Hedging WTI Crude Oil: United Continental Holdings, Inc. (UAL)
Hee Joo Kim Joyce Chung Michael Chen Orlando Ardila May 8, 2012
Slide 2 Company Overview We are United Continental Holdings Inc., a
leading American airline. Fuel costs comprise over 30% of our total
operating expenses, and so we face high risks of fluctuations in
jet fuel prices. We will need to purchase and use jet fuel in June.
Since OTC jet fuel hedging is too expensiveand there is a high
correlation between the prices for jet fuel and crude oilwe are
looking to protect against price increases by hedging a proportion
of our fuel consumption in WTI crude oil (CL). Slide 3 Slide 4
Market View Method: We used 6 different trend models to forecast
spot price for April, May and June. Trend models include monthly
crude oil price starting in January 1986. Conclusion: Our models
lead us to forecast that the average price of crude oil in June
2012 will be approximately $98.94, DOWN from the current spot price
of $104.64. Slide 5 Slide 6 Factors Considered for View Economic
Factors Oil is pro-cyclical Expect bearish economy decrease in
demand for oil Growing concerns regarding European Sovereign Debt
Crisis (Italy and Spain) Slowing growth in China (8.1% in 2012Q1
lowest since 2009) Weak U.S. job market 55,000 less job creations
than economists expected Geopolitical Factors Easing political
tensions with Iran less supply risk 3 rd largest exporter of crude
oil in the world Six Party negotiations in motion to ease EUs oil
embargo on Iran, Irans partial oil embargo, and other countries
sanctions Increase in U.S. domestic crude oil production to average
6.2 million barrels per day in 2012 highest level of production
since 1998 (U.S. Energy Information Administration, 2012) End of
high season transition to warmer weather decrease in demand Slide 7
Other Factors That Affect CL Prices Natural disasters Pressure from
speculation War & military action Changes in OEPCs crude oil
production and supply Increase in global demand New technological
energy development Management of crude oil inventories Slide 8
Further Support Based on the trending oil prices, we expect market
oil prices to go DOWN. Our outlook on CL prices in the next month
(June 2012 delivery) is down. This view is generally supported by
analysts and economists. Slide 9 Volatility We see that while oil
is subject to high volatility (and is cyclical), implied and
historical volatilities have steadily converged and have remained
within the mid- 20% range in the past few months. Slide 10
Volatility Graph - Last 6 Months Implied volatility is comparable
to historical vol (10D and 30D) at around 23% Slide 11 Our View on
Volatility Implied volatility and historical (realized) volatility
are both around 23%.. After analyzing the volatility graphs and
running volatility forecasts using the GARCH model, we expect
volatility to remain STABLE until June. Slide 12 Risk Assumptions
Crude Oil Contract Price (4/17/2012): $104.64 Contract Settlement
Date: 5/22/2012 Days Remaining: 35 days Amount of Crude Oil
Required: 150,000 barrels UALs total fuel consumption in 2011 was
4.028 billion gallons We assume fuel consumption levels will remain
the same in 2012 1 barrel = 42 US gallons converts to 96.123
million barrels UAL hedges 2% of total fuel consumption in WTI
crude oil call options and swaps 2% of 96.123 million barrels 2
million barrels We took 1/12 th of this figure to assume that this
project constitutes UALs June fuel consumption 150,000 barrels
Slide 13 Slide 14 Price Calculations Expected Future Price &
Upper/Lower Critical Prices Slide 15 To Satisfy Risk Limits Slide
16 Value @Risk Spreadsheet UAL should hedge 74.1% of its underlying
CL position and leave 25.9% of its position unhedged. Slide 17
Unhedged Position Slide 18 Forward Hedge The forward hedge position
reflects the Value @Risk calculations, and indicates how many
forward contracts we need hedge to be within our risk limits. Slide
19 Market View & Potential Strategies The matrix below
indicates both components of our market view (highlighted in darker
blue). The alternative market views UAL can consider are
highlighted in the lighter blue. For each view, we recommend an
appropriate option strategy for UAL. Slide 20 Slide 21 Synthetic
Bear Spread View: Limited down, Worry big up Purpose: Trading,
Insurance, Income The synthetic bear spread best addresses our view
of a limited down and concern for a big up. In this position, we
forgo potential upside gains to protect our company from the
ramifications of price increases. Slide 22 Synthetic Bear Spread
(more OTM call) View: Direction Down, Worried about big up (not as
much 1 st bull-spread) Purpose: Trading, Insurance, Income
Preference over the other bull-spread if slightly more biased in
the down direction we can reap higher gains when prices fall at the
cost of decreasing our protection against possible increase in
price). Slide 23 Synthetic Short Straddle View: Stable, Neutral
Direction Purpose: Trade Volatility, Income We assume prices will
more-or-less remain the same. We earn little income (i.e. premium)
when prices have little to no movement in either direction. The
range of prices is narrower than in a short strangle. Slide 24
Synthetic Short Strangle View: Stable, Neutral Direction Purpose:
Trade Vol, Insurance, Income We believe there will be little to no
price movement (but more than short straddle position). We have a
limited gain upside for a wider range of prices than we would in a
straddle. Slide 25 Synthetic Short Call View: Stable, Not Up
Purpose: Trade, Income This position results in unlimited losses if
prices go up (but less than F position). If prices go down as we
expect, we gain limited upside. Slide 26 Synthetic Long Put View:
Direction Down, but Unsure Purposes: Trading, Insurance We would
hold this position if our view was the prices were going to go
down, but we want to protect ourselves from potential losses if
prices go up instead. Slide 27 Synthetic Long Put (ITM) View:
Direction Down, but Unsure Purposes: Trading, Insurance We realize
unlimited gains if prices go down, but we will forgo potential
gains to protect ourselves from an increase in volatility (cap
losses at higher price level than an ATM synthetic long put). Slide
28 Recommended Strategy: Synthetic Bear Spread Slide 29 Slide 30
The loss at the upper critical price level associated with a
standard deviation of 1.65 and a target loss of 5% is : This
position gives us protection from in the event of rising prices,
but allows us to get higher gains when prices has limited down.
This matches our views and our projections on future spot prices
and volatility. Slide 31 As seen in the graph, varying strike
prices can adapt the hedging position to better fit the companys
market views on direction and volatility.
