Fuel Hedging and Risk Management ForothertitlesintheWileyFinanceSeries pleaseseewww.wiley.com/finance Fuel Hedging and Risk Management Strategies for Airlines, Shippers, and Other Consumers S. MOHAMED DAFIR VISHNU N. GAJJALA Thiseditionfirstpublished2016 ©2016S.MohamedDafirandVishnuN.Gajjala Registeredoffice JohnWiley&SonsLtd,TheAtrium,SouthernGate,Chichester,WestSussex,PO198SQ,United Kingdom Fordetailsofourglobaleditorialoffices,forcustomerservicesandforinformationabouthowtoapply forpermissiontoreusethecopyrightmaterialinthisbookpleaseseeourwebsiteatwww.wiley.com. Allrightsreserved.Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,or transmitted,inanyformorbyanymeans,electronic,mechanical,photocopying,recordingor otherwise,exceptaspermittedbytheUKCopyright,DesignsandPatentsAct1988,withouttheprior permissionofthepublisher. 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ISBN978-1-119-02672-3(hardback) ISBN978-1-119-02675-4(ebk) ISBN978-1-119-02673-0(ebk) ISBN978-1-119-02674-7(obk) Coverdesign:Wiley Coverimage:Airplaneimage:©06photo/iStockphoto;Sunset/Shipimage:©zeroin/iStockphoto; Bottomimage:©GeoPappas/iStockphoto Setin10/12ptTimesbyAptaraInc.,NewDelhi,India PrintedinGreatBritainbyTJInternationalLtd,Padstow,Cornwall,UK Tomydearparents,LinYi,andmynieces,princessesMalak,Omayma, Myriam,andAsma,without forgettingCaptainZacharyYacinandallthe familyDafir. -S.M.D. Tomyparents,Sairoopa andPrasad. -V.G. Contents Preface xiii Acknowledgments xix AbouttheAuthors xxi CHAPTER1 EnergyCommoditiesandPriceFormation 1 EnergyasaStrategicResource 1 EnergyasaTradableCommodity 3 EnergyCommodities 5 CrudeOil 5 OilProducts 8 NaturalGas 11 Coal 11 PriceDriversinEnergyMarkets 12 GeopoliticalRisks 12 TheGeopoliticalChessboard–ThePetrodollarSystemandRisingChina 12 Long-TermSupplyandDemand 15 Short-TermSupplyandDemand:SupplyChainandInfrastructure 17 FinancializationofCommodities 19 Market-SpecificPriceDrivers 19 Summary 20 CHAPTER2 MajorEnergyConsumersandtheRationaleforFuelHedging 23 EnergyMarketParticipants 23 RisksFacedbyFuelConsumers–TheCaseoftheAirlineIndustry 27 AirlineIndustry–MetricsandOperationalRisks 27 AirlineIndustry–FinancialRisks 30 RisksFacedbyOtherMajorFuelConsumers 35 ShippingCompanies 35 LandTransportation 37 OilRefining,Petrochemicals,andPowerGeneration 37 IndustrialUsersofEnergyCommodities 38 TheCaseforHedging 39 TheEffectofHedgingonAirlineStockPriceVolatility 39 vii viii CONTENTS CommodityDerivativeMarkets 41 ABriefHistoryofCommodityMarkets 42 CommoditySpotMarketsandtheNeedforStandardization 43 ForwardContracts 44 FuturesContracts 45 OptionContracts 50 Summary 53 AppendixA 54 CHAPTER3 DevelopingFuelHedgingStrategies 55 TheRationaleforCommodityHedging 55 DevelopingaFuelHedgingProgram 57 RiskIdentificationandAssessment 57 TypesofRisk 58 RiskIdentification 59 ForecastingPricesandConductingSimulations 59 ArticulatingtheFirm’sRiskAppetite 60 SettingObjectivesforFuelHedgingandtheScopeofHedging 60 IdentifyingRiskManagerswithintheOrganization 61 DeterminingtheScopeoftheHedgeProgram 61 ImplementationofHedging 62 SelectingtheFuelCostManagementMethod 62 IdentifyingtheUnderlyingtoHedgewithandBasisRisk 63 QuantityandTenorofHedging 66 SelectionofInstrumentsforHedging 67 MarketRisk 68 ManagementoftheUnwantedRisksofaPortfolio 68 CreditRisk 68 LiquidityRisk 69 OperationalRisk 69 LegalandReputationalRisk 70 MonitoringandCalibrationoftheHedgingProgram 70 TemplateforaRiskManagementPolicy 71 TheAirlineIndustry–TrendsinFuelRiskManagement 71 MagnitudeofFuelPriceRisk 71 UnderlyingsandHedgingInstruments 73 QuantityandTenorofHedging 74 RecentDevelopments 75 Summary 75 CHAPTER4 ShippingandAirlines–BasicsofFuelHedging 77 Spot–ForwardRelationships 77 TheoriesontheShapeofForwardCurves 78 Spot–ForwardRelationshipsforInvestmentAssets 79
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