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Abstract ： Due to the international financial crisis in 2008， the oil price dropped sharply， causing a great shock among Chinese airlines. Some airlines suffered great loss from the aviation fuel hedging business and even went bankruptcy due to the event. This article takes Air China Limited for example and tries to find the cause of the widespread huge hedging loss. In this case， the article analyzes the external causes and the internal causes by collecting a large amount of relevant data and information and interviewing the internal working staff. Besides， this article also tries to give a relatively detailed analysis in terms of aviation fuel option hedging. In the final part of the article， it presents a successful example of Southwest Airline Co. as a comparison to see what Chinese airlines can learn from the successful hedging business.
Key words ： oil price， hedging strategy， Air China Limited
1. Background of the event
According to the news report in the 23rd number magazine of the Finance in 2008， "Air China Limited （Shanghai exchange code as 60111； Hong Kong exchange code as 00753） has released quarterly season report； this airline had appeared huge losses in fuel hedging business. By September 30th 2008.Air China Limited had reported a 961 million yuan loss in their operating in fuel derivatives. Moreover， Air China Limited is not the only company who suffered such great loss from the hedging business； countless airlines faced the disaster and even the articleity bankruptcy. To get the reason why the airline didn't benefit from the hedging business， the article made a telephone interview to the clerk working in Air China Limited， and also asked some professional teachers and do some search on the internet.
According to the results that the article gained， the reason attribute to the loss can be divided into two parts. One is the external cause， and the other is the internal cause.
2. External cause of the hedging loss
2.1 Hedge products
According to our interview from Bank of China who has the international bank services， the article have a clear view of the external cause of the airline's fuel hedging loss： From the long-term observation the article get the information that the value of RMB is increasing continuously and the price of bulk stock fluctuating greatly. Many multinational companies in China are facing a great risk nowadays. Here are some major products the bank can provide to help the company to hedge the risks： （1） Forward Transaction of Foreign Ex-
change refers to the foreign exchange transaction on a foreign exchange rate agreed by the buyer and seller under a foreign exchange contract， and for delivery on an agreed day， which is generally a certain day after the second working day after the transaction.
（2） Long dated foreign exchange forward
trading is a forward foreign exchange transaction with the value date one year later. The customer purchases one currency from the bank and sells another currency on the settlement day which is designated by the customers.
（3） Call option of RMB： It gives to the buyer the right to buy a certain amount of RMB at a certain exchange rate in the future market.
（4） Cash settlement of commodity forwards refers to such commodity transactions in which two parts of the transaction conduct the netting settlement according to the terms agreed in the contract at an agreed commodity price and within the pre-arranged term （generally a certain day after the second working day of transaction）.
（5） Foreign currency to RMB swap： As one of the foreign exchange swap business， foreign currency to RMB swap is actually the combination of a spot deal and a forward deal of foreign currency to RMB. Specifically， commercial bank and the customer sign the swap agreement through mutual consultation， and agree on the spot foreign exchange rate and the value date as the forward foreign exchange rate and its value date respectively. The customer shall conduct the conversion between the RMB and foreign exchange with the commercial bank in accordance with the agreed spot exchange rate and value date.
2.2 Main findings
Based on the abovementioned information， the cause of the airline's huge loss seems not so largely related to the financial product they choose. To further develop the analysis， the article also compares the hedge product market between China and other developed countries and find that most of companies in China use foreign currency hedging products through the intermediaries like hedging products exporting company. Such kind of company exports commodities to other countries in the form of foreign currency receivables. Instead， there is more foreign currency payables in developed countries. Furthermore， RMB is not a complete market currency and the exchange rate may be controlled by the central bank of China， which is political risk. Such reason is the main external cause of the hedging loss for Air China based on this paper's analysis. 3. Internal cause of the huge loss
3.1 Brief introduction of Air China Limited
Air China Limited is the flag carrier and one of the major airlines of China， with its headquarters in Shunyi District， Beijing. The airline's flight operations are based from out of Beijing Capital International Airport and are the world's 10th largest airline by fleet size. The enterprise logo of Air China consists of an artistic phoenix pattern. In 2010， Air China carried 60 million domestic and international passengers with an average load factor of 80%. The airline reported a net profit of 12 billion yuan in 2010.
