2 I-ClickerWhat do you think the current oil prices are
A. 50 per barrel
B. 60 per barrel
C. 70 per barrel
D. 80 per barrel
3 (No Transcript) 4 Changes in Oil Prices
War in the Middle East
Continuing demand from worlds largest economies
Concerns over limited production capacity
Closure of US oilfield after a fire
Ongoing cold snap
5 Impact on US Companies
Companies need stable oil prices to keep prices fixed
Because crude prices are so volatile oil producers and consumers use exchange-traded derivative instruments to hedge against adverse price fluctuations
Hedging is used to limit risk in the changes of price.
Eliminates risk but give up potential for upside gain.
Forward contracts are used to hedge against the fluctuations in changes of oil prices.
Suppose you wanted to buy a quantity of oil in 6 months time. Spot Price 60 per barrel.
- Could wait 6 months and purchase at new spot price.
- Could purchase forward today of 65 per barrel and lock in a fixed price today.
Eliminates risk if price is higher than 65
8 Southwest Airlines
Competitive low cost airline
Use forwards and fuel options to hedge against fuel prices.
Call Options give the right to buy at a certain price in the future but allows for potential gain
9 Southwest Airlines
Example If current price for oil is 60 Southwest buy an option to buy oil for no more than 60 in 6 months.
- If the price is more than 60 then Southwest can exercise option and purchase at 60
- If price less than 60 then can let option expire and purchase at lower price
10 Southwest Airlines
Currently purchasing oil at 50 of market price
One of the only airlines to maintain profit after 2001 and Hurricane Katrina
Fully hedged until 2009
11 Thank you for your time!
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