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Airline Ops Expenses Soar Along With Fuel Prices, Hedging Could Help
Aviation Week & Space Technology
04/19/2004, page 30
Barry Rosenberg
Thousand Oaks, Calif.
As fuel prices keep climbing, major airlines see even less room to maneuver
SKY HIGH
Pick a global trend and watch airline revenue and operating expenses react. War sends load factors plummeting, along with revenue, as it did in 1991 and again recently. The booming economy of the go-go '90s bounced revenues into the black. And oil production cut-backs and political uncertainty typically send jet fuel costs skyrocketing.
It is the last that is bedeviling airlines today, and first-quarter airline revenues now being released portend bad news for the airline industry as a whole. Delta Air Lines, for example, reported Apr. 14 a stiff first-quarter loss of $383 million, partially attributable to rising fuel costs.
"Investors hardly require a reminder at this point that escalating energy costs and uninspiring domestic revenue trends are transpiring to depress recovery efforts," said JPMorgan analyst Jamie Baker.
As a result of greater fuel expenses, JPMorgan has widened its first-quarter operating loss forecast for U.S. airlines to $900 million from $300 million, and reduced its 2004 operating profit estimates to $1.6 billion from $3.3 billion for airlines as a whole. On a net basis, that translates into an industry net loss this year of $1.7 billion against last year's $5.8-billion loss.
Oil, at $38 per barrel, is at its highest price in 13 years. The per-gallon rate for jet fuel has escalated the most in Los Angeles--jumping from $0.83 per gallon on Oct. 1, 2003, to about $1.37 on Apr. 13 this year, a nearly 40% jump, according to Platts, which, like Aviation Week & Space Technology, is a division of the The McGraw-Hill Companies. Increases for jet fuel have been smaller in the New York harbor and U.S. Gulf Coast regions.
"As most carriers are only modestly hedged against rising fuel prices, the impact of higher fuel prices to the industry's bottom line is material," said Merrill Lynch analyst Michael Linenberg, adding that for every $1 change in the price of oil per barrel, U.S. industry profitability swings by roughly $500 million.
It may be no surprise that the airline which leads the industry in profitability has also apparently played the fuel-hedge game spot on. Southwest Airlines has about 80% of its fuel needs hedged for 2004 at about $24 per barrel, and 60% of 2005 fuel needs hedged at similar levels.
At the other end of the scale, Northwest Airlines and United Airlines have no fuel hedge position, according to Merrill Lynch, and are totally exposed to the vagaries of the oil market.
Holding the middle ground are: JetBlue, 40% hedged at $27.63 per barrel; Alaska Air, 33% hedged at $28 per barrel; Delta, 32% hedged at $26.10 per barrel; and AirTran, which is hedged at 28% at $31.80 per barrel. America West, American Airlines and Frontier Airlines have smaller hedges, at 11%, 5% and 4%, respectively.
"Hedging takes a certain amount of financial wherewithal that Southwest has in spades," said one analyst. "Southwest's hedges started to build long ago when nobody thought that rising prices from last year would sustain."
It was an obvious tactical miscalculation on the part of most airlines, other than Southwest, who bet (wrongly) that fuel prices wouldn't climb. "The point of hedging is to avoid uncertainty," said Michael Roach, an associate of Unisys R2A management consultants, and founding president of America West Airlines. Roach, who led the carrier from 1981-84, thinks fuel price hedging can always play a tactical role in an airlines' long-term strategy. "It is never too late to hedge the requirements you'll have two quarters from now," he said.
Like JPMorgan, Merrill Lynch believes rising fuel prices will lead to reduced earnings expectations for many airlines, including AMR's American, Continental Airlines, Southwest, Northwest, Alaska Air and America West. Merrill is forecasting a pretax loss of $2.2 billion for the industry as a whole, up from its earlier estimate of $600 million.
To offset the sting of higher fuel prices, airlines are making every effort to raise airfares. Some small, targeted fare increases have stuck, but most have not.
