jet fuel trading and airline hedging€¦ · likewise, the words “we”, “us” and “our”...

Copyright of Shell International CONFIDENTIAL 1

JET FUEL TRADING AND AIRLINE HEDGING

Airline Hedging & Risk Management Forum Dubai – October 2016

Claire Pontal Risk Manager

04 October 2016

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Copyright of Shell International CONFIDENTIAL

Definitions & Cautionary Note

The companies in which Royal Dutch Shell plc directly and indirectly owns investments are separate legal entities. In this presentation “Shell”, “Shell group” and “Royal Dutch Shell” are sometimes used for convenience where

references are made to Royal Dutch Shell plc and its subsidiaries in general. Likewise, the words “we”, “us” and “our” are also used to refer to subsidiaries in general or to those who work for them. These expressions are also used

where no useful purpose is served by identifying the particular company or companies. ‘‘Subsidiaries’’, “Shell subsidiaries” and “Shell companies” as used in this presentation refer to companies over which Royal Dutch Shell plc

either directly or indirectly has control. Entities and unincorporated arrangements over which Shell has joint control are generally referred to “joint ventures” and “joint operations” respectively. Entities over which Shell has significant

influence but neither control nor joint control are referred to as “associates”. The term “Shell interest” is used for convenience to indicate the direct and/or indirect ownership interest held by Shell in a venture, partnership or

company, after exclusion of all third-party interest.

This presentation contains forward-looking statements concerning the financial condition, results of operations and businesses of Royal Dutch Shell. All statements other than statements of historical fact are, or may be deemed to be,

forward-looking statements. Forward-looking statements are statements of future expectations that are based on management’s current expectations and assumptions and involve known and unknown risks and uncertainties that could

cause actual results, performance or events to differ materially from those expressed or implied in these statements. Forward-looking statements include, among other things, statements concerning the potential exposure of Royal

Dutch Shell to market risks and statements expressing management’s expectations, beliefs, estimates, forecasts, projections and assumptions. These forward-looking statements are identified by their use of terms and phrases such as

‘‘anticipate’’, ‘‘believe’’, ‘‘could’’, ‘‘estimate’’, ‘‘expect’’, ‘‘goals’’, ‘‘intend’’, ‘‘may’’, ‘‘objectives’’, ‘‘outlook’’, ‘‘plan’’, ‘‘probably’’, ‘‘project’’, ‘‘risks’’, “schedule”, ‘‘seek’’, ‘‘should’’, ‘‘target’’, ‘‘will’’ and similar terms and phrases.

There are a number of factors that could affect the future operations of Royal Dutch Shell and could cause those results to differ materially from those expressed in the forward-looking statements included in this presentation, including

(without limitation): (a) price fluctuations in crude oil and natural gas; (b) changes in demand for Shell’s products; (c) currency fluctuations; (d) drilling and production results; (e) reserves estimates; (f) loss of market share and industry

competition; (g) environmental and physical risks; (h) risks associated with the identification of suitable potential acquisition properties and targets, and successful negotiation and completion of such transactions; (i) the risk of doing

business in developing countries and countries subject to international sanctions; (j) legislative, fiscal and regulatory developments including regulatory measures addressing climate change; (k) economic and financial market

conditions in various countries and regions; (l) political risks, including the risks of expropriation and renegotiation of the terms of contracts with governmental entities, delays or advancements in the approval of projects and delays in

the reimbursement for shared costs; and (m) changes in trading conditions. All forward-looking statements contained in this presentation are expressly qualified in their entirety by the cautionary statements contained or referred to in

this section. Readers should not place undue reliance on forward-looking statements. Additional risk factors that may affect future results are contained in Royal Dutch Shell’s 20-F for the year ended December 31, 2015 (available at

www.shell.com/investor and www.sec.gov ). These risk factors also expressly qualify all forward looking statements contained in this presentation and should be considered by the reader. Each forward-looking statement speaks only

as of the date of this presentation, October 4, 2016. Neither Royal Dutch Shell plc nor any of its subsidiaries undertake any obligation to publicly update or revise any forward-looking statement as a result of new information, future

events or other information. In light of these risks, results could differ materially from those stated, implied or inferred from the forward-looking statements contained in this presentation.

We may have used certain terms, such as resources, in this presentation that United States Securities and Exchange Commission (SEC) strictly prohibits us from including in our filings with the SEC. U.S. Investors are urged to

consider closely the disclosure in our Form 20-F, File No 1-32575, available on the SEC website www.sec.gov.

2


Agenda

Physical Jet Trading: What Is It Really About? Airlines Hedging: Solving The Jigsaw CO2: What’s In Store? Shell Price Risk Management: One Stop Shop

04 October 2016 3


What Is It Really About?

