Case Analysis on Jet Blue Airways

Student Name
University Name
JETBLUE CASE STUDY

Jet Blue Case Study
Contents
Introduction............................................................................................................... 2
Should Jet blue hedge its fuel cost?..................................................................................2
Various strategies used by airlines to hedge fuel price risk......................................................4
Crack spread.............................................................................................................. 5
What is Crack spread?............................................................................................... 5
Calculation of the crack spread.................................................................................... 5
Volatility in the crack spread and its effect on the hedging..................................................6
Hedging strategies by the airlines.................................................................................... 6
What risks are hedged?.............................................................................................. 6
Price risk and Quantity risk......................................................................................... 7
To what extent should airlines hedge their fuel risk...........................................................7
Reason to switch from WTI to Brent hedging......................................................................8
Conclusion................................................................................................................ 9
References................................................................................................................ 9
1

Jet Blue Case Study
Introduction
This report discusses the hedging strategies used by JetBlue Airways and the related
issues. It is a low-cost airline that was started in 2000. Its business model of providing in-
flight entertainment and other customer centric services at affordable costs helps the
company grow remarkably. It went public in 2002 and experienced high profitability.
But, in 2005 the company’s profits were hit by the rising costs of jet fuel. JetBlue found it
difficult to pass these rising costs as surcharges to the customers as it was not matched by
the other competitors. Hence, the company started hedging its fuel prices to protect its
cost structure and profitability. The company entered into various contracts like swaps,
call options, swaps and collars with underlying as crude oil, jet fuel or heating oil to
hedge its fuel costs. These hedges help airlines to fix the future costs for its jet fuel but
these derivatives contract can be too costly. Also, they can have negative effects if fuel
prices decline drastically. The report first discusses the need for the airlines and JetBlue
in particular to hedge its fuel costs. The advantages of fixing a future price are discussed
along with the negative effects and costs of these contracts. Then the report discusses
various hedging strategies used by the company. The report also talks about the crack
spread and its calculation. It is discussed that basis risk is involved when cross hedging
strategies are used and there is difference between the price of the crude oil and its refined
products. The report further discusses about the price risk and quantity risks. It discusses
which risks need to be hedged and which need to be left unhedged by the company. It
discusses whether airlines should 100% hedge its fuel prices. Finally, the report talks
about the reason to shift from the WTI to Brent crude oil contracts for hedging jet fuel
prices based upon the 2007 to 2011 data.
Should Jet blue hedge its fuel cost?
Hedging refers to the risk management strategy commonly used by the investors in the
stock exchange, with the purpose of reducing or mitigating the risks arising out of price
fluctuations in currencies, commodities, interest rates, securities, weather etc. It can also
be referred as a tactic to transfer risks without having any kind of insurance policies
(Advisorymandi, 2019). It assists companies to maintain their profits during the down
season.
2

Jet Blue Case Study
There are airline companies which do not choose to hedge with two assumptions in their
mind. First, these companies think that prices of fuel would come down in the near future.
Second, they develop the thought of passing inflation of jet fuel prices onto the fliers or
consumers. However, both assumptions are extremely dangerous because of the highly
volatile fuel prices and competition posing a downward pressure over the profit margins.
Therefore, it is always better for the airline companies to focus more on hedging fuel
prices to avoid price shocks in future instead of putting an effort to outperform the
market.
However, there are many derivative instruments which are used for hedging purpose but
most of the financiers fail to understand the uses of these instruments. At the end, airline
companies have to take the support of banks and other hedge fund managers to hedge
their position. However, these banks and hedge fund managers may not have the best
interest of these airline companies in their heart (Kholeif, 2017). In order to form a
perfect and useful hedging strategy it is required for the airline companies to integrate it
with the entire corporate strategy for matching strategic investments.
If we talk about the airlines industry then hedging of fuel prices have become a common
practice. It has been seen that cost of jet fuel accounts for 30%-40% of entire operating
costs of the airline companies. In the same way, Jet Blue Airways accounts for 40% of the
company’s total cost and therefore it treats the process of fuel hedging as an insurance
policy. Prices of fuel are highly volatile in nature when compared to any other type of
operational cost incurred by the airline companies. Therefore, it is always safe for the
airline companies to hedge its fuel prices to avoid any type of loss in future due to sudden
change in fuel price. These airline companies hedge the fuel prices by buying or selling
crude oil at a price expected in future using different instruments like options, forwards,
future, swaps etc. which are known as hedging instruments or derivative instruments.
Derivatives are costly affairs sometimes hedging fuel prices poses a great risk for the
company. It happens that prices of fuel decline sharply in future and at the end airline
companies bear a heavy loss.
At present, Jet Blue airways has entered into number of hedging contracts like call
options, swaps and collar contracts to hedge fuel risk. These contracts cost millions of
3