For many airlines, the problem can be blamed on the Southwest effect. If this was a typical cycle, airlines would respond to higher fuel prices with increased passenger fares--as there is usually a positive correlation between revenue and fuel prices. But with Southwest being 80% hedged at a very advantageous per-barrel price for oil, it can hold the line on fares--forcing competitors to do the same and driving them into deeper losses.
AND THOUGH ANALYSTS think the industry is in a profit recovery mode, high fuel prices are masking the progress of cost-reduction initiatives. At the same time, 2004 industry capacity is expected to be only 1-2% less than operations during the peak of 2000. But, this may prove to be too much capacity as 2004 industry revenue is likely to be at least 10-15% less than in 2000, according to Linenberg.
"If fuel prices remain high, and revenue growth continues to be anemic--exacerbated by localized fare skirmishes--we think it is likely that most, if not all, carriers will have to rethink their 2004 capacity plans," he said.
US Airways is in a relatively good position in relation to fuel prices, with 30% of its fuel hedged for 2004. Credit: GEORGE HAMLIN
Also mitigating possible capacity creep is that a large part of the capacity growth by the majors is either back-filling what was pulled down last spring due to war and the severe acute respiratory syndrome (SARS) health scare, or incremental international market adds. Analysts further believe that plans to add capacity on the part of airlines like United, US Airways and Delta will go by the wayside due to their financial travails.
It is interesting to note that the most profitable airlines, or more accurately those airlines that are not expected to experience downwardly revised earnings due to higher fuel prices, are the carriers operating fuel-efficient fleets. JetBlue Airways rises to the top in that category.
Flying an all-Airbus A320 fleet (though it has placed a $3-billion order for 100-seat Embraer 190s), JetBlue generates roughly 30% more revenue passenger miles (RPMs) per gallon of fuel than any other carrier.
According to a Unisys R2A report, JetBlue produces 65.8 RPMs per gallon at an average hop of 1,196 mi., contrasting sharply with airlines such as Southwest, US Airways, Delta, Northwest and American. They all came in below 45 RPMs per gallon with shorter average hops.
JetBlue's success is accounted for by high scores in each of the four most important factors contributing to low fuel consumption, according to the study: an all current-generation fleet; long average hops; relatively high seating density, and very high load factors.
Aviation Week & Space Technology
04/19/2004, page 30
Barry Rosenberg
Thousand Oaks, Calif.
As fuel prices keep climbing, major airlines see even less room to maneuver
SKY HIGH
Pick a global trend and watch airline revenue and operating expenses react. War sends load factors plummeting, along with revenue, as it did in 1991 and again recently. The booming economy of the go-go '90s bounced revenues into the black. And oil production cut-backs and political uncertainty typically send jet fuel costs skyrocketing.
It is the last that is bedeviling airlines today, and first-quarter airline revenues now being released portend bad news for the airline industry as a whole. Delta Air Lines, for example, reported Apr. 14 a stiff first-quarter loss of $383 million, partially attributable to rising fuel costs.
"Investors hardly require a reminder at this point that escalating energy costs and uninspiring domestic revenue trends are transpiring to depress recovery efforts," said JPMorgan analyst Jamie Baker.
As a result of greater fuel expenses, JPMorgan has widened its first-quarter operating loss forecast for U.S. airlines to $900 million from $300 million, and reduced its 2004 operating profit estimates to $1.6 billion from $3.3 billion for airlines as a whole. On a net basis, that translates into an industry net loss this year of $1.7 billion against last year's $5.8-billion loss.
Oil, at $38 per barrel, is at its highest price in 13 years. The per-gallon rate for jet fuel has escalated the most in Los Angeles--jumping from $0.83 per gallon on Oct. 1, 2003, to about $1.37 on Apr. 13 this year, a nearly 40% jump, according to Platts, which, like Aviation Week & Space Technology, is a division of the The McGraw-Hill Companies. Increases for jet fuel have been smaller in the New York harbor and U.S. Gulf Coast regions.
"As most carriers are only modestly hedged against rising fuel prices, the impact of higher fuel prices to the industry's bottom line is material," said Merrill Lynch analyst Michael Linenberg, adding that for every $1 change in the price of oil per barrel, U.S. industry profitability swings by roughly $500 million.
