The State of Airline Fuel Hedging & Risk Management in

2012

The study reveals the current fuel hedging and risk management practices of twenty-four commercial airlines across the globe.

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 air-lines are hedging their fuel price risk, nearly half stated that their hedging programs should be utilizing hedging strategies which better reflect their tol-erance 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 company’s risk tolerance and hedging goals

Over the course of the past few years, volatile oil prices have wreaked havoc on the airline industry, a trend which doesn’t 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.

Introduction

52% of participants indicated that their company’s shares are publicly traded, 33% indicated that they are privately held, 10% indicated that they are government owned, while 5% answered other. 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, 10% in Africa, and 4% answered common wealth of independent states. 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:

Demographics

33.33%

38.10%

4.76%

23.81%

0%

10%

20%

30%

40%

1 - 24 25 - 75 76 - 150 > 150

Number of Aircraft in Fleet

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 company’s hedging decisions, participants indicated the following:

Fuel Hedging Policy & Governance

22%

39%

11%

22%

6%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Responsibility for Hedging Decisions

Board of Directors

Hedge Committee

CEO/President/MD

CFO/VP of Finance

Other

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. When asked what is the primary purpose of their fuel hedging and

risk management program, participant stated the following:

State of Industry Hedging Practices

32%

52%

16%

0%

10%

20%

30%

40%

50%

60%

Primary Goal of Fuel Hedging Program

Mitigate cash flowvolatility

Protect againstshort-term fuel

price increases

Protect againstlong-term fuel price

increases

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.

Most Utilized Hedging Instruments

3.23% 3.23%

38.71%

29.03%

12.90% 12.90%

Futures Forwards(Physical)

Swaps CallOptions

CostlessCollars

Three-WayCollars

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

Hedging Instruments Utilized

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 shouldn’t 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 Tenor of Hedge Positions

38.46%

30.77%

23.08%

7.69%

0%

10%

20%

30%

40%

50%

0-6 Months 7-12 Months 13-18 Months 19-24 Months

Average Duration of 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.

Current Hedge Positions

7%

43%

29%

14%

7%

0%

10%

20%

30%

40%

50%

0-20% 21-40% 41-60% 61-80% 81-100%

Average Percentage of Fuel Hedged for Next 12 Months

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.

Fuel Hedging Success

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. 13% of respondents stated that they are content with their hedging program. 9% of participants indicated that optimizing or monetizing their existing hedge positions would be the best way to improve their fuel hedging program.

Improving Fuel Hedging & Risk Management Programs

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.

Sources of Fuel Hedging Advice, Data & Information

68.42%

15.79%10.53%

5.26%

0%

10%

20%

30%

40%

50%

60%

70%

80%

FinancialInstitution

Fuel Supplier Consultant InternalResources

Primary Source of Hedging Advice, Data & Information

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.

Methodology

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 our website at www.mercatusenergy.com or contact us by phone: Houston: +1.713.970.1003. London: +44.20.3608.1277

Mercatus Energy Advisors

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