PHYSICAL JET TRADING

1.0

Copyright of Shell International CONFIDENTIAL 04 October 2016 5

Percentage of distillate coming out of refining: 22-50%

Of which jet: 11-17%

Physical vs. paper price:

Physical / spot prices: Platts / Argus / OPIS jet price

Paper:

Exchange: ICE Brent and Gasoil futures / Nymex

WTI, Heating Oil and Rbob futures

OTC: Jet swaps, which are a composite of gasoil

futures or swaps and Jet diff or regrade

PHYSICAL JET TRADING: Breaking down the price of jet

$26/mt

Crude price

Jet diff/ regrade

Gasoil crack $8/bbl

$49/bbl

European Jet October 2016

Source: Rounded values based on October ICE Brent, ICE Gasoil and broker’s input for Jet CIF NWE diffs on September 22nd

Ex. Jet CIF NWE October = (7*Oct ICE Gasoil/21)+(14*Nov ICE Gasoil/21)+Oct jet diff


PHYSICAL JET TRADING: CRUDE PRICES ARE UNPREDICTABLE 1/2

04 October 2016 6

0

20

40

60

80

100

120

140

160

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

US Economic Slowdown

Iraq War

Rising geopolitical

tension in Iran, Iraq &

Venezuela

Hurricanes Rita & Katrina

Alaska and Nigeria supply

disruptions

Global Credit

Squeeze Began

Large Influx of Investment Funds into Commodities

Global Credit Squeeze

Worsened

OPEC Supply

Restraint

911 Terrorist Attacks

Global Recession

QE2 & weaker

USD

High demand growth rate

MENA Turmoil

Commodity Sell off

IEA stock Announcement

Iran Sanctions

Over supplied market - no cut from OPEC

Syria conflict

Demand elasticity from low oil price

Disruptions Saudi and Russia pumping record

volumes

Macroeconomic balances

(demand, risk on/off)

Liquidities (QE, etc)

Geopolitics (war, terrorism,

etc)

Production (rig counts,

disruptions, OPEC monthly

output)

Technology (breakeven

level)

OPEC

Climate

Regulatory environment Source: Shell Trading Market Analysis


PHYSICAL JET TRADING: CRUDE PRICES ARE UNPREDICTABLE 2/2

Date Month 2016 7

40

42

44

46

48

50

52

Reuters OPEC supply survey shows high

volume

Rumours of OPEC/Non-

OPEC meeting in Algeria

Continued rally as Saudi Oil

minister hints at co-ordination at

meeting

US Econ data (strong dollar) pressuring oil

Heavy US crude builds

Putin releases statement on possible co-

ordination with OPEC

Big US stock draws

Rumours (disruptions, etc)

OPEC / political statements

Reports (banks, EIA, etc)

Foreign Exchange (FED

speech, economic data

release)

Inventories

Weather (hurricanes, winter

consumption)

Source: Shell Trading Market Analysis


PHYSICAL JET TRADING: JET FUEL TRADING FLOWS 1/2

04 October 2016 8

CAN

US

NWE

LAT

AFR SEA

ME

FSU

JPN

AUS/NZ

S.A

CHN

47

78

12

63

19

120

42

Net imports quoted in kbd (Source: PIRA)

Legend Key kero arbitrages Other interregional flows

32

25

86 From SEA

77 287

24

40

94

37

39

42

as of Q2 2016

Middle East to Europe and

East Africa

Intra Far East: China and

Japan to Singapore

Far East to US West Coast,

US East (Gulf) Coast to

Europe

Net flows (eg: Europe to US

East Coast / Caribs)


PHYSICAL JET TRADING: JET FUEL TRADING FLOWS 2/2

04 October 2016 9

2012 Q2 2016

North America

2012 Q2 2016

Latin America

2012 Q2 2016

Europe 2012 Q2 2016

FSU

2012 Q2 2016

China

2012 Q2 2016

Rest of Asia 2012 Q2 2016

South Asia

2012 Q2 2016

Middle East

2012 Q2 2016

Africa

Source: Shell Trading Market Analysis


PHYSICAL JET TRADING: WHAT AFFECTS THE PRICE OF JET

04 October 2016 10

DEMAND

Gasoil demand

Economy

Macro: travel demand (business, leisure)

Micro: foreign exchange

Seasonality

Geopolitics (safety, terrorism)

Weather (winter kero)

Fuel efficiency

Substitution: cargo shipping, high speed train

SUPPLY

Gasoil supply

Refinery infrastructure:

maintenance and upgrades

closure and commissioning

Refinery economics

Run rates

Cut points

Arbitrage in and out

Storage

Ullage

Commissioning / decommissioning

Freight rates (floating storage)


PHYSICAL JET TRADING: WHAT TRADERS DO LOCKING IN MARKET DISCREPANCIES AND TAKING A FORWARD VIEW

ON LESS VOLATILE PRICE ELEMENTS WHERE SPECIALISED KNOWLEDGE

ALLOWS TO FORM A MORE RELIABLE PICTURE

04 October 2016 11

HOW?

