Jetblue Airways Case

JETBLUE AIRWAYS CASE

Introduction

JetBlue Airways Corporation is an U.S.  low-cost airline.it was founded 1999 with the name “NewAir” and started operations in 2000 after receiving the formal authorization. It distinguishes itself by offering in-flight entertainment and other amenities.

In 2005, JetBlue experienced the profit hit due to the increasing jet fuel costs. They tried to apply fuel surcharge to the tickets’ prices. However, it is unviable unless matched by competitors. Besides, according to the annual report, fuel expenses represented about 40% of its operation cost in 2011. Therefore, fuel hedging is important to protect the airline’s operation, like an insurance policy.

In fourth quarter 2011, JetBlue hedging 45% of its fuel consumption, in which more than half used crude oil derivatives that relied on West Texas Intermediate (WTI) crude oil hedges. However, it is concerned that WTI had become less well correlated with the global crude oil market in 2011 and this kind of ineffective caused the losses of airlines. Thus, JetBlue need to rethink the fuel hedging strategy that whether it should switch to Brent or heating oil derivatives or continue to use WTI.

Analysis

Hedging position in U.S, European and Asian airlines

We can see from the Exhibit 1, JetBlue hedged 45% of its fourth quarter 2011 consumption and as mentioned above half of it is used traditional way (WTI). Besides, the average of hedged in U.S airlines is 40.38%, compared with the 72% in Europe and 10.20% in Asia. With the exception, many of U.S airlines relied on WTI crude oil hedges traditionally, including JetBlue. However, European and Asian airlines use Brent crude. Consider the high figure of hedged fuel in Europe, JetBlue should take some advise from this success result of hedging.

WTI’s hedging ineffective

Since April 2011, WTI, the main U.S oil price benchmark had become less well correlated with the global crude oil market. Exhibit 2 shows that WTI started to drop dramatically from April to September 2011 and began to increased sharply until November, while Jet fuel, Heating oil and Brent experienced the similar trend. The fact is that Jet fuel prices had tracked the price of Brent instead of WTI during that period. As a result, the dislocation of WTI caused many of U.S airlines reduced their profit heavily. Someone believed that the WTI ineffective is temporary phenomenon, because the oil glut and easing transportation constraints lead to the falling of the Brent-WTI premium. However, the spread is still high compared with the historical record.

Basis risk

Basis risk is that the jet fuel price would not change perfectly in tandem with the value of the WTI derivative instrument used to hedge it, which is the reason caused to the WTI dislocation affecting the jet fuel hedging strategy. The price of jet fuel has high correlation with the price of crude oil because of the process of distillation (Exhibit 2). Exhibit 3 describes the difference between the price of jet fuel less the price of crude oil and the crack spread had oscillated from $3.9 to $41.9 per barrel. This variation constituted basis risk for any jet fuel hedging strategy based on crude oil derivatives. It happens because there was a mismatch in the quality of the underlying products, and jet fuel and crude oil were different commodities.