COLIN BAKER LONDON
In an uncertain market, airlines are taking advantage of the recent fall in jet-kerosene prices
If there has been one piece of good news for the airline industry of late, then it has come in the shape of a fall in the price of jet kerosene. As with much else in the world economy, the decline was already in evidence before the events of 11 September, but the trend has since been magnified in the aftermath of the disaster. It is perhaps an irony that the same sharp global downturn in demand which has sent the airline industry into a tailspin has also helped cushion the fall, at least a little, by depressing the world oil price.
However, the good news comes with some cautions. It is true that 2001 saw a steady monthly fall in the cost of jet kerosene, but that was in comparison with the record highs of 2000. Despite this decrease, prices are still comfortably above the levels of 1999 and 1998, when oil was at a 10-year low. So while rates are now roughly in line with those of the mid-1990s, they are still well below the low-point seen at the time of the 1990-1 Gulf War (see tables over page).
The impact of fuel costs on the airline business is difficult to ignore. In 2000, as the oil price soared, the US passenger carriers spent around $12 billion on fuel which represents around 15%of their total expenses. During that year the price had hit an average of over 80¢ per US gallon, the highest rates since 1984 and up from the 50-60¢ mark where it had sat for much of the previous decade. In 2001 the prices have come down from their height but until September the average was still hovering around that 80¢ mark.
Hedging has helped to take some of the edge off the fuel price fluctuations. US aviation consultancy Morten Beyer & Agnew notes that the amount paid by individual US carriers varies considerably from the average even in 2000. Delta Air Lines, which has been one of the best-hedged, paid just under 65¢ per US gallon on average over the last five years, compared to 77¢ for the US majors as a whole. Alaska Airlines, on the other hand, paid nearly 94¢. And the majors themselves paid nearly 5¢ less than that for the industry as a whole, suggesting that the more sophisticated fuel-buying strategies of the larger carriers have indeed paid handsome dividends.
European carriers too have been hedging hard. Andrew Light, airline analyst at Schroder Salomon Smith Barney, estimates that, on average, European carriers hedged 60-70% of their fuel in 2001, although 50%was the most common proportion. In order to create that average, some must clearly have hedged around 90%.
Light calculates that a 20% fall in the cost of fuel will improve next year's pre-tax results for European carriers by 1.5%. Low-cost carriers stand to gain more than mainline carriers because fuel makes up a higher proportion of their cost base, he adds. Also, it is clear that those carriers which have hedged most aggressively are likely to feel less of the benefit as fuel prices now fall. And this includes low-fares Ryanair, which hedged around 90% of its fuel needs in 2001. By contrast, Alitalia, hedged only 40%of its fuel requirements in 2001 and stands to gain more as prices fall.
However, the fuel advantage could still prove to be short-lived if oil prices simply soar again from the current low. Indeed, Loyola de Palacio European Commissioner for energy, as well as transport, has made clear her displeasure at the instability in the fuel market - even in a time of falling prices. "The low oil price is not sustainable in the medium-to-long term. The main issue for us in Europe is to have stable prices at a reasonable level. A low oil price doesn't interest us," she says.
Low oil prices accompanied by low (or negative) economic growth is hardly good news for the airline industry. This is doubly so given the commercial pressure to pass on at least some of the benefits to the consumer. This is truer of the leisure market than for corporate or cargo customers, although Lufthansa Cargo, the largest of the world's airline freight carriers, recently withdraw fuel charges originally imposed last February. It is possible that others who were successful in pushing through fuel surcharges could have to follow suit. Chris Avery, financial analyst at JP Morgan, notes that the US carriers were able to pass on five price rises in 2000 when fuel prices surged. "Customers accepted it because they could see gasoline prices going up," he says. Now prices are on the decline.
Price forecasts
Now the key question is what will happen to prices in 2002 and to that there are no easy answers. "This is a period of significant uncertainty," says Anton Bray, global supply and logistics manager at Shell International Trading and Shipping. Forward trading prices are showing a slight upward trend in the second half of 2002, but Bray explains that this merely reflects a vague idea that prices must rise at some point in the future rather than being based on hard evidence of an upswing in the market.
Much depends on the Organisation of Petroleum Exporting Countries (OPEC) and how successful it is in curbing production and keeping crude prices in a range of $22-28 per barrel (53-68¢ per gallon). OPEC has become increasingly irritated at having to bear the brunt of production cuts over the past year, while non-OPEC production has increased.
Leo Drollas, analyst at the London-based Centre for Global Energy Studies believes that higher forward prices in the fourth quarter will reflect an expectation that OPEC will be successful in agreeing production cuts at some point over the year ahead. He expects prices to be benign in the first three-quarters, however. "We are not going to see the horror story of 2000. Nor are we going to see prices as low as the [$16 per barrel] we saw in the first quarter of 1999." he says, adding, however, that considerable uncertainty remains over OPEC's willingness to curb output.
An example of the climate of uncertainty, and how quickly the market can move, is the fact that Rotterdam spot jet fuel prices fell by around 15% from the end of October to mid-November. This reflects the fact that the US terrorist attacks led to a significant amount of jet fuel being shipped from the Caribbean to Rotterdam.
