Group Assignment 2

Aayush Sureka
Simon Plauchu
Yoann Bernerd
Thomas Mieg de Boofzheim
Part 1
Question 1)

WTI stands for “West Texas Intermediate” otherwise known as “WTI, Cushing, Oklahoma” or
“Texas Light Sweet”. WTI is a light crude oil with less than 0.24% of sulphur which is refined
in USA (Midwest and Gulf Coast). It is one of the two important benchmarks used to price
crude oil, alongside Brent, and is traded in the commodity and future markets. WTI is traded
on the New York Mercantile Exchange (NYMEX) which is the exchange specialised in energy.
The NYME has been acquired by the Chicago Mercantile Exchange (CME) in 2008.

Question 2)

Originally, Brent is the name of an oil field located in the North Sea between the Shetland
Islands (Scotland) and Norway. Nowadays, the term "Brent" is more commonly used to refer
to a combination of many different types of light oils refined in northern Europe. Despite limited
production, it serves as a benchmark in the stock markets of parts of Europe, Africa and the
Mediterranean. Its value determines the price of nearly two-thirds of the world's oil production.
Brent is traded internationally, including Rotterdam, the US Intercontinental Exchange (ICE)
and the New York Mercantile Exchange.

Question 3)

WTI/Brent 10 years price evolution

140.00

120.00

100.00

80.00

60.00

40.00

20.00

0.00

Brent WTI
Question 4)

Futures Prices evolution with different maturities

63.8
63.6
63.4
63.2
63
62.8
62.6
62.4

WTI Brent

Question 5)

By looking at the difference between the spot rate i.e. the price of fuel today, and the future
price, we can make an estimation of the future oil price. Currently, the spot price is trading at
$0.77 below the future price, thus we can expect the price of fuel to increase in the near future.
Numerous studies have found that future price is an excellent estimator of future oil prices,
thus, the difference in trading price holds enough information to make this estimation.
Part 2)

Question 1)

SIA’s profit is sensitive to changes in jet fuel prices, which is in turn affected by oil prices.
Higher fuel prices lead to increased flight costs and thus a decrease in operating profit. This can
have to negative impacts. Firstly, a decrease in profit reduces shareholder value, which may
result in shareholders selling their ownership of SIA, driving the stock price down. Moreover,
increased flight costs are reflected on costs to the consumer who may prefer other alternative
airlines or low-cost flights instead. This reduces consumer engagement and fidelity to
Singapore airlines, and can further decrease profit.
Question 2)

Fuel cost before hedging Fuel hedging (gain)/loss Fuel cost (net)
Fiscal Year
($ million) ($ million) ($ million)
2006-2007 3,787.0 94.0 3,881.0
2007-2008 4,240.0 (185.0) 4,055.0
2008-2009 5,043.0 306.0 5,349.0
2009-2010 3,076.6 460.1 3,536.7
2010-2011 3,755.2 49.9 3,805.1
2011-2012 4,888.7 (19.9) 4,868.8
2012-2013 4,979.1 (27.7) 4,951.4
2013-2014 4,843.7 (71.1) 4,772.6
2014-2015 4,079.3 456.9 4,536.2
2015-2016 2,636.7 926.6 3,563.3
2016-2017 2,624.5 269.0 2,893.5

Within the last ten years, SIA has always maintained a hedge to protect itself against surging
fuel prices. While the average net loss on per year is $205 million, there has been four instances
of SIA’s hedge proving beneficial and alleviating increases in oil prices. However, in any
occasions, SIA has missed out on financial benefits from decreasing jet fuel prices. The
following chart further illustrates this.

