| ATF CONTRACTS: A TIMELY INSTRUMENT The ATF futures, launched recently by the MCX, will enable industry players to hedge their costs as prices of ATF in India are based on international import parity prices. Also, prices of ATF vary across the states due to the variable tax structure
By Sandip Das
The Multi Commodity Exchange of India (MCX) on July 7 launched the aviation turbine fuel (ATF) futures contract, the first of its kind in India, in order to help domestic refiners and airlines from the uncertainty prevailing in global oil markets.
Aviation turbine fuel, as is obvious from its name, is used for powering jet and turbo-prop engine aircraft. This kerosene type fuel was chosen due to its excellent combination of properties. Notably, in India, the kerosene market is divided in three segments namely kerosene for public distribution system (PDS), industrial kerosene and aviation turbine fuel (ATF). According to industry estimates, India produces 78,05,000 tonnes ATF annually and exports 36,62,000 tonnes.
With a booming airline industry in India and surge in air traffic, both domestically as well as internationally, the demand for ATF is rising sharply and so is its price. Record high fuel prices in global market and supply uncertainties have put pressure on domestic aviation industry, as ATF prices alone constitute around 40 per cent of the total operating cost of airlines. In June, the International Air Transport Association (IATA) revised its industry financial forecast for 2008 significantly downwards to a loss of $2.3 billion. It said that for every dollar that the price of ATF increases, costs go up by $1.6 billion.
Domestic ATF prices have increased by over 160 per cent from the beginning of 2005 till July this year and by over 80 per cent from a year-ago levels. This year alone, prices have jumped up by over 50 per cent.
In India, after the dismantling of the administered price mechanism (APM), effective April 2001, the oil companies revise ATF prices at regular intervals. The prices of ATF in India are based on international import parity prices. Also, prices of ATF vary across the states due to the variable tax structure. Notably, oil companies in India do not import ATF directly; rather they refine it from imported crude oil. With rising crude oil prices, imports are becoming expensive (Indian basket) day by day. At the same time, the government is unable to pass on the full impact of this rise to the consumer by raising fuel prices (petrol and diesel). As a result, the state owned oil marketing companies (almost 95 per cent of the market is with state owned firms) are forced to sell diesel, petrol, kerosene and LPG at way below cost, a cost they are trying to somewhat make up by raising the price of ATF, which is under their control. As a result prices of ATF in India are much higher than some of the other Asian countries. For example, price of ATF sold at Singapore airport is approximately 39 per cent below Indian prices.
With uncertainty in global crude oil prices, it becomes important that domestic airlines hedge their fuel price risk on an exchange platform. In the absence of such contracts, domestic airlines buy ATF in spot markets. Against this background, the Government of India allowed domestic airlines to hedge their fuel risk and after getting approval from the market regulator, the Forward Markets Commission (FMC), the MCX launched the ATF futures contract for trading.
According to MCX, oil refining companies and airlines are already hedging in MCX crude oil contracts, which has a 90 per cent correlation with ATF futures. ATF futures can reduce the uncertainty as they will make it an obligation for the seller to supply the underlying commodity and will allow airlines to minimise the risk of rising fuel prices, thereby ensuring stable profitability.
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