Hurricane Katrina has jacked up jet fuel prices far more than crude oil costs, hobbling attempts by major carriers to restructure without bankruptcy protection
The descriptions say it all: the single greatest civil disaster in US history and the single largest blow to the nation’s economy since the terror attacks of 2001. Hurricane Katrina was the force of nature that turned several hundred thousand square kilometres of the US coast along the Gulf of Mexico into a disaster zone.
The result is a crimping of economic growth by 1% of GDP or more, the loss of 500,000 jobs, the infliction of at least $30 billion in property losses, $38 billion in consumer spending lost from this year’s economy, short-term oil prices spurred from $55 a barrel in June to $70 a barrel, and closure of half the nation’s oil refineries and drilling rigs. But to the airlines it is nothing new.
It is, to use words that are close to becoming a buzz phase, a tipping point. The US legacy airline industry may have already rested on a shaky structure waiting to either be propped up for a temporary solution or to be pushed over – but the simple fact is that Katrina imploded the industry before repairs could be accomplished from the inside. AirlineForecasts consultant Vaughn Cordle says: “They just ran out of time. Even Herb Kelleher of Southwest Airlines, arguably the best airline manager, cannot save these airlines from financial failure.” The sad truth is that disaster brings little new to the US airlines: they cannot turn a profit when basic supplies cost as much as fuel does and as long as customers pay as little as they do.
That is why this round of restructuring is different. The industry, like the unfortunate residents of New Orleans, is dealing with a force of nature. Moreover, crude oil prices must also now be looked at as a starting price point. Another 20% or so must be added on top for the difference between crude and jet fuel prices, what is called the crack spread. An ugly phrase, and an unpleasant reality.
The crack spread widens
But the meaning is simple and ominous. Jet fuel prices no longer follow their historic and relatively close relationship to crude oil prices (see top chart on page 29). The spread is growing wider and, as airline executives see headlines about oil at $60 a barrel, they have to do a double take, or at least a 20% mental multiplication. Squeezed by a domestic thirst for automobile gasoline and insatiable worldwide demand, refiners are doing to airlines exactly what airlines try to do to passengers: differentiate prices by product segment.
They are charging what the market can bear for oil refined to jet uses, a not especially demanding technological achievement compared with the relatively sophisticated environmentally tailored blends used in motoring. Bear Stearns analyst David Strine has estimated that jet fuel is rising at a substantially higher rate than crude itself. He says a benchmark crude, West Texas Intermediate (WTI in the commodities tables) increased by about 40% in the first half of the year, while jet fuel increased by almost 50%, meaning that almost 20% of the rise in jet fuel prices stems from the spread.
And it is getting worse, says the Air Transport Association (ATA), which represents US carriers. After Katrina, the crack spread hit about $30 a barrel, pushing the spot price of a barrel of fuel to the high $90s a barrel. Within three weeks of Katrina’s landfall, refiners were enjoying 30% margins on jet fuel. This is more than for heating oil or clean diesel and behind only the 50% margins on gasoline, says the ATA’s chief economist John Heimlich.
Cordle sees the crack spread continuing into 2007. It will push Delta’s 2006 fuel bill up to $5.2 billion from $2.9 billion in 2004. Delta gets about a quarter of its fuel from the refineries that Katrina knocked out, it says. In the first half of 2005, the crack spread for jet fuel reached $11 a barrel, compared with about $2.59 a barrel as recently as 2002. According to the Bear Stearns analysis, on a per gallon basis jet fuel costing $1.21 a gallon in 2004 will be $1.73 by the end of this year and $1.89 by the end of 2006 on the spot market.
Northwest Airlines chief executive Doug Steenland explained minutes after the airline’s bankruptcy filing in mid-September that “we were in essence paying close to $100 a barrel for jet fuel. When you compare that to the $42 a barrel we were paying earlier in the year, plus about $10 in refining costs [the crack spread], you see the staggering impact of fuel costs on Northwest and on the entire industry.”
Several carriers have been using hedging as a tactic to bring a degree of predictability to their fuel prices. But as the accompanying table shows (below), its use is highly variable, with only four carriers hedged beyond 50% of their consumption. And only one carrier – Southwest – is hedged past 2008. It has bought 30% of its fuel needs in 2008 at $30 per barrel and a quarter of its anticipated 2009 consumption at $35 per barrel. Notably most of the majors, with those in bankruptcy unable to hedge because of their status, have bought very little of their fuel going forward.
The crisis is, of course, global. Giovanni Bisignani, IATA’s director general, who flew to Washington immediately after Katrina, says: “Oil is once again robbing the industry of a return to profitability.” At $57 a barrel, the industry fuel bill for 2005 will top $97 billion. That makes up 25% of costs. “In less than two years the total bill has more than doubled,” he says.
The industry also turned to Washington as well. ATA president James May told a Senate panel: “The government can take at least one step to help – grant a one-year holiday from the 4.3¢ per gallon jet fuel tax.” The break would be worth around $600 million per year, May told the panel. Joined by Regional Airline Association president Debbie McElroy, May also urged a long-term look at the tax, which was enacted in 1993 as a temporary deficit-reduction measure.
The members of the Senate aviation subcommittee to whom May and McElroy made their plea have been politely sympathetic, but others in Washington, where the clear-up and rebuilding effort from Katrina is already building up a tab that will shake the national budget deficit, are less inclined to aid this particular group of hurricane victims. The senators who actually oversee taxes and tax breaks are even less sympathetic, with the chairman of the tax-writing finance committee, Iowan Chuck Grassley, saying “maybe you might as well let the bankruptcy courts sort it out”. And the leading aviation expert on the other side of the Capitol, House aviation subcommittee chairman John Mica, says the government had offered enough bail-outs and it is time for “tough love”.
A few hours after their tax pleas, Delta followed Northwest by minutes in filing for bankruptcy protection, citing its fuel bill. The timing was a coincidence, and Delta chief financial officer Edward Bastian said in a court filing: “The unexpected cost of fuel has offset the benefits of the transformation plan and as a result forced an immediate liquidity crisis.” Both carriers say that the government could aid them in their pensions problems, and Steenland says that Northwest, which has led the campaign for retirement plan change, “has strong and committed supporters” for reform.
The hurricane has not been the only force at play: a major change in the bankruptcy laws takes effect during October and both carriers concede that this has played a role in their submissions. The new statute limits to 18 months the time during which a bankrupt company can reorganise without any outside parties trying to take it over or liquidate it, the so-called “period of exclusivity”. The new law also limits executive bonuses and retention plans, although Steenland says he will take another pay cut if necessary and Delta chief executive Gerry Grinstein has already done so.
The hurricane overwhelmed what effect there may or may not have been of a strike begun on 20 August by Northwest’s Aircraft Mechanics Fraternal Association. The action cost the airline as much as $55 million in added costs, but was not a major factor in the bankruptcy filing, Steenland says. The two bankruptcies came exactly a year after the most recent bankruptcy filing of US Airways – a reorganisation that has brought it into the corporate arms of healthier America West in a merger that has recently cleared all remaining hurdles.
US Airways was not expected to emerge from its second bankruptcy until America West strode onto the scene as a white knight. Arizona-based America West is the surviving entity, although it will use the US Airways name. But for the airlines reeling in their deepest crisis since this decade of emergencies began, no white knight is now on any horizon.
DAVID FIELD/WASHINGTON
Source: Airline Business