Uncertain climate
Given this lack of certainty, airlines and fuel suppliers are taking the opportunity to lock themselves into lower fuel prices by trading on the basis of estimated future prices through the purchase of swaps or options, says Bray. "Prices are so much lower than they were. At around two-thirds historical levels, people seem to be thinking at least we're going to be three-quarters right."
Even Europe's low-cost easyJet, which has not hedged against fuel at all in recent years, has decided to insure itself against fuel-price spikes by purchasing fuel caps. This offers some protection against a major Middle East crisis, for instance, by enabling the carrier to buy at least some of its fuel needs below a guaranteed price.
It is not just jet-fuel prices that have been decreasing. So has the refining margin: the difference in price between the refined product (in this case jet fuel) and crude oil. That margin spent much of 2000 above historical norms but has come down in 2001. According to the Centre for Global Energy Studies, the long-term average ratio for jet fuel to the spot-price for Brent crude oil has been below average for all but two months over the past year.
US analyst Brian Harris at Salomon Smith Barney estimates that the margin between jet fuel and WTI (West Texas Intermediate), which is one of the main US crude benchmarks, stood at $9 in September 2000. That margin was three times above the historical average. This meant carriers were paying an extra 15-20%, on top of the 40% yearly rise from which they were already suffering.
Harris points out that, although many US carriers were heavily hedged in 2000, most of that was against the WTI market, which is far more liquid than that for jet fuel. Delta was one of the few exceptions, mainly hedging against heating oil, which is in the same distillate product group as jet fuel. Since they are extracted at a similar stage of the refining process jet-fuel prices tend to rise in the winter when demand for heating oil is at its peak. However, while Delta was rewarded for its hedge, it is normally more expensive to hedge against heating oil than crude.
Peak demand
Figures from ICIS-LOR, a sister service to Airlines Business which tracks world oil markets, show how consistently jet kerosene prices have dropped during 2001 (see graphs right). Having started the year still near to 80¢ per gallon, prices closed in December close to the 55¢ mark. That is more or less back to the levels of 1999. These figures are based on an aggregate figure made up of the Rotterdam cargo price, together with that for US pipeline and Singapore barge. The best guesses from oil experts are for prices now to stay in the 55-65¢ range for the foreseeable future.
However, Drollas says that falls in US refinery kerosene stocks in October may indicate that suppliers and airlines have been buying jet kerosene to take advantage of the low prices. Refiners are also reacting to the downturn. With demand down, Bray says many are taking the opportunity to bring forward upgrade work to their refineries.
Annual demand for jet fuel typically rises at around half the increase in the number of passengers, due to factors such as higher load factors and the increased efficiency of aircraft and engines. Before 11 September, the trend was for an annual increase in jet fuel demand of around 3%. This number, however, has since turned to a decline of 15% or so. "Its anyone's guess how soon this will bounce back," says Bray.
He says, however, that the large hubs, which are more exposed to the transatlantic, have seen much steeper falls in jet fuel demand than secondary airports - 15-20% rather than 10-15%. Bray adds that demand from one major customer has fallen much less than forecast due to the ability of the carrier to transfer capacity successfully into the cargo market, using combination aircraft.
The decline in fuel price has provided airlines with a much-needed breathing space during a time of uncertainty across the industry. This is in stark contrast to the early 1990s when a fuel spike in response to the Gulf War exacerbated a steep industry downturn.
While forward markets suggest that prices may begin to climb at some point in the second half of the year ahead, observers point out that there may still be "some gravity" in the market. Much depends on whether, and to what extent, OPEC agrees to cut production, but any anxiety over a rise in fuel prices is likely to be tempered if its cause is an accompanying recovery in the world economy. As the events of 11 September demonstrate, however, there is always the danger of an unforeseen catastrophe.
| TABLE: Jet kerosene 10-year world price trend - ICIS-LOR | |||
| Years | Period year/quarter | World average price* | |
| ¢/gallon | change | ||
| 1992 | annual | 59.6 | -9.1% |
| 1993 | annual | 56.1 | -5.9% |
| 1994 | annual | 50.7 | -9.6% |
| 1995 | annual | 52.2 | 3.0% |
| 1996 | annual | 65.0 | 24.4% |
| 1997 | annual | 58.4 | -10.0% |
| 1998 | annual | 39.8 | -31.9% |
| 1999 | Q1 | 34.8 | 19.3% |
| Q2 | 43.9 | 8.1% | |
| Q3 | 57.2 | 49.5% | |
| Q4 | 67.0 | 80.5% | |
| annual | 50.7 | 27.5% | |
| 2000 | Q1 | 78.7 | 125.7% |
| Q2 | 74.5 | 69.7% | |
| Q3 | 91.9 | 60.8% | |
| Q4 | 97.1 | 44.8% | |
| annual | 85.6 | 68.6% | |
| 2001 | Q1 | 76.5 | -2.7% |
| Q2 | 76.7 | 2.9% | |
| Q3 | 73.2 | -20.4% | |
| Q4 | 57.4 | -40.9% | |
| annual est | 71.0 | -17.0% | |
| 2002-3 | forecast range | 55-65 | |
Source: Airline Business