Physical arbitrage

How: curving, vessel tracking, stocks information

Example: Jet from Singapore to Europe

Paper arbitrage

How: curving

Example: EBOB crack vs. TA arb

Forward view

How: Supply / demand, vessel tracking, storage

information, refinery information, curving, headlines

Life of a deal / operational excellence

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

Jan-

04O

ct-0

4Ju

l-05

Apr

-06

Jan-

07O

ct-0

7Ju

l-08

Apr

-09

Jan-

10O

ct-1

0Ju

l-11

Apr

-12

Jan-

13O

ct-1

3Ju

l-14

Apr

-15

Jan-

16

Brent

Jet vs Brent

Gasoil vs Brent

WHAT?

Lower volatility price components: cracks, diff

/ regrade, structure, HoGo…

That they can form a view on and / or put on

a physical trade against: arb, E/W, jet/diesel

Source: Platts’s prints


Solving The Jigsaw

AIRLINE HEDGING

2.0 04 October 2016


AIRLINES HEDGING: RISK MANAGEMENT AND PRICE STABILITY

04 October 2016 13

04 October 2016

Manage your oil price exposure for the right reasons: Not for a better price, but for a predictable price

Protect or stabilise revenue stream

Protect cash flows – manage borrowings

Deliver against budgets – no surprises

The goal is to lock in a financially acceptable result for your company

HEDGING

“Intentional transfer of price risk away from the organization”

SPECULATION “Act of taking price risk in exchange for the potential of making a profit”


AIRLINES HEDGING: THE BUILDING BLOCKS

04 October 2016 14

04 October 2016

COMPETENCY DEVELOPMENT

DATA ACCURACY

ROBUST RISK MANAGEMENT PRACTICES

HEDGING POLICY AND MOA

HEDGE EXECUTION

CONTRACT MANAGEMENT

HIGH DEMAND FORECAST ACCURACY / UNDERSTANDING OF EXPOSURE


AIRLINE HEDGING: FIT FOR PURPOSE POLICY (1/2)

04 October 2016 15

CONSTRAINTS AND PRIORITIES

Cash flows Embedded vs. derivatives, contract type, margining

Credit rating Contract type, margining, tenor, volume, type of counter-

parties

Cost Contract type, swaps vs. options

Flexibility Swaps vs. options, crude vs. jet underlying

Human factor Embedded vs. derivatives, swaps vs. options, contract type

OBJECTIVES

Lock in acceptable margin Hedge as you sell, CSA, jet swaps

Protect against short term price increases Short tenor, caps / options

Protect against long term price increases Long tenor, caps / options

Meet budget Target based market entry, layered volumes, options

Protect cash flows No CSA or put options, use of options


AIRLINE HEDGING: FIT FOR PURPOSE POLICY (2/2)

04 October 2016 16

REGULATIONS & INTERNAL RULES / CULTURE

Accounting rules: derivatives vs. embedded

Margining requirements: derivatives vs. embedded,

swap vs. option structures

Manual of Authority, ownership / management

structure and approval process

RISK APPETITE

Supply: embedded vs. derivatives

Instrument: swap vs. option

Underlying: eg. product vs. crude

Volumes: percentage of exposure

Entry point: pre-determined time vs. “optimised

hedging”

Semi Risk Averse

Companies that prefer stable cost/revenue structure. More sensitive to

“opportunity losses/gains” than risk-averse group

Companies that are willing to take some price risk but also prefer somewhat stable

cost/revenue structure. Concerned about “opportunity losses”

Semi Risk Taking Risk Averse

Companies that require extremely stable cost/revenue structure. Willing to accept “opportunity losses/gains”

Risk Taking

Companies that are willing to absorb price risk. They only Fix opportunistically under

extremely favorable market conditions


AIRLINE HEDGING: LEGACY CARRIER, LONG HAUL FOCUS EXAMPLE

04 October 2016 17

OBJECTIVE: Meet budget and avoid giving away competitive advantage

CONSTRAINTS: Average credit rating, leveraged balance sheet, good internal competencies and succession plans,

multiple fuelling locations

RISK APPETITE: Medium

REGULATIONS AND PROCEDURES: Good knowledge of regulations, resources for hedge accounting, long decision

chain and centralised decision process

EXAMPLE OF HEDGING POLICY

Derivatives, ISDA with no CSA

Flexibility of instrument and underlying, with preference for Brent (liquidity, complex portfolio of fuelling locations)

