The State of Airline Fuel Hedging & Risk Management

Executive Summary
The State of Airline Fuel Hedging & Risk Management is the result of a study conducted to reveal the current state of fuel hedging and risk management among commercial airlines.
The most noteworthy finding of the study is that, while the majority of airlines are hedging their fuel price risk, nearly half stated that their hedging programs should be utilizing hedging strategies which better reflect their tolerance for risk and corporate objectives.
81% stated they are or, have previously, hedged their jet fuel price risk Of those who are or have engaged in jet fuel hedging, 76% stated that

they have an official fuel hedging policy

When asked about the primary purpose of their fuel hedging program,

44% stated that it is to protect against short term price increases

Swaps and call options are the most popular hedging instruments

utilized among study participants

82% stated that they currently have fuel hedges in place When asked how they could most improve their fuel hedging program,

39% stated that they could do so by utilizing hedging strategies which better reflect the companys risk tolerance and hedging goals

Introduction
Over the course of the past few years, volatile oil prices have wreaked havoc on the airline industry, a trend which doesnt appear to be ripe for change anytime in the foreseeable future. Between crude oil rising to nearly $150/BBL in 2008, subsequently collapsing to below $40, and recently rising to above $125, the past five years have proven to be a very challenging time for the airline industry. Adding insult to injury, the state of the capital markets has left many airlines without access to much needed capital. In these times of significant change and uncertainty, it is essential that commercial airlines employ a sound fuel hedging and risk management program. These programs will not only allow the airlines to survive the most challenging times, but should also allow them to excel in the best of times as well. The primary focus of energy risk management as it relates to commercial airlines is the hedging and risk management of jet fuel price risk. Consequently, this subject forms the basis of this study, which strives to analyze the current fuel hedging and risk management practices of commercial airlines across the globe.

Demographics
52% of participants indicated that their companys shares are publicly traded, 33% indicated that they are privately held, while 10% indicated that they are government owned. When asked where the majority of their flights originate, 48% stated that their flights originate in Europe, 24% in North America, 14 % in the Asia-Pacific region and 10% in Africa. 57% of participants indicated that the majority of their flights are international, while the remaining 43% indicated that they majority of their flights are domestic. The participants stated that the number of aircraft in their fleet are as follows:

Number of Aircraft in Fleet

40% 33.33% 30% 20% 10% 0% 1 - 24 25 - 75 76 - 150 > 150 23.81% 38.10%

4.76%

Fuel Hedging Policy & Governance

76% of participants stated that they have an official fuel hedging and risk management policy while the remainder stated that they do not have such a policy. 63% stated that they do employ hedge accounting, 25% said they do not, while the remainder indicated that hedge accounting is not applicable to their fuel hedging program. When asked who is responsible for making their companys hedging decisions, participants indicated the following:

Responsibility for Hedging Decisions

45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 11% 6% 22% 22% CFO/VP of Finance Other 39% Board of Directors Hedge Committee CEO/President/MD

State of Industry Hedging Practices

When asked if they are currently hedging and/or whether they have previously engaged in hedging, 81% answered in the affirmative. Of those who indicated that they are currently hedging or have previously engaged in hedging, 82% indicated that they currently have fuel hedges in place. What asked what is the primary purpose of their fuel hedging and risk management program, participant stated the following:

Primary Goal of Fuel Hedging Program

60% 52% 50% 40% 32% 30% 20% 10% 0% 16% Protect against short-term fuel price increases Protect against long-term fuel price increases Mitigate cash flow volatility

Most Utilized Hedging Instruments

Participants stated that they are currently and/or have previously utilized various hedging instruments and structures as indicated in the chart shown below. As we would have assumed, the majority of participants are utilizing fixed price swaps and call options, which tend to be the favored hedging instruments of the industry.