3.2 Descriptions of Air China fuel hedging losses
ir China， the country's largest international carrier， said its loss in the fair value of fuel hedging contracts jumped to 3.1 billion yuan by the end of September， 2008. In a statement from the Shanghai Stock Exchange Saturday， the company said it signed the contracts in July 2008 with the longest term till 2011 to mitigate the risks of future possible rises in fuel price. On the basis of the data that Air China shot he articled， in 2008 they planned to use 2，800，000 tons of aviation fuel， since 50 percent of the fuel was used on the international air line. That is 1，400，000 tons. Until now， there are 24630 thousand barrels of air fuel which is not covered， for 1040 thousand tons per year. So the article can see that the fuel price has high impact on the company profit. They thought that they must do something to hedge the exposure.
What is an aviation fuel hedging？ In order to deal with oil price fluctuations of the business risks， maintain the future use of aviation fuel and develop the financial derivative instrument， airlines use an order to buy or sell forward contracts and lock the cost of aviation fuel. Loss or profits before expiration of the contract belongs to floating gains or loss. In the case of Air China， it signed the contracts when the international oil prices reaches at historical high levels and the general market consensus of the high oil prices also prevailed for a long period of time. Then Air China took a long position of which the underlying asset is the aviation fuel. However， the wrong-way bets made Air China buy fuel at higher than spot prices when crude oil prices had plunged 66 percent from its peak of 147.27 U.S. dollars per barrel on July 11th 2008 on concerns over a deep and prolonged recession of the global economy.
3.3 Main findings
Based on the past information， Air China Limited aviation fuel hedging begins in 2003， in 2007 they only produced 53.5 Million of floating losses， which hedged the costs of risk that caused by the increasing of aviation fuel price. According to the Air China bulletin， the contract of aviation fuel hedging options is divided into two sections： in a given price range， buyer purchases a call option， and seller sells the put options. Generally in the bull market， the main strategy for hedging against costly fees is selling out put options and purchase a call option and at the same time bearing the risk if the market price of aviation fuel is lower than the limit of the put option locks. Air China's option contracts can be divided into three types： if aviation fuel prices better than 62.35 $ ～150 dollars per barrel， set option quantity for 1135 Million barrels， that is Air China can set price （ less than $150 ） for the aviation fuel of 1135 Million barrels. At the deadline of contract， no matter how much the aviation fuel price is， Air China can decide whether to buy it or not. This is the most basic set of hedging contracts， because the airline company has the right to make a good use of hedging， once the price increases 10 dollars， Air China has to pay $1.4 million more options contracts cost， but if the contract is terminated， Air China does not need to purchase it and the option premium is the amount of the actual payment of the price difference. At the same time， Air China sells put options and promise to purchase call seller's aviation fuel 1135 million barrels no less than 62.35 dollars per barrel. On the maturity date of the contract， no matter how much the future spot aviation fuel price is， the call seller has the right to decide whether sell it or not， and Air China must accept it .On the other hand Air China sells the contract they receive at a higher price （72.35 ～ 200 in US dollars） for 300 million barrels， the put buyer has the right of purchase and Air China must accept it as well. In the contracts that will mature at the end of 2008， Air China has already payout 1000 Million US dollar， although the contract has expired， the actual payment was continuing to increase， and causing a 62 million difference. In addition， in order to compensate for the first contract premium they signed the second kind of passive contracts， which directly led to the great loss of Air China. After signing the contract， international fuel prices drop from 140 dollars / Barrel to 40 dollars per barrel. While the fuel owning price fell below 62.35 dollars per barrel， the loss of Air China airline expanded rapidly. When the Oil prices fell below 62.35 dollars， for the decrease of fuel price per dollar， Air China need $ 1 × 1135 million barrels = $ 1135 for its compensation payment. As the article can see each rising 10 $ / barrel produce1.4 $/ barrel premium， the hedging to this premium did lead to a big consequence.