Target based market entry

Longer tenor, volume layering

As they sell tickets, they may want to lock in the PnL: sell the Brent collar and buy the jet swap


AIRLINE HEDGING: REGIONAL CHARTER AIRLINES EXAMPLE

04 October 2016 18

OBJECTIVE: Lock in acceptable margin

CONSTRAINTS: Relatively low credit rating, lean staff leading to limited resources / competencies

RISK APPETITE: Low

REGULATIONS AND PROCEDURES: Limited resources for hedge accounting, simple ownership structure and quick

decision making

EXAMPLE OF HEDGING POLICY

Embedded hedging, helped by limited number of fuelling locations

Derivatives: ISDA with no CSA, use of jet swaps, market entry, volume and tenor determined by sales


AIRLINE HEDGING: EXECUTING A PAPER STRATEGY

04 October 2016 19

Instrument

Swaps (lower cost, simple accounting and monitoring)

Options: call, put, collar, 3 or 4-way, with upfront premium or not (higher cost, complex accounting / monitoring)

Underlying

Crude (higher liquidity, higher basis risk)

Jet (liquidity depends on regional quote, lowest basis risk) – possibly Gasoil (intermediate)

Tenor

Volume

Profiling

Layering

Market Entry

Fixed

“Optimised”


AIRLINE HEDGING: EMBEDDED HEDGING

04 October 2016 20

The airline purchases jet fuel from the

supplier at a fixed price

For a specific volume and period

At a specific uplift location

With an obligation to lift the exact volume –

and the balance remains formula or spot

price based

The supplier has an obligation to deliver


AIRLINE HEDGING: EMBEDDED VS. DERIVATIVES HEDGING

04 October 2016 21

Derivatives “Fixed” Price Physical

OFFER CHARACTERISTICS Advantages No physical requirements Flexibility managing hedge positions Obligations Standard ISDA contract Separate credit evaluations (physical & derivative) Product basis risks is with customer IAS39 accounting /reporting standards apply M2M requirement - impacts customer’s financial statements Margin calls may be necessary

OFFER CHARACTERISTICS Pre-requisite Physical supply with Shell Advantages No product basis risk Simple 4 page master agreement IAS 39 reporting not typically required No M2M requirements No margin calls Easy float to fixed price conversion

Obligations Physical vol. must be lifted from Shell 1 deal covers1 country only

Customer may opt to enter into “fixed” price physical or derivatives

or both depending on needs


THE SPECULATOR, THE TRADER AND THE HEDGER

04 October 2016 22


What’s In Store?

CO2

3.0 04 October 2016


CO2: OUR trading NETWORK

04 October 2016 24

Hamburg

Beijing

Calgary

Singapore

London

Houston San Diego

Milan

NEW COMPANY: SHELL ENERGY CHINA

COMPLIANCE POSITION MANAGEMENT Manage the CO2 position for the Royal Dutch Shell Group

covering ~50 installations across the Globe

CUSTOMER BUSINESS Trading in Europe, California, Northeast US, NZ, China Large portfolio of clients covering Utilities, Industrials, Airlines and Financials. Comprehensive offering from trade execution to complex structured deals

PROPRIETARY TRADING First ever trade of EUAs in 2003 Significant market presence & liquidity provider globally

SHELL ENERGY IN ASIA

Building footprint in Emerging Markets Traders & Trading Entities in China & Singapore One of the first foreign companies to trade allowances on the Hubei Exchange in April 2014.


CO2: AVIATION IN THE EU ETS

04 October 2016 25

The EU ETS (European Union Emissions Trading Scheme) works on the “cap and trade” principle* – a market based mechanism.

The aviation sector was brought into the EU ETS on 1 January 2012 (but application for flights to and from non-European countries are suspended until December 2016: “ Stop the clock”)

Operators receive a ‘free allocation’ of allowances at the beginning of each compliance year. Operators have to surrender one allowance per tonne of CO2 emitted.

The penalty for each allowance not surrendered to meet actual emissions by 30 April of each year is €100 plus the

allowance must still be surrendered.

Shell can help Airlines to source their CO2 Allowances by purchasing EUAs or cheaper CERs (emission reductions issued by offset project**).

Shell can also provide Airlines the ability to participate in government auctions and buy EUAA (European Union Aviation Allowance).