Hedging Instruments Utilized

45.00% 40.00% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00%

38.71% 29.03%

12.90% 3.23%
Futures

12.90%

3.23%
Forwards (Physical) Swaps Call Options Costless Three-Way Collars Collars

Average Tenor of Hedge Positions

When asked, at any given time, what is the average duration of their fuel hedges, participants stated the following, as indicated in the chart shown below. While it shouldnt come as a surprise that the majority stated that their hedge positions average less than one year, it is interesting to note the low percentage of longer dated hedging. When compared to historical financial statements of numerous airlines, it appears that highly volatile oil prices are driving most airlines towards hedges of shorter tenors than would be the case in a lower volatility environment.

Average Duration of Hedge Positions

50% 40% 30% 23.08% 20% 10% 0% 0-6 Months 7-12 Months 13-18 Months 19-24 Months 7.69% 38.46% 30.77%

Current Hedge Positions

When asked, at any given time, what percentage of their anticipated fuel consumption is hedged for the upcoming year, participants stated the following, as indicated in the chart shown below. While some participants are clearly very well hedged for the coming year, just shy of half of the participants are less than forty percent hedged, indicating that they are quite comfortable having very significant exposure to spot market prices. This is interesting as many airlines have recently stated that they are fearful of oil prices rising above the current forward curve.
Average Percentage of Fuel Hedged for Next 12 Months 50% 43% 40% 30% 20% 10% 0% 0-20% 21-40% 41-60% 61-80% 81-100% 7% 29%

14% 7%

Fuel Hedging Success

When asked how their company determines whether their fuel hedging program is and/or has been successful: 36% stated that avoiding exposure to short-term fuel price increases is their definition of success. An additional 36% stated that their fuel hedging program is deemed to be a success if they are ability to mitigate cash flow volatility. Interestingly, 14% stated they believe their hedging program is successful if said program provides them with a competitive advantage in the industry. The remainder of the participants equally stated that their fuel hedging program is considered a success if they are able to avoid exposure to long-term fuel price increases or if it improves their profitability.

Improving Fuel Hedging & Risk Management Programs

When asked how they could most improve their fuel hedging and risk management program: 39% said utilizing hedging strategies that better reflect the company's risk tolerance and corporate goals. 22% stated that establishing a consistent approach of hedging on a regular basis would most improve their hedging program. 17% indicated that their hedging program would be most improved by developing better processes to execute and implement their hedging strategies. 9% of participants indicated that optimizing or monetizing their existing hedge positions would be the best way to improve their fuel hedging program.

Sources of Fuel Hedging Advice, Data & Information

When participants were asked if and whom they receive hedging advice, data or information they indicated the following: The fact that the vast majority of the participants stated that they are relying on financial institutions and fuel suppliers, most likely their counter-parties, to provide them with hedging advice, data and information, implies that many in the airline industry have yet to adopt energy hedging and risk management best practices.
Primary Source of Hedging Advice, Data & Information 80% 70% 60% 50% 40% 30% 20% 10% 0% Financial Institution Fuel Supplier Consultant Internal Resources 15.79% 10.53% 5.26% 68.42%

Methodology
The State of Airline Fuel Hedging & Risk Management provides an overview of the current fuel hedging and risk management practices of the commercial airline industry. The twenty-four participants of the study were invited to participate via email and telephone. The study was conducted online during the winter of 2011-2012.

Acknowledgements
We would like to thank Airline Economics for their communications and marketing assistance on this project.

Mercatus Energy Advisors

Mercatus Energy Advisors is the leading, independent energy hedging & risk management advisory firm. Our client base includes energy consumers, marketers, producers, refiners, and traders as well as financial institutions, institutional investors and professional services firms. For more information, please visit www.mercatusenergy.com or contact us by phone in Houston +1.713.970.1003 or London +44.20.3608.1277.

Airline Economics
Airline Economics is the foremost global publication dedicated to news and analysis for aircraft owners, operators and lessors and everything that affects the day-to-day running of their business. As a lead publication of Aviation News Ltd, Airline Economics fills a market void with editorial staff able to write about the things that airlines and lessors need to know in order to make informed decisions. To view the latest issue of Airline Economics, please visit www.aviationnews-online.com/airline-economics.