4. Lesson from a successful example of Southwest Airlines Corporation
4.1 Descriptions of Southwest Airlines Co.
Southwest Airlines Co. is a major American airline that provides primarily short haul， high-frequency， point-to-point and low-fare service. It has almost the lowest cost structures in the American airline industry and consistently offers the lowest and simplest fares. This kind of commercial strategy was despised by some stronger competitors among a long period， such as Delta Air Lines and Northwest Airlines.
Southwest Airlines got an infinite development potential in the airlines business， and that enabled this firm to dispose its global expand strategy in the nearly future. However， the company could not achieve the success and these ambitious goals without its excellent hedging operation.
4.2 Descriptions of Southwest Airlines Co.'s hedging strategy
Southwest Airlines is famous for its fuel hedge. According to its annual report， fuel and oil cost for fiscal 2008 and 2007 represent 35 and 30 present of its operating expense. So a slight change in oil price may bring a big difference to the expenditure of the company and fuel hedging become an important way to keep this company run stable. Even in 2008， the whole airline industry faced a big challenge of volatile oil price； Southwest Airlines still benefited from the hedge operation which amount to $1.3 billion. Southwest used a mixture of swaps and call options to secure fuel in future years charge them with the price they believed were low. As a result， Southwest Airlines' average cost of fuel per gallon is smaller than other airline companies. This program gives the company space to lower its price and allow it to become more competitive. 4.3 Main findings
Here are some experience Chinese airlines can learn to successfully hedge the risks. Chinese airlines can buy contracts of crude oil or unleaded gasoline， and reap a gain if prices rise， offsetting the higher cost of jet fuel； they can also buy a "call option" that gives them the right to buy fuel at a certain price. The lost of a call option is limited if the oil price drop down and the profit is unlimited with the raise of price； Furthermore， they can also use collar hedges， a combination of rights to buy and sell at set prices （"call" and "put" options）. Collars provide protection from a decline in prices but less upside if prices rise. Last， Airlines in China may use swaps， contracts that require them to buy oil or fuel on a certain date at a set price. These are risky - one party in a swap wins， the other loses. These four methods can be seen as a portfolio to hedge the risks successfully.
5. Conclusion
Based on the combined information the author gains from interviews and resources on the Internet， the paper gets the underlying reasons of the great hedging loss of Air China Limited. Moreover， the internal reason illustrated in Section Three is the main cause of this event， which is the mistake of choosing hedging policy. In section four the paper also analyzes the American Southwest Airlines' successful experience. For Air China Limited， it still has to work on hedge for a long time that can provide them with vast experience to deal with changeable and complex situations. The company， as well as many other Chinese airlines should clearly figure out that the critical purpose of the company is to hedge the risks but not speculate， so the airline has to be extremely cautious when making hedging strategy.
Reference
[1] Eun and Resnick， 2007， International Financial Management[M]， Irwin McGraw-Hill， Boston， 4th Edition
[2] Company profile and financial data of Air China Limited http：//www.securities.com/Public/company-profile/CN/AIR_CHINA_LIMIED__%E4%B8%AD%E5%9B%BD%E5%9B%BD%E9%99%85%E8%88%AA%E7%A9%BA%E8%82%A1%E4%BB%BD%E6%9C%89%E9%99%90%E5%85%AC%E5%8F%B8__en_1736441.html
[3] Financial statistics of Southwest Airlines Co.http：//www.southwest.com/html/about-southwest/history/fact-sheet.html
[4] Carter， David A.， Rogers， Daniel A. and Simkins， Betty J.， Fuel Hedging in the Airline Industry： The Case of Southwest Airlines [J] （July 2004）. Available at SSRN： http：//ssrn.com/abstract=578663 or http：//dx.doi.org/10.2139/ssrn.578663.
