Deepansh Kakkar G16021
Gopal Gopesh G16023
Harshal Namdeo G16024
Utkarsh Tiwari G16057
Yugandhar Garde G16061
Executive Summary:

JetBlue Airways was a low cost airline that distinguished itself by offering in-flight entertainment and
other amenities. It had started in 2000 and after experiencing remarkable growth, went public on
NASDAQ in 2002.

But as a result of rising fuel prices, from 2005, JetBlue’s profits started to decline. The airline adopted
fuel hedging as a means to protect itself from fuel spikes and subsequent losses. JetBlue ventured
into a variety of instruments such as swaps, call options, caller contracts, etc with underlyings of jet
fuel, crude and heating oil.

Because of the changes in the oil market due to changing conditions in the oil producing markets like
UAE and Libya, Jet fuel prices crossed $3-per-gallon mark, which was the highest since 2008.

Almost all of the US airlines hedged about half of their fuel needs as per the market trends.

A lot of the airlines were dependent on West Texas Intermediate (WTI) crude oil hedges. JetBlue had
used crude oil derivatives contracts for more than half of its 2011 hedging. But there were some
concerns with the WTI’s ineffectiveness as a result of which airlines might incur losses and therefore
the WTI’s price bench mark became less correlated with the global crude oil market.

In 2011, WTI started trading at a discount to the leading global price European benchmark Brent
Crude due to an oil glut in Cushing, Oklahama- the physical delivery hub for the WTI oil futures
contracts for the Chicago Mercantile Exchange group(CME group). Cushing was facing a bottleneck
and Brent’s premium to WTI reached a record level of $30 per barrel in September 2011. Becauseof a
relatively higher quality of WTI, Brent would trade at a discount of 1-2 dollars to WTI. However, the
discount of Brent was turned into a premium over WTI on account of the oil glut in Cushing. Because
of the ease on transportation constraints of Cushing by October and November 2011, ConocoPhillips
sold 50% share of its seaway crude oil pipeline. This phenomenon would also reverse oil flow to run
from north to south. This resulted in the fall in WTI to a value below $10 per barrel and also made
the difference between the spot price of Brent crude oil. Also, it was seen that the reversal of the
Seaway pipeline would not do away with the bottlenecks displacing WTI’s crude oil to downstream
markets based on a report from US Energy Information Administration.

In line with the points above, it is needed to analyze if the Brent-WTI premium be a temporary event.
Also, the oil glut in Cushing was because of the record crude oil production in Bakken shale formation
and Canadian Oil Sands. However, in October-November, there were signs of transportation ease
after the news of the reversal of the Seaway pipeline and the price of the premium of Brent-WTI fell
by almost $20 per barrel. But the spread ended the year close to $10 per barrel which was still high.
It is needed to comprehend if JetBlue would continue using WTI for hedges or would it be profitable
for them to switch to Brent or heating oil.

Case facts:

1. Jet blue started suffering losses after jet fuel prices started increasing
2. JetBlue’s fuel costs also increased to approximately 40% of their operating costs because of
the airline’s expansion.
3. JetBlue started hedging 45% of its fuel consumption in the fourth quarter of 2011
 4. Southwest airline had been a pioneer in fuel hedging and had benefited from lower than
average fuel costs; from 2000 to 2010 it saved an estimated 3.5 billion dollars in fuel costs
due to hedging.
5. Brent’s premium to WTI reached a record level of $30 per barrel in September 2011
6. After the news of the reversal of the seaway pipeline, price of the Brent-WTI premium fell
almost 20 dollars per barrel but still since the spread ended the year close to 10 dollars a
barrel it was still high by historical standards.

Problems identified:

1. The derivatives considered could cost millions of dollars, and there was a risk that the airline
would suffer negative effects from a sharp decline in fuel prices.
2. WTI, the main US oil price benchmark, had become less well correlated with the global crude
oil market and as a result there was a concern that airlines would suffer losses because of
WTIs ineffectiveness.
3. There were concerns that the jet fuel price would not change perfectly in tandem with the
value of WTI derivative instrument used to hedge it.
4. There were concerns that the tightening of the Brent-WTI spread could hurt Delta Air Lines
and others pricing against Brent
5. There was a risk that the analysts who predicted that the Brent-WTI spread would narrow
may be wrong and WTI would continue to decouple from global oil markets
6. Increasing Canadian supplies and lack of export pipelines to the USGC would lead to
inventory buildup around Cushing and pipelines were unlikely to be reversed. Poor
infrastructure of a land locked delivery location could lead to the demise of WTI as the mail
oil benchmark.