Showa Shell Sekiyu K.K. is the 50 percent owned Japanese subsidiary of the oil giant Royal Dutch Shell. Unlike giant multinationals such as Exxon or Royal Dutch Shell that are vertically integrated from oil exploration and extraction all the way to distribution, Japanese oil companies are primarily engaged in downstream activities—namely domestic refining and distribution operations through company-owned service stations. Such activities are almost exclusively focused on the Japanese market, which offers very stable market conditions in terms of price controlled by the Japanese government and quantity sold (relatively stable with a 12. 5 percent share of the Japanese market). International dealings are limited to importing petroleum products whose prices are set in dollars.

a. Map out the cash flows configuration characteristic of a Japanese domestic oil refiner and distributor such as Showa Shell. What is the nature of Showa Shell’s exposure to foreign exchange risk?

b. Showa Shell experiences spikes in operating costs due to jumps in the price of oil or the yen price of the dollar. Such spikes squeeze operating income since Showa Shell is not able to translate or pass through immediately its higher costs into higher prices (because of governmental price controls). How should Showa Shell protect itself from such occurrences?

c. Would your answer be different if Showa Shell sourced all crude oil from

(1) its parent Royal Dutch Shell or (2) the spot oil market?