作者简介：许雁凌，出生年月日：1992年9月19日，女，民族：汉，籍贯：安徽合肥，最高学历：大学本科，专业职称：学生，工作单位及职务：江西财经大学学生，主要教学科目或研究方向：国际金融。
（作者单位：江西财经大学）
Key words ： oil price， hedging strategy， Air China Limited
1. Background of the event
According to the news report in the 23rd number magazine of the Finance in 2008， "Air China Limited （Shanghai exchange code as 60111； Hong Kong exchange code as 00753） has released quarterly season report； this airline had appeared huge losses in fuel hedging business. By September 30th 2008.Air China Limited had reported a 961 million yuan loss in their operating in fuel derivatives. Moreover， Air China Limited is not the only company who suffered such great loss from the hedging business； countless airlines faced the disaster and even the articleity bankruptcy. To get the reason why the airline didn't benefit from the hedging business， the article made a telephone interview to the clerk working in Air China Limited， and also asked some professional teachers and do some search on the internet.
According to the results that the article gained， the reason attribute to the loss can be divided into two parts. One is the external cause， and the other is the internal cause.
2. External cause of the hedging loss
2.1 Hedge products
According to our interview from Bank of China who has the international bank services， the article have a clear view of the external cause of the airline's fuel hedging loss： From the long-term observation the article get the information that the value of RMB is increasing continuously and the price of bulk stock fluctuating greatly. Many multinational companies in China are facing a great risk nowadays. Here are some major products the bank can provide to help the company to hedge the risks： （1） Forward Transaction of Foreign Ex-
change refers to the foreign exchange transaction on a foreign exchange rate agreed by the buyer and seller under a foreign exchange contract， and for delivery on an agreed day， which is generally a certain day after the second working day after the transaction.
（2） Long dated foreign exchange forward
trading is a forward foreign exchange transaction with the value date one year later. The customer purchases one currency from the bank and sells another currency on the settlement day which is designated by the customers.
（3） Call option of RMB： It gives to the buyer the right to buy a certain amount of RMB at a certain exchange rate in the future market.
（4） Cash settlement of commodity forwards refers to such commodity transactions in which two parts of the transaction conduct the netting settlement according to the terms agreed in the contract at an agreed commodity price and within the pre-arranged term （generally a certain day after the second working day of transaction）.
（5） Foreign currency to RMB swap： As one of the foreign exchange swap business， foreign currency to RMB swap is actually the combination of a spot deal and a forward deal of foreign currency to RMB. Specifically， commercial bank and the customer sign the swap agreement through mutual consultation， and agree on the spot foreign exchange rate and the value date as the forward foreign exchange rate and its value date respectively. The customer shall conduct the conversion between the RMB and foreign exchange with the commercial bank in accordance with the agreed spot exchange rate and value date.
2.2 Main findings
Based on the abovementioned information， the cause of the airline's huge loss seems not so largely related to the financial product they choose. To further develop the analysis， the article also compares the hedge product market between China and other developed countries and find that most of companies in China use foreign currency hedging products through the intermediaries like hedging products exporting company. Such kind of company exports commodities to other countries in the form of foreign currency receivables. Instead， there is more foreign currency payables in developed countries. Furthermore， RMB is not a complete market currency and the exchange rate may be controlled by the central bank of China， which is political risk. Such reason is the main external cause of the hedging loss for Air China based on this paper's analysis. 3. Internal cause of the huge loss
3.1 Brief introduction of Air China Limited
Air China Limited is the flag carrier and one of the major airlines of China， with its headquarters in Shunyi District， Beijing. The airline's flight operations are based from out of Beijing Capital International Airport and are the world's 10th largest airline by fleet size. The enterprise logo of Air China consists of an artistic phoenix pattern. In 2010， Air China carried 60 million domestic and international passengers with an average load factor of 80%. The airline reported a net profit of 12 billion yuan in 2010.
