Includes bibliographical references and index.

Preface xiii Acknowledgments xix About the Authors xxi CHAPTER 1 Energy Commodities and Price Formation 1 Energy as a Strategic Resource 1 Energy as a Tradable Commodity 3 Energy Commodities 5 Crude Oil 5 Oil Products 8 Natural Gas 11 Coal 11 Price Drivers in Energy Markets 12 Geopolitical Risks 12 The Geopolitical Chessboard The Petrodollar System and Rising China 12 Long-Term Supply and Demand 15 Short-Term Supply and Demand: Supply Chain and Infrastructure 17 Financialization of Commodities 19 Market-Specific Price Drivers 19 Summary 20 CHAPTER 2 Major Energy Consumers and the Rationale for Fuel Hedging 23 Energy Market Participants 23 Risks Faced by Fuel Consumers The Case of the Airline Industry 27 Airline Industry Metrics and Operational Risks 27 Airline Industry Financial Risks 30 Risks Faced by Other Major Fuel Consumers 35 Shipping Companies 35 Land Transportation 37 Oil Refining, Petrochemicals, and Power Generation 37 Industrial Users of Energy Commodities 38 The Case for Hedging 39 The Effect of Hedging on Airline Stock Price Volatility 39 Commodity Derivative Markets 41 A Brief History of Commodity Markets 42 Commodity Spot Markets and the Need for Standardization 43 Forward Contracts 44 Futures Contracts 45 Option Contracts 50 Summary 53 Appendix A 54 CHAPTER 3 Developing Fuel Hedging Strategies 55 The Rationale for Commodity Hedging 55 Developing a Fuel Hedging Program 57 Risk Identification and Assessment 57 Types of Risk 58 Risk Identification 59 Forecasting Prices and Conducting Simulations 59 Articulating the Firm s Risk Appetite 60 Setting Objectives for Fuel Hedging and the Scope of Hedging 60 Identifying Risk Managers within the Organization 61 Determining the Scope of the Hedge Program 61 Implementation of Hedging 62 Selecting the Fuel Cost Management Method 62 Identifying the Underlying to Hedge with and Basis Risk 63 Quantity and Tenor of Hedging 66 Selection of Instruments for Hedging 67 Market Risk 68 Management of the Unwanted Risks of a Portfolio 68 Credit Risk 68 Liquidity Risk 69 Operational Risk 69 Legal and Reputational Risk 70 Monitoring and Calibration of the Hedging Program 70 Template for a Risk Management Policy 71 The Airline Industry Trends in Fuel Risk Management 71 Magnitude of Fuel Price Risk 71 Underlyings and Hedging Instruments 73 Quantity and Tenor of Hedging 74 Recent Developments 75 Summary 75 CHAPTER 4 Shipping and Airlines Basics of Fuel Hedging 77 Spot Forward Relationships 77 Theories on the Shape of Forward Curves 78 Spot Forward Relationships for Investment Assets 79 Spot Forward Relationships for Commodities 80 Spot and Futures Volatility 81 Options 82 Call and Put Options 83 Put Call Parity 84 Option-Based Hedging for a Shipping Company 85 Implied Volatility and the Black Scholes Model 86 The Black Scholes Merton Model 88 Black s Model for Pricing Options on Futures Contracts 89 The Greeks 89 Delta 90 Gamma 92 Theta 92 Vega 94 Rho 94 Higher-Order Greeks 95 Black s Model Option Greeks 95 Asian Swaps and Options 96 Asian Swap-Based Hedging for a Shipping Company 97 Option Structures 97 Call Spreads and Put Spreads 97 Collars, Three-Ways, and Calendar Spread Options 99 Straddles, Strangles, and Butterflies 100 Capped Forwards 102 Capped Swap Usage for a Shipping Company 103 Derivatives Pricing 104 Stochastic Processes for Asset Prices An Introduction 104 Brownian Motion and Wiener Processes 104 Ito s Lemma 106 Option Pricing Using the Black Scholes Merton Formula 107 Asian Option Pricing 109 Summary 112 CHAPTER 5 Advanced Hedging and Forward Curve Dynamics 113 Swap and Vanilla Option-Based Structures 113 Zero-Cost Structures and the Usage of Options 114 Leveraged Swaps 114 Capped Swaps 116 Floored Swaps 117 The Volatility Surface 118 Multi-option Structures 119 Zero-Cost Collar 120 Three-Ways 120 Risk Reversals and their Hedging 121 Early-Expiry Options and Instantaneous Volatility Term Structures 122 The Samuelson Effect and the Storage Theory 122 Implied Volatility of Energy Futures Contracts 123 Early-Expiry Profile Construction 124 Commodity Swaptions and Extendible Swaps.

The book focuses on fuel hedging techniques, related commodity hedging techniques and relevant risk management solutions. It covers a wide variety of key topics including derivatives and related instruments, exotic hedging products and leverage, the relationship between creditworthiness and commodity hedging, hedge accounting, CVA/DVA costs, CSA and cash management constraints for fuel consumers, exposure management techniques, etc. All risk management strategies and hedging products are analyzed in light of the extreme scenarios experienced during 2008-09, when some fuel hedgers suffered big losses on their derivatives positions and paid a dire price in terms of competitiveness.