MARKET BRIEFING

July 29, 2010 PAGE 5

Departures
Opinions On Current Issues In Aviation

Why carriers Need A New Fuel-Hedging Game planNow

By Mark Robson and Hans-Kristian Bryn of Oliver Wyman

After much partisan wrangling, Congress has signed

financial legislation into law that will limit the size of
trades for anyone not hedging fuel with the intent of
actually using it.
Some airlines may be tempted to think this new
Dodd-Frank Act will solve many of their fuel-hedging problems. But we believe airlines should not be
lulled into a false sense of security.
This legislation may curb the trading activities of
energy trading participants like investment banks
and hedge funds. But they will remain significant
players in energy markets. Moreover, large fuel
price swings will return. The only questions are
when, and which airlines will emerge from the turbulence in the strongest position.
The fact remains that energy markets have fundamentally changed.
In the last six months alone, New
York Harbor jet fuel prices have oscillated 23% from $1.95 per gallon
to as high as $2.39. Traditionally, jet
fuel prices have risen by about 5%
annually. Today, they move by that
much on a weekly basis. That is in
large part because demand for all
refined petroleum products often
outstrips supply. Oil drilling has become more problematic and politicized just when fast-growing countries like India and China use more fuel than ever.
Airlines still need to invest in fuel-hedging capabilities that can mitigate the instability fuel prices
introduce into their earnings. Jet fuel is the largest
expense for many airlines and now accounts for
about 25% of their total costs. Yet airlines employ
many more full-time employees to handle operational risks than they do to control risks created by
volatile fuel prices.
Some airlines recognize that developing more sophisticated fuel-hedging capabilities can be a competitive advantage. One airline recently built up a
substantial energy trading team and invested in its
own jet fuel storage. By doing so, the airline not only
gains better visibility into what its fuel will cost, but

also can reduce the total into wing expense.

The critical first step for an airline to steady its
fuel hedge positions is for it to develop a set of analytics that make regularly evaluating fuel-hedging
recommendations manageable. Such tools rapidly
process data to capture the jet fuel market's dynamics while examining thousands of potential scenarios involving risks, such as the sudden decoupling of traditionally correlated energy prices.
For these tools to be effective, airlines need to introduce the infrastructure necessary to review hedging recommendations on at least a monthly basis.
Following a hedging strategy set at one particular
point in time may create difficulties given the speed
at which fuel prices shift.
Finally, airlines require a clear
reporting structure to make important fuel-hedging decisions
quickly. Responsibility for market
analysis, potential hedging strategies and their execution must
be segregated. A risk oversight
committee with authority to approve hedge recommendations
should also be formed.
Coping with volatile fuel prices will continue to be a challenge for the airline industry.
Large price swings could potentially force unprepared airlines to make difficult
tradeoffs. We estimate that major airlines lost
an estimated $8 billion on jet fuel hedges last
year. In response, many have implemented rigid
hedging strategies determined annually or abandoned hedging fuel altogether. Instead, airlines
should make a preemptive strike to gain control
over how increasingly complex energy markets
impact their earnings.

Large price swings

could potentially force
unprepared airlines
to make difficult
tradeoffs.

Mark Robson and Hans-Kristian Bryn are partners in

the Corporate Risk practice for Oliver Wyman, an international management consulting firm with offices
in 16 countries. It also supplies data, separate from
this opinion piece, to The DAILY under contract.

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