Jet Fuel Price Risk Insurance
Scenario: Covid-19 and the Airline Industry
In the wake of the Covid-19 induced oil price collapse, many airlines faced severe financial distress.
The unprecedented collapse of air traffic due to Covid, put the survival of the airline industry at risk not only from substantial multi-million dollar margin calls as a result of their derivative fuel price hedges, but also from the additional peril of plummeting jet fuel usage as worldwide travel ground to a halt. In effect, unwittingly, without any fault on their part, the airlines had colossally over-hedged their fuel exposure.
The complex financial derivative transactions that the airlines had entered into (e.g., swaps, zero cost collars), effectively committed them to buy fixed volumes of oil at a set price, thus further compounding their distress as fuel consumption dramatically ground to zero. Even the most sophisticated corporates can find derivatives overly complex, costly, time-consuming to monitor, and difficult to access. Entering into derivatives instruments without a specialist oil trading infrastructure is complicated and the risk is substantial and difficult to quantify.
On average, a major international airline lifts about 110,000 barrels per day (bpd) of jet fuel, at an annual cost of $4-$5 billion. The notional cost of managing such risk by an expert firm would be around $25 million (0.5% of gross risk) per year.
In 2016, a global airline found itself looking at an abyss of a $12.6 billion derivatives hedge loss. Some 250 million barrels of oil derivatives had been purchased at $90 per barrel in an attempt to negate the uncertainty caused by the Libyan civil war. However, with a ferocious OPEC price war well underway, Brent crude prices collapsed to $30 per barrel. The airline was haemorrhaging cash and, crucially, exposed to reputational damage.
If the airlines had taken out a Paratus insurance policy, they would have avoided significant financial and potentially, bankruptcy risk. The Paratus policy provides price protection against an increase in the jet fuel price beyond a set level over a period of cover and defined volume. The marginal cost of the premium paid for the Paratus cover is a fraction of the unpredictable costs incurred using traditional hedges.
With the Paratus insurance policy, there are no margin calls, no credit changes, and no additional or hidden costs. The insurance premium is fixed and paid at the start of the policy. Policies are transparently priced and are designed to settle by paying a predefined claim amount. The insured airline is free to benefit from the lower cost of purchasing physical fuel, or purchasing limited amounts of fuel, in periods of low or no demand for air travel.
We partner with airlines to mitigate adverse energy price movements, and balance sheet risk to protect revenue and stabilize cashflow. The policy enables our clients to allocate capital into further investment in sustainable aviation fuels (SAF).