Question 1: Crude oil price shocks have a long history (see below chart, source: US Energy Department). 140 Globa Uprisings financial in Egypt & Libya collapse 120 Iran-Iraq War begins 100 80 Saudi Arabia abandons. "swing producer" role Gulf War 60 Asian economic crisis 40 20 Constant $2013 per barrel 0 Iranian Revolution hul Arab Oll Embargo - OPEC PdVSA cuts worker's production strike in Venezuela 134 In the lead up to the global financial crisis (GFC), oil price spiked to almost $140 per barrel. To hedge the risk of further oil price increase, many airlines bought large numbers of forward/future contracts to 'lock in' the price and to protect them from further price increases. However, the GFC caused the oil price to dive, from as high as $140 per barrel to as low as $40. As a result, many airlines lost a lot of money due to the use of forward or future oil contracts. (a) why using forward/future contracts caused the airlines to lose money in this example? (b) does this suggest that forward/future contracts are a bad hedging tool? Why or why not? Prices rise on OPEC cutbacks, increased demand 9/11 attacks Iraq invades Kuwait 1970- 1971 1972 1973- 1974 1975 1976 1977- 1978- 1979 1980 1981 1982 1983 1984 1985 1986 1987- 1987- 1988- 1989- 1990 1991- 1992 1993 1994 1995 1996 1997 1998 1999- 2000- 2001- 2002 2003- 2004- 2005 Excess Supply V Lose! Syrian Conflict