*Annex 1 ** Annex 2

http://ec.europa.eu/clima/policies/transport/aviation/index_en.htm

http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32013D0377


CO2: MOVING TO A GLOBAL MARKET…

26 Footer Date Month 2016

ICAO agreed in 2013 (38th ICAO meeting) to

develop a global market-based mechanism to

address international aviation emissions by 2016

and apply it by 2020. This agreement followed

years of pressure from the EU for global action. In

the next ICAO meeting (September 2016) ICAO

will take a decision on how to implement the

GMBM from 2020.

Aspirational goal: carbon neutral growth from

2020

All operators will be treated equally on the same

route

Source: icao.int


One Stop Shop

SHELL PARTNERSHIP

4.0 04 October 2016


SHELL PARTNERSHIP: A WORLD CLASS TRADING AND SUPPLY ORGANISATION

04 October 2016 28


SHELL PARTNERSHIP: ONE STOP SHOP

04 October 2016 29

Oil derivatives:

Risk Marketing team in London and Singapore

Supported by an oil trading network in the main hubs of Houston,

London, Rotterdam, Dubai and Singapore

Embedded hedging (Fixed price physical)

Shell Aviation (and partners) deliver in around 900 locations

Account manager focal point

Close cooperation with Shell Trading and the Risk Marketing team

CO2: 8 worldwide locations, open communication lines with oil risk

marketing


Questions and Answers

04 October 2016 30


Annexes

04 October 2016 31


INSTRUMENTS: FIXED PRICE / SWAP

04 October 2016 32

BASIC

SAFETY

FLEXIBILITY

Counter Party buys a fixed price /swap at an

agreed level for a specified period

Every month the relevant market price is

checked against the fixed price /swap level:

i. If market price is above fixed price/swap

level, c/p receives the difference

ii. If market price is below fixed price/swap

level, c/p pays the difference


INSTRUMENTS: MAX PRICE / CALL OPTION (CAP)

04 October 2016 33

Counter Party buys a call at X price (call level)

for a specified period. Premium fee payable.

Every month the relevant market price is

checked against the call level

i. If market price is above call level, c/p

receives the difference

ii. If market price is below call level, nothing

happens

BASIC

SAFETY

FLEXIBILITY

c/p receives the difference

Month 1

Month 2

Month 3

Month 4

Month 5


INSTRUMENTS: MAX-MIN PRICE / COLLAR

04 October 2016 34

Counter Party buys a call and sells a put for the

same specified period. Potential premium fee

payable.

Every month the relevant market price is checked

against the call level

i. If market price is below put level, c/p pays the

difference

ii. If market price is above call level, c/p receives

the difference

iii. If market price is between call and put levels, market price is paid

BASIC

SAFETY

FLEXIBILITY

c/p receives the difference

c/p pays the difference

Max /Call level

Min / Put level


INSTRUMENTS: 3-WAY COLLAR

04 October 2016 35

Counter Party buys a call and sells a higher call and a

lower put, all for the same specified period. Potential

premium upfront.

Every month the relevant market price is checked against

the call level

i. If market price is below put level, c/p pays the

difference

ii. If market price is above lower call level, c/p receives

the difference

iii. If market price is above higher call level, c/p receives

difference between lower and higher call

iv. If market price is between lower call and put levels, nothing happens

BASIC

SAFETY

FLEXIBILITY


INSTRUMENTS: FROM A COLLAR TO A SWAP

04 October 2016 36

BASIC

SAFETY

FLEXIBILITY

In Q315, Air Flagship is hedging some Q316 volume to meet budget and buys a zero cost collar on Brent: 42/65

(when the swap is worth $52/bbl, and the jet swap is $528/mt)

In Q116, Air Flagship starts selling tickets and decides to lock in the profit on those sales: they sell the Brent collar and

buy the swap (Brent, gasoil or jet)

SCENARIO 1

Q315 brent = $35/bbl

Intrinsic value of collar: 35-42 = -$7/bbl

Time value of collar: $1/bbl

New fixed price: 35-(-7+1) = $41

If the Q315 Jet crack is $9/mt, jet fixed at

$394/mt vs. market @ $347/mt

SCENARIO 2


Intrinsic value of collar: 80-65 = +$15/bbl


New fixed price: 80-(15+1) = $64


$646/mt vs. market @ $772/mt)

SCENARIO 3


Intrinsic value of collar: 0


New fixed price: 50-1 = $49


$504/mt vs. market @ $512/mt)


CO2: CAP AND TRADE BASICS

04 October 2016 37

jet fuel trading and airline hedging€¦ · likewise, the words “we”, “us” and “our”...

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