400.0
Relationship between Hedge profit and jet fuel price 3.500

200.0 3.000

0.0 2.500

-200.0 2.000

-400.0 1.500

-600.0 1.000

-800.0 0.500

-1,000.0 0.000

Hedge gain/loss Jet fuel price

Question 3)

Europe Brent Spot

WTI Spot Price MoM change Price FOB MoM change Jet Fuel Spot Price MoM change
Date FOB ($/Barrel) in % ($/Barrel) in % FOB ($/Barrel) in %
Oct-2015 $ 46.22 $ 48.43 $ 58.42
Nov-2015 $ 42.44 -8.178% $ 44.27 -8.590% $ 55.69 -4.673%
Dec-2015 $ 37.19 -12.370% $ 38.01 -14.141% $ 45.44 -18.401%
Jan-2016 $ 31.68 -14.816% $ 30.70 -19.232% $ 39.06 -14.048%
Feb-2016 $ 30.32 -4.293% $ 32.18 4.821% $ 40.87 4.624%
Mar-2016 $ 37.55 23.846% $ 38.21 18.738% $ 44.90 9.866%
Apr-2016 $ 40.75 8.522% $ 41.58 8.820% $ 48.17 7.297%
May-2016 $ 46.71 14.626% $ 46.74 12.410% $ 54.56 13.252%
Jun-2016 $ 48.76 4.389% $ 48.25 3.231% $ 58.04 6.390%
Jul-2016 $ 44.65 -8.429% $ 44.95 -6.839% $ 53.42 -7.959%
Aug-2016 $ 44.72 0.157% $ 45.84 1.980% $ 54.39 1.808%
Sep-2016 $ 45.18 1.029% $ 46.57 1.592% $ 55.40 1.853%
Oct-2016 $ 49.78 10.181% $ 49.52 6.335% $ 61.19 10.462%
Nov-2016 $ 45.66 -8.276% $ 44.73 -9.673% $ 56.95 -6.932%
Dec-2016 $ 51.97 13.820% $ 53.31 19.182% $ 62.62 9.956%
Jan-2017 $ 52.50 1.020% $ 54.58 2.382% $ 63.59 1.543%
Feb-2017 $ 53.47 1.848% $ 54.87 0.531% $ 64.97 2.180%
Mar-2017 $ 49.33 -7.743% $ 51.59 -5.978% $ 60.69 -6.593%
Apr-2017 $ 51.06 3.507% $ 52.31 1.396% $ 63.42 4.498%
May-2017 $ 48.48 -5.053% $ 50.33 -3.785% $ 59.30 -6.490%
Jun-2017 $ 45.18 -6.807% $ 46.37 -7.868% $ 54.39 -8.286%
Jul-2017 $ 46.63 3.209% $ 48.48 4.550% $ 59.51 9.421%
Aug-2017 $ 48.04 3.024% $ 51.70 6.642% $ 65.56 10.162%
Sep-2017 $ 49.82 3.705% $ 56.15 8.607% $ 75.60 15.311%
Oct-2017 $ 51.58 3.533% $ 57.51 2.422% $ 69.68 -7.833%
Nov-2017 $ 56.64 9.810% $ 62.71 9.042% $ 73.92 6.088%
Dec-2017 $ 57.88 2.189% $ 64.37 2.647% $ 76.31 3.239%
Jan-2018 $ 63.70 10.055% $ 69.08 7.317% $ 81.98 7.430%
Feb-2018 $ 62.23 -2.308% $ 65.32 -5.443% $ 77.66 -5.277%
Mar-2018 $ 62.73 0.803% $ 66.02 1.072% $ 78.04 0.487%
Apr-2018 $ 66.25 5.611% $ 72.11 9.224% $ 84.63 8.450%
May-2018 $ 69.98 5.630% $ 76.98 6.754% $ 90.51 6.948%
Jun-2018 $ 67.87 -3.015% $ 74.41 -3.339% $ 87.78 -3.016%
Jul-2018 $ 70.98 4.582% $ 74.25 -0.215% $ 88.12 0.383%
Aug-2018 $ 68.06 -4.114% $ 72.53 -2.316% $ 88.96 0.953%
Sep-2018 $ 70.23 3.188% $ 78.89 8.769% $ 91.94 3.352%
Question 4)

Using the data from the above table, we ran the regression of the price of Jet fuel on the price
of WTI and Brent. The following results were obtained:

∆𝑃𝑗𝑒𝑡 𝑓𝑢𝑒𝑙 = 0.349 + 0.8072∆𝑃𝑊𝑇𝐼

∆𝑃𝑗𝑒𝑡 𝑓𝑢𝑒𝑙 = 0.058 + 0.8493∆𝑃𝐵𝑟𝑒𝑛𝑡

The two regressions had the following characteristics:

WTI Brent
R-squared 0.661 0.783
Std. Errors 4.695 3.759

It appears that the spread between the Brent and jet fuel is less volatile (as indicated by lower
standard errors). Furthermore, 78% of the change in jet fuel price can be attributed to the change
in price of the Brent, against 66% for the WTI. The difference in Betas can simply be attributed
to the difference in price of WTI and Brent. With all these factors in mind, Brent seems to be a
better hedging options due to lower volatility and closer fit.

