How can airlines optimally hedge fuel price risk? [EDP Energias de Portugal, S.A. – hedging in multinationals: focus on FX and IR risks]

Abstract

This paper is divided in two main parts. The first describes the main aspects of the business project carried on with EDP throughout the semester, namely the benefit of managing interest rate and foreign exchange risks simultaneously. The second explores the complexity of insulating fuel price risk from the airlines point of view, showing that rising fuel costs do not necessarily imply lower cash flows and, thus, hedging by locking in the cost of future fuel purchases is not optimal. In fact, moves in oil prices depends on supply and demand shocks which differently impact airlines’ operations.