3.2 Descriptions of Air China fuel hedging losses
ir China， the country's largest international carrier， said its loss in the fair value of fuel hedging contracts jumped to 3.1 billion yuan by the end of September， 2008. In a statement from the Shanghai Stock Exchange Saturday， the company said it signed the contracts in July 2008 with the longest term till 2011 to mitigate the risks of future possible rises in fuel price. On the basis of the data that Air China shot he articled， in 2008 they planned to use 2，800，000 tons of aviation fuel， since 50 percent of the fuel was used on the international air line. That is 1，400，000 tons. Until now， there are 24630 thousand barrels of air fuel which is not covered， for 1040 thousand tons per year. So the article can see that the fuel price has high impact on the company profit. They thought that they must do something to hedge the exposure.
What is an aviation fuel hedging？ In order to deal with oil price fluctuations of the business risks， maintain the future use of aviation fuel and develop the financial derivative instrument， airlines use an order to buy or sell forward contracts and lock the cost of aviation fuel. Loss or profits before expiration of the contract belongs to floating gains or loss. In the case of Air China， it signed the contracts when the international oil prices reaches at historical high levels and the general market consensus of the high oil prices also prevailed for a long period of time. Then Air China took a long position of which the underlying asset is the aviation fuel. However， the wrong-way bets made Air China buy fuel at higher than spot prices when crude oil prices had plunged 66 percent from its peak of 147.27 U.S. dollars per barrel on July 11th 2008 on concerns over a deep and prolonged recession of the global economy.
3.3 Main findings
Based on the past information， Air China Limited aviation fuel hedging begins in 2003， in 2007 they only produced 53.5 Million of floating losses， which hedged the costs of risk that caused by the increasing of aviation fuel price. According to the Air China bulletin， the contract of aviation fuel hedging options is divided into two sections： in a given price range， buyer purchases a call option， and seller sells the put options. Generally in the bull market， the main strategy for hedging against costly fees is selling out put options and purchase a call option and at the same time bearing the risk if the market price of aviation fuel is lower than the limit of the put option locks. Air China's option contracts can be divided into three types： if aviation fuel prices better than 62.35 $ ～150 dollars per barrel， set option quantity for 1135 Million barrels， that is Air China can set price （ less than $150 ） for the aviation fuel of 1135 Million barrels. At the deadline of contract， no matter how much the aviation fuel price is， Air China can decide whether to buy it or not. This is the most basic set of hedging contracts， because the airline company has the right to make a good use of hedging， once the price increases 10 dollars， Air China has to pay $1.4 million more options contracts cost， but if the contract is terminated， Air China does not need to purchase it and the option premium is the amount of the actual payment of the price difference. At the same time， Air China sells put options and promise to purchase call seller's aviation fuel 1135 million barrels no less than 62.35 dollars per barrel. On the maturity date of the contract， no matter how much the future spot aviation fuel price is， the call seller has the right to decide whether sell it or not， and Air China must accept it .On the other hand Air China sells the contract they receive at a higher price （72.35 ～ 200 in US dollars） for 300 million barrels， the put buyer has the right of purchase and Air China must accept it as well. In the contracts that will mature at the end of 2008， Air China has already payout 1000 Million US dollar， although the contract has expired， the actual payment was continuing to increase， and causing a 62 million difference. In addition， in order to compensate for the first contract premium they signed the second kind of passive contracts， which directly led to the great loss of Air China. After signing the contract， international fuel prices drop from 140 dollars / Barrel to 40 dollars per barrel. While the fuel owning price fell below 62.35 dollars per barrel， the loss of Air China airline expanded rapidly. When the Oil prices fell below 62.35 dollars， for the decrease of fuel price per dollar， Air China need $ 1 × 1135 million barrels = $ 1135 for its compensation payment. As the article can see each rising 10 $ / barrel produce1.4 $/ barrel premium， the hedging to this premium did lead to a big consequence.
