Oil Prices Kristin Rine Ravi Radia. I-Clicker What do you think the current oil prices are? A. $50 per barrel B. $60 per barrel C. $70 per barrel D. $80.

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Presentation transcript:

Oil Prices Kristin Rine Ravi Radia

I-Clicker What do you think the current oil prices are? A. $50 per barrel B. $60 per barrel C. $70 per barrel D. $80 per barrel

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

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 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.

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

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

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

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

Thank you for your time!