Question 5)

The optimal hedge ratio is the β that we have estimated in our previous regressions.
Since we have decided to use Brent, the optimal hedge ratio is 0.849.

Question 6)

If SIA was to hedge using only oil futures as a proxy for jet fuel, for each barrel of jet fuel it
requires, the formula is as follows:
𝐻𝑒𝑑𝑔𝑒 𝑝𝑜𝑠𝑖𝑡𝑖𝑜𝑛 = 𝐴𝑠𝑠𝑒𝑡 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 ∗ 𝛽

Thus, the required hedge position for SIA is

𝐻𝑒𝑑𝑔𝑒 𝑝𝑜𝑠𝑖𝑡𝑖𝑜𝑛 = 1,000 𝑏𝑎𝑟𝑟𝑒𝑙 𝑜𝑓 𝐽𝑒𝑡 𝐹𝑢𝑒𝑙 ∗ 0.849
𝐻𝑒𝑑𝑔𝑒 𝑝𝑜𝑠𝑖𝑡𝑖𝑜𝑛 = 849 𝐵𝑟𝑒𝑛𝑡 𝑜𝑖𝑙 𝑏𝑎𝑟𝑟𝑒𝑙𝑠 𝑜𝑟 0.849 𝐵𝑟𝑒𝑛𝑡 𝑓𝑢𝑡𝑢𝑟𝑒𝑠.

Question 7)
If shareholders in SIA are already hedged on their portfolios, SIA’s effort to hedge profit may
counteract investors own hedging strategies. Some investors would invest in an airline as a
risky business, or as a hedge against fuel price. SIA hedging their fuel costs defeats this purpose.
As we have seen earlier, the hedge may create a counter effect of preventing SIA from
benefiting from lower jet fuel prices. Moreover, hedging is not free, and the added costs are
borne by the investor as owners of the company. Both these consequences reduce profit and
profit to the shareholder.
Question 8)

SIA hedges the fuel price risk by using swap, option and collar contracts and hedging as far as
20 quarters forward using jet fuel swap, option and collar contracts, ICE Brent swap contracts
and Brent-MOPS crack swap contracts. It has applied cash flow hedge accounting to these
derivatives as they are highly effective hedging instruments. As of March 2018, the company
had entered longer dated Brent hedges with maturities extending to the financial year 2022-23
that cover nearly half of the Group’s projected annual fuel consumption, at average prices
ranging from USD55-58 per barrel.
Appendix 1) & 2)

Results of the regression of the MoM price changes (in%) of WTI & Brent on MoM price
changes (in%) of Jet fuel

SUMMARY
OUTPUT WTI

Regression Statistics
Multiple R 0.8132
R Square 0.6613
Adjusted R Square 0.6507
Standard Error 4.6950
Observations 34.0000

ANOVA
Significance
df SS MS F F
Regression 1.0000 1377.1356 1377.1356 62.4746 0.0000
Residual 32.0000 705.3803 22.0431
Total 33.0000 2082.5159

Standard
Coefficients Error t Stat P-value
Alpha (intercept) 0.3479 0.8258 0.4213 0.6764
Beta 0.8072 0.1021 7.9041 0.0000

SUMMARY
OUTPUT Brent

Regression Statistics
Multiple R 0.8848
R Square 0.7829
Adjusted R Square 0.7761
Standard Error 3.7585
Observations 34.0000

ANOVA
Significance
df SS MS F F
Regression 1.0000 1630.4665 1630.4665 115.4186 0.0000
Residual 32.0000 452.0494 14.1265
Total 33.0000 2082.5159

Standard
Coefficients Error t Stat P-value
Alpha (Intercept) 0.0581 0.6646 0.0874 0.9309
Beta 0.8493 0.0791 10.7433 0.0000