4. Lesson from a successful example of Southwest Airlines Corporation
4.1 Descriptions of Southwest Airlines Co.
Southwest Airlines Co. is a major American airline that provides primarily short haul， high-frequency， point-to-point and low-fare service. It has almost the lowest cost structures in the American airline industry and consistently offers the lowest and simplest fares. This kind of commercial strategy was despised by some stronger competitors among a long period， such as Delta Air Lines and Northwest Airlines.
Southwest Airlines got an infinite development potential in the airlines business， and that enabled this firm to dispose its global expand strategy in the nearly future. However， the company could not achieve the success and these ambitious goals without its excellent hedging operation.
4.2 Descriptions of Southwest Airlines Co.'s hedging strategy
Southwest Airlines is famous for its fuel hedge. According to its annual report， fuel and oil cost for fiscal 2008 and 2007 represent 35 and 30 present of its operating expense. So a slight change in oil price may bring a big difference to the expenditure of the company and fuel hedging become an important way to keep this company run stable. Even in 2008， the whole airline industry faced a big challenge of volatile oil price； Southwest Airlines still benefited from the hedge operation which amount to $1.3 billion. Southwest used a mixture of swaps and call options to secure fuel in future years charge them with the price they believed were low. As a result， Southwest Airlines' average cost of fuel per gallon is smaller than other airline companies. This program gives the company space to lower its price and allow it to become more competitive. 4.3 Main findings
Here are some experience Chinese airlines can learn to successfully hedge the risks. Chinese airlines can buy contracts of crude oil or unleaded gasoline， and reap a gain if prices rise， offsetting the higher cost of jet fuel； they can also buy a "call option" that gives them the right to buy fuel at a certain price. The lost of a call option is limited if the oil price drop down and the profit is unlimited with the raise of price； Furthermore， they can also use collar hedges， a combination of rights to buy and sell at set prices （"call" and "put" options）. Collars provide protection from a decline in prices but less upside if prices rise. Last， Airlines in China may use swaps， contracts that require them to buy oil or fuel on a certain date at a set price. These are risky - one party in a swap wins， the other loses. These four methods can be seen as a portfolio to hedge the risks successfully.
5. Conclusion
Based on the combined information the author gains from interviews and resources on the Internet， the paper gets the underlying reasons of the great hedging loss of Air China Limited. Moreover， the internal reason illustrated in Section Three is the main cause of this event， which is the mistake of choosing hedging policy. In section four the paper also analyzes the American Southwest Airlines' successful experience. For Air China Limited， it still has to work on hedge for a long time that can provide them with vast experience to deal with changeable and complex situations. The company， as well as many other Chinese airlines should clearly figure out that the critical purpose of the company is to hedge the risks but not speculate， so the airline has to be extremely cautious when making hedging strategy.
Reference
[1] Eun and Resnick， 2007， International Financial Management[M]， Irwin McGraw-Hill， Boston， 4th Edition
[2] Company profile and financial data of Air China Limited http：//www.securities.com/Public/company-profile/CN/AIR_CHINA_LIMIED__%E4%B8%AD%E5%9B%BD%E5%9B%BD%E9%99%85%E8%88%AA%E7%A9%BA%E8%82%A1%E4%BB%BD%E6%9C%89%E9%99%90%E5%85%AC%E5%8F%B8__en_1736441.html
[3] Financial statistics of Southwest Airlines Co.http：//www.southwest.com/html/about-southwest/history/fact-sheet.html
[4] Carter， David A.， Rogers， Daniel A. and Simkins， Betty J.， Fuel Hedging in the Airline Industry： The Case of Southwest Airlines [J] （July 2004）. Available at SSRN： http：//ssrn.com/abstract=578663 or http：//dx.doi.org/10.2139/ssrn.578663.
作者简介：许雁凌，出生年月日：1992年9月19日，女，民族：汉，籍贯：安徽合肥，最高学历：大学本科，专业职称：学生，工作单位及职务：江西财经大学学生，主要教学科目或研究方向：国际金融。
（作者单位：江西财经大学）