According to its Delta Air Lines FY 2015 annual report, for the sake of this exercise, assume that Delta Airlines currently does not have a fuel cost hedging program despite the fact that the price of oil has risen significantly in recent years (currently Delta hedged the jet fuel price risk with crude oil, heating oil, and jet fuel swap, collar and call option contracts). Suppose you are the CFO of Delta and are seriously considering using futures contracts from New York Mercantile Exchange to hedge rising fuel costs. Write a report to Delta’s CEO from the perspective of the CFO evaluating the importance and feasibility of implementing the hedging program. Your analysis should address the following issues:
From a financial perspective, is hedging an urgent need for the company? Suppose fuel prices go up by 20% from the 2015 level, what is the potential impact of this “oil shock” on Delta’s 2016 earnings? Please assess the impact based on your forecast of Delta’s 2016 income statement.
Please follow the basic rules of financial forecast: assume that the data items will increase at the historical growth rate from 2015 level.
Your forecast can be simplified statements which include only the most important data items.
If Delta decides to hedge one month’s fuel consumption for its fleet using futures contracts, what NYMEX product(s) should be used? Please provide a brief reason why you chose this product. Since jet fuel futures contracts are not available, a perfect hedge is not possible. You need to consider a cross-hedging product (i.e., crude oil, No. 2 heating oil (a.k.a, ULSD futures, i.e., ultra-low sulfur diesel futures), and RBOB futures contract) which has the highest correlation with the jet fuel spot prices.
Suppose that Delta wants to hedge one month’s fuel consumption for its fleet. Simulate potential hedging gains/losses using last month’s historical data (assuming that you entered the position of the futures contracts at the beginning of your simulation period). Please specify the contract, contract month, number of contracts required for the hedge, position (long or short), and margin requirements, as well as your daily margin account balance. Did you get any margin calls from the simulated hedging position? What is the total gain/loss of your position during the simulation period? Use a table similar to Table 2.1 on page 28 of the textbook to summarize the simulation results.
Please find the one month’s fuel consumption of Delta from its annual report (use projected fuel consumption of 2016 on page 50 (note 1 to the table) under section Item7A). Assume that the fuel consumption is spent evenly across each month and there is no seasonality in different months.
Access the New York Mercantile Exchange and choose the following margin requirements: “NYM” for exchange, “Crude oil” or “Refined products” for asset class, “CL” (crude oil futures), “HO” (No. 2 heating oil futures), or “RB” (RBOB gasoline futures) for product. Please note that different maturity month contracts may have different performance bond levels.
You need to calculate the minimum hedge ratio and number of contracts using historical data of spot jet fuel prices and futures prices (the product that you choose). These materials will be covered in Lesson 6 (a similar example is provided on page 57 of the textbook (Example 3.3)).
Please follow the NYMEX Future Prices Link link for historical daily settlement prices (daily “closing” prices) for crude oil, No.2 heating oil, RBOB gasoline futures contracts. You can use these prices of last month for the simulation purpose. Use settlement price of day 1 of your simulation period as the start settlement price of the simulation.
Please following the Spot Prices for Crude Oil and Petroleum Products Link for the historical spot prices for crude oil, jet fuel, No. 2 heating oil, RBOB gasoline.
What are the potential costs/pitfalls of this hedging program? You can include your simulation results for your discussion.
The format of your report should be as follows:
On the cover page, you should provide team information, as well as a brief executive summary followed by a short list of the key assumptions made in your analysis.
Your analysis should focus on the logic of the argument leading to your conclusion.
Please leave calculations, definitions and detailed information regarding the futures contracts in the notes to the tables in the appendix.
The report is limited to three pages of text (typed, double-spaced, reasonable point sizes and margins).
Supporting tables, spreadsheets and graphs (herein called exhibits) are limited to five pages.
The exhibits should be referred to in the text of your analysis. Reference to exhibits should be as explicit as possible.
Tables and graphs should be clearly labeled. The assumptions being maintained and formulas being used should be obvious to the reader. A rule of thumb is that the tables should be able to stand alone.
Please submit your Excel spreadsheet with calculations and work in a separate Excel file along with your final report.
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