Oil Prices

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Oil Prices

• Kristin Rine
• Ravi Radia

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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

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(No Transcript)
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Changes in Oil Prices

• Economic disasters
• Hurricane Katrina
• Seasonality
• Shortage/Oversupply
• Political conflict
• War in the Middle East
• Currently
• Continuing demand from worlds largest economies
• Concerns over limited production capacity
• Closure of US oilfield after a fire
• Ongoing cold snap

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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

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Hedging

• 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.

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Example

• Suppose you wanted to buy a quantity of oil in 6
  months time. Spot Price 60 per barrel.
• Two possibilities
• - 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

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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

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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

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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

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Thank you for your time!