It may be no surprise that the airline which leads the industry in profitability has also apparently played the fuel-hedge game spot on. Southwest Airlines has about 80% of its fuel needs hedged for 2004 at about $24 per barrel, and 60% of 2005 fuel needs hedged at similar levels.
At the other end of the scale, Northwest Airlines and United Airlines have no fuel hedge position, according to Merrill Lynch, and are totally exposed to the vagaries of the oil market.
Holding the middle ground are: JetBlue, 40% hedged at $27.63 per barrel; Alaska Air, 33% hedged at $28 per barrel; Delta, 32% hedged at $26.10 per barrel; and AirTran, which is hedged at 28% at $31.80 per barrel. America West, American Airlines and Frontier Airlines have smaller hedges, at 11%, 5% and 4%, respectively.
"Hedging takes a certain amount of financial wherewithal that Southwest has in spades," said one analyst. "Southwest's hedges started to build long ago when nobody thought that rising prices from last year would sustain."
It was an obvious tactical miscalculation on the part of most airlines, other than Southwest, who bet (wrongly) that fuel prices wouldn't climb. "The point of hedging is to avoid uncertainty," said Michael Roach, an associate of Unisys R2A management consultants, and founding president of America West Airlines. Roach, who led the carrier from 1981-84, thinks fuel price hedging can always play a tactical role in an airlines' long-term strategy. "It is never too late to hedge the requirements you'll have two quarters from now," he said.
Like JPMorgan, Merrill Lynch believes rising fuel prices will lead to reduced earnings expectations for many airlines, including AMR's American, Continental Airlines, Southwest, Northwest, Alaska Air and America West. Merrill is forecasting a pretax loss of $2.2 billion for the industry as a whole, up from its earlier estimate of $600 million.
To offset the sting of higher fuel prices, airlines are making every effort to raise airfares. Some small, targeted fare increases have stuck, but most have not.
For many airlines, the problem can be blamed on the Southwest effect. If this was a typical cycle, airlines would respond to higher fuel prices with increased passenger fares--as there is usually a positive correlation between revenue and fuel prices. But with Southwest being 80% hedged at a very advantageous per-barrel price for oil, it can hold the line on fares--forcing competitors to do the same and driving them into deeper losses.
AND THOUGH ANALYSTS think the industry is in a profit recovery mode, high fuel prices are masking the progress of cost-reduction initiatives. At the same time, 2004 industry capacity is expected to be only 1-2% less than operations during the peak of 2000. But, this may prove to be too much capacity as 2004 industry revenue is likely to be at least 10-15% less than in 2000, according to Linenberg.
"If fuel prices remain high, and revenue growth continues to be anemic--exacerbated by localized fare skirmishes--we think it is likely that most, if not all, carriers will have to rethink their 2004 capacity plans," he said.
US Airways is in a relatively good position in relation to fuel prices, with 30% of its fuel hedged for 2004. Credit: GEORGE HAMLIN
Also mitigating possible capacity creep is that a large part of the capacity growth by the majors is either back-filling what was pulled down last spring due to war and the severe acute respiratory syndrome (SARS) health scare, or incremental international market adds. Analysts further believe that plans to add capacity on the part of airlines like United, US Airways and Delta will go by the wayside due to their financial travails.
It is interesting to note that the most profitable airlines, or more accurately those airlines that are not expected to experience downwardly revised earnings due to higher fuel prices, are the carriers operating fuel-efficient fleets. JetBlue Airways rises to the top in that category.
Flying an all-Airbus A320 fleet (though it has placed a $3-billion order for 100-seat Embraer 190s), JetBlue generates roughly 30% more revenue passenger miles (RPMs) per gallon of fuel than any other carrier.
According to a Unisys R2A report, JetBlue produces 65.8 RPMs per gallon at an average hop of 1,196 mi., contrasting sharply with airlines such as Southwest, US Airways, Delta, Northwest and American. They all came in below 45 RPMs per gallon with shorter average hops.
JetBlue's success is accounted for by high scores in each of the four most important factors contributing to low fuel consumption, according to the study: an all current-generation fleet; long average hops; relatively high seating density, and very high load factors.
