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HOW THE COVID-19 CRISIS DEMONSTRATES THE NEED FOR PARAMETRIC FUEL PRICE INSURANCE

In the wake of the Covid-19 induced oil price collapse, many airlines are facing severe financial distress.


As the unprecedented collapse of air traffic demand put the survival of the airline industry at risk, the drop in oil prices proved to be a second source of major insecurity for many of the world’s biggest airlines.

Traditionally, airlines have purchased conventional fixed-priced or multi-structured option hedging products to protect themselves from rising jet fuel prices. In fact, price hedging in the airline industry is around 60% to 90% of fuel demand, with some airlines electing to hedge their entire consumption a full year in advance. Airlines directly purchase derivatives such as zero-cost options, or fixed-price swaps, as a way of managing balance sheet risk. But these complex financial instruments commit the consumer to buy fixed volumes of oil at a fixed price.

In cases of dramatic price collapses, this strategy actually exposes them to greater peril from ‘margin calls.’ When the price falls below the fixed entry price, the bank that ‘sold’ the derivative submits a demand for an immediate payment in cash.

This means that at a time when revenue in the aviation industry has dramatically decreased, many airlines are now forced by their hedges to buy fuel volumes that are way above their actual consumption; they are locked-in to paying a fuel price that is way above the current spot market value; and they are being sent demands for cash settlements. This chain of events may unfortunately push some carriers going into bankruptcy or they will need government bailouts to survive.

Had they bought Parametric Jet Fuel Price Insurance - a cost-effective and simple risk management tool - they would only have lost the initial premium, paid at the inception of their policy.

Parametric policyholders are never on the hook for any additional margin calls and are free to benefit from the lower physical costs of purchasing fuel...or to not purchase fuel at all during periods of low or no demand for air travel.