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 MARKET BRIEFING July 29, 2010 • PAGE 5 MARKET BRIEFING Why Carriers Need A New Fuel-H edging Game Plan—Now ‘Large price swings could potentially force unprepared airlines to make dicult tradeos.’ 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-hedg- ing 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 participant s 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 tur- bulence in the strongest position. The fac t remains that energy mar - kets have fundamentally changed. In the last six months alone, New York Harbor jet fuel prices have os- cillated 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 be- come more problematic and politi- cized just when fast-growing coun- tries like India and China use more fuel than ever. Airlines still need to invest in fuel-hedging capa- bilities 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 opera- tional risk s than they do to control risks cr eated by volatile fuel prices. Some airlines recognize that developing more so- phisticated fuel-hedging capabilities can be a com- petitive 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 Departures Opinions expressed are not those of Aviation Daily or McGraw-Hill. Bylined submissions should be sent via e-mail to  Jennifer_Mi- [email protected] and limited to 680 words. The DAILY reserves the righ t to edit for space. A photo of the author, in print form or via e-mail, is welcome. Submissions become the property of McGraw-Hill and will not be returned. Opinions On Current Issues In Aviation 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 ana- lytics that make regularly evaluating fuel-hedging recommendations manageable. Such tools rapidly process data to capture the jet fuel market's dy- namics while examining thousands of potential sce- narios involving risks, such as the sudden decou- pling of traditionally correlated energy prices. For these tools to be effective, airlines need to in- troduce the infrastructure necessary to review hedg- ing 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 im- portant fuel-hedging decisions quickly . Responsibility for market analysis, potential hedging strat- egies and their execution must be segregated. A risk oversight committee with authority to ap- prove hedge recommendations should also be formed. Coping with volatile fuel pric- es will continue to be a chal- lenge for the airline industry. Large price swings could poten- tially 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 aban- doned hedging fuel altogether. Instead, airlines should make a preemptive strike to gain control over how increasingly complex energy markets impact their earnings. Mark R obson and Hans-Kristian Bryn are partners in the Corporate Risk practic e for Oliver Wyman, an in- ternational management consulting firm with offices in 16 countries. It also supplies data, separate from this o pinio n piece, to The DAILY under cont rac t. By Mark Robson and Hans-Kristian Br yn of Oliver Wyman Posted from Aviation Week’s A viation Daily, July 29, 2010, copyright by The McGraw-Hill Companies, Inc. with all rights reserved. No reproduction or distribution without permission. This reprint implies no endorsement, either tacit or expressed, of any company, product, service or investment opportunity. #1-27940959 Managed by The YGS Group, 717.505.9701. For more i nformation visit www.theYGSgroup.com/re prints.

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MARKET BRIEFING

July 29, 2010 • PAGE 5

MARKET BRIEFING

Why Carriers Need A New Fuel-Hedging Game Plan—Now

‘Large price swings

could potentially force

unprepared airlines

to make difficult

tradeoffs.’

After much partisan wrangling, Congress has signedfinancial legislation into law that will limit the size oftrades for anyone not hedging fuel with the intent ofactually using it.

Some airlines may be tempted to think this newDodd-Frank Act will solve many of their fuel-hedg-ing problems. But we believe airlines should not belulled into a false sense of security.

This legislation may curb the trading activities ofenergy trading participants like investment banksand hedge funds. But they will remain significantplayers in energy markets. Moreover, large fuelprice swings will return. The only questions arewhen, and which airlines will emerge from the tur-bulence in the strongest position.

The fact remains that energy mar-kets have fundamentally changed.In the last six months alone, NewYork Harbor jet fuel prices have os-cillated 23% from $1.95 per gallonto as high as $2.39. Traditionally, jetfuel prices have risen by about 5%annually. Today, they move by thatmuch on a weekly basis. That is inlarge part because demand for allrefined petroleum products oftenoutstrips supply. Oil drilling has be-come more problematic and politi-cized just when fast-growing coun-tries like India and China use more fuel than ever.

Airlines still need to invest in fuel-hedging capa-bilities that can mitigate the instability fuel pricesintroduce into their earnings. Jet fuel is the largestexpense for many airlines and now accounts forabout 25% of their total costs. Yet airlines employmany more full-time employees to handle opera-tional risks than they do to control risks created byvolatile fuel prices.

Some airlines recognize that developing more so-phisticated fuel-hedging capabilities can be a com-petitive advantage. One airline recently built up asubstantial energy trading team and invested in itsown jet fuel storage. By doing so, the airline not onlygains better visibility into what its fuel will cost, but

Departures

Opinions expressed are not those of Aviation Daily or McGraw-Hill. Bylined submissions should be sent via e-mail to  Jennifer_Mi-

[email protected] and limited to 680 words. The DAILY reserves the right to edit for space. A photo of the author, in print form

or via e-mail, is welcome. Submissions become the property of McGraw-Hill and will not be returned.

Opinions On Current Issues In Aviation

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 ana-lytics that make regularly evaluating fuel-hedgingrecommendations manageable. Such tools rapidlyprocess data to capture the jet fuel market's dy-namics while examining thousands of potential sce-narios involving risks, such as the sudden decou-pling of traditionally correlated energy prices.

For these tools to be effective, airlines need to in-troduce the infrastructure necessary to review hedg-ing recommendations on at least a monthly basis.Following a hedging strategy set at one particularpoint in time may create difficulties given the speed

at which fuel prices shift.Finally, airlines require a clear

reporting structure to make im-portant fuel-hedging decisionsquickly. Responsibility for marketanalysis, potential hedging strat-egies and their execution mustbe segregated. A risk oversightcommittee with authority to ap-prove hedge recommendationsshould also be formed.

Coping with volatile fuel pric-es will continue to be a chal-lenge for the airline industry.Large price swings could poten-

tially force unprepared airlines to make difficulttradeoffs. We estimate that major airlines lostan estimated $8 billion on jet fuel hedges lastyear. In response, many have implemented rigidhedging strategies determined annually or aban-doned hedging fuel altogether. Instead, airlinesshould make a preemptive strike to gain controlover how increasingly complex energy marketsimpact their earnings.

Mark Robson and Hans-Kristian Bryn are partners inthe Corporate Risk practice for Oliver Wyman, an in-ternational management consulting firm with officesin 16 countries. It also supplies data, separate fromthis opinion piece, to The DAILY under contract.

By Mark Robson and Hans-Kristian Bryn of Oliver Wyman

Posted from Aviation Week’s Aviation Daily, July 29, 2010, copyright by The McGraw-Hill Companies, Inc. with all rights reserved. No reproduction or distribution without permission.This reprint implies no endorsement, either tacit or expressed, of any company, product, service or investment opportunity.

#1-27940959 Managed by The YGS Group, 717.505.9701. For more i nformation visit www.theYGSgroup.com/reprints.