Those Magnificent Men in their Flying Machines
February 13th 2009

‘Those Magnificent Men In Their Flying Machines.

They Can Fly Upside Down With Their Feet In The Air.

They Don't Think Of Danger. They Really Don't Care.

Newton Would Think He Had Made A Mistake.

To See Those Young Men And The Chances They Take.

Those Magnificent Men In Their Flying Machines.

They Go Up, Tiddly, Up, Up.

They Go Down, Tiddly, Down, Down.

They Enchant All The Ladies And Steal All The Scenes

With their Up, Tiddly, Up, Up

And Their Down, Tiddly, Down, Down’

Just about the only thing that’s going ‘Up, Tiddly, Up, Up’ and ‘Down, Tiddly, Down, Down’ these days is the oil price, flying upside down has largely been banned in my learned experience and of course the industry has safety as its number one priority. However, those young men and women that look after the fuel costs in your organisation might be taking more chances than they need or more than your business would like.

The air industry is renowned for embracing paradigm shift from the Zeppelin to the aeroplane, to the change from the propeller to the jet, this sector of the world economy has always been at the forefront of innovation and change management. However in the risk management of jet fuel costs for airlines and gas and electricity costs for the airports, your industry and your organisation would appear to be lagging behind.

In the last three years energy price volatility has plagued the airlines and airports alike, however whilst other industrial sectors have been learning to deal with the problem and turn it into an opportunity, the airlines and airports have largely stuck to old methods which seem to be reactionary and always just a bit too little, just a little too late.

Click here for Fig.1

Consider the chart overleaf (Fg.1): This is the budgetary variance of a company expecting to consume 12,000 tonnes of 0.1% Gas Oil and 12,000 tonnes of 1% fuel oil in Denmark for 2009. At the time they started to manage the risk of this position they could have fixed the price for their consumption requirement at 75m DKK (approx $12m).

On this chart the black line is a time series of the mark to market budgetary variance from October 2007 to the present day. The pink shaded area is the time series of the Value at Risk of this budgetary variance. The red line is the risk limit that would be imposed by a customer that was rationally managing its risk.

Budgetary Variance of a position that is completely exposed to the market

From October 2007 to July 2008 the market value of this spend for 2009 delivery increased from 75m DKK to 140m DKK; an increase of 86% before falling down recently to 80m DKK some 6% higher than where it could have been bought some 13 months ago.

A company that has not been risk managing its jet fuel or energy costs has effectively speculated its company’s money by taking an uncontrolled risk which could potentially have increased the company’s costs by over 80%. It is important to realise that such speculation arises whenever your organisation completely fixes its price (when it removes the risk of absolute costs rising but creates the risk that prices fall and the company has fixed at a high uncompetitive price) and when the company leaves its price exposed to the market (when its knows it will benefit from favourable market movements and maintain its price competitiveness when prices fall but creates the risk that costs may increase in an unlimited way).

However companies in the food, retail, building, chemical and other sectors are not leaving things to such chance. Figure (2) below shows the results that a company using risk management has controlled its exposure to the oil markets in a way that could have easily been applied to the jet fuel costs of an airline or the gas and power requirements of an airport.

Click here for Fig.2

Budgetary variance of a risk managed position

Through the active risk management of their exposure to the oil markets, this energy consumers avoided the risk of market peak; instead of facing cost of 140m DKK they had an exposure of 105DKK and more importantly as the price has fallen they have been able to systematically unwind their exposure and are currently 1m DKK below where they could have originally fixed the price of the oil. This would mean a real cost saving of 7% in a market that had previously risen 80%

More importantly if you consider the width of the pink area in the two charts (the value at risk of the position on each given day) then you will observe that the risk of the position in the second chart (the risk managed position) is 70% narrower than the unmanaged position; in essence the consumer added value whilst taking less risk on average than the company that stayed floating on the market.

If you consider these results compared to the performance of your own organisation it is difficult not to consider applying their merit to your own fuel and energy costs. There is currently $3bn of energy risk managing their energy exposure in this way; its time for one of the biggest fuel consuming sectors to consider it.

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