With jet fuel prices outpacing crude oil increases, airlines are facing a USD54 billion fuel bill this year, according to US Air Transport Association Chief Economist John Heimlich, who noted US Gulf Coast jet fuel sold for USD3.20 per gallon on 4-Mar-2011.
At USD3 per gallon, Mr Heimlich predicted US airlines' fuel bill will jump by USD15 billion over the USD39 billion paid last year. The resulting USD54 billion would equal the total cumulative net loss for the industry for the entire first decade of the 21st century.
“Annually, a 1.0 cent increase in a gallon costs US airlines USD175 million; a USD1 increase in a barrel costs them $415 million,” he said of statistics we know so well. “To put this into some context, in 2010, US airlines posted an estimated net profit of USD3 billion with a meagre 2% margin, one of only three profitable years in the entire decade. From 2001-2010, US airlines had a cumulative net loss of approximately USD54 billion.”
Yesterday, Mr Heimlich indicated the first quarter fuel volatility between 1-Jan and 4-Mar-2011 produced a 67-cent per gallon increase in jet fuel, compared with the 44-cent increase in all of 2010. Worldwide operations of US carriers require 17.5 billion gallons of jet fuel annually, or approximately 415 million barrels, according to ATA.
“When jet-fuel prices rise rapidly, airlines have limited options to mitigate these costs, principally generating more revenue or decreasing non-fuel expenses,” said Mr Heimlich. “As fuel prices increase, flights become less profitable so airlines may also reduce capacity, and some carriers already have reported downward growth plans. Unfortunately, fuel-hedging programmes are increasingly expensive and provide only limited protection when jet fuel prices are outpacing crude oil prices.”
Derivatives rule in the works
The news comes at a time when the derivative rule the industry fought for, and won, last year, is coming under increasing threat with the US Chamber of Commerce indicating that the 3% margin requirement on swaps would cut capital spending between USD5.1 billion to USD6.7 billion and cost up to 130,000 jobs because the additional capital required could be used for other business purposes.
Efforts to decrease the volatility of fuel created by speculators were written into the Dodd-Frank Wall Street Reform Act passed and signed in July. It exempted airlines and other end users but last minute changes to the legislation further muddied the interpretation as to whether end users would be required to put to the additional 3% margin required of financial institutions.
Transactions must be done through regulated clearing houses which supports the overall system if there is a default. End users want to avoid this additional capital requirement and Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler categorically stated he understands the legislative intent exempts non-financial end users.
“The Commodity Futures Trading Commission is working to adapt the law into meaningful rules that curb speculation on the price of oil and other energy commodities,” ATA told CAPA. “These new rules must reestablish strict position limits on energy commodities without creating new loopholes. The industry’s goal, as end users, is to restore balance to the futures market.”
As the legislative intent made its way through the Notice of Proposed Rule Making at the CFTC, Air Transport Association said the rules weakened the intent of the legislation considerably. The idea of the legislation was to limit the impact of oil speculation on a fragile economy. CFTC has until 15-July-2011 to publish a final rule.
“Excessive speculation, unrelated to the fundamentals of supply and demand, creates volatility in prices that simply cannot be effectively managed by the airlines or, for that matter, any other industry where fuel is a key cost item, and it damages the economy,” said ATA Vice President and General Counsel David Berg in January. “The extraordinary price fluctuations that harmed consumers, industry and the economy in recent years will not be prevented by the proposed limits, and with predictions.”
The Federal Reserve also has jurisdiction over the margin requirement, making the Fed rule more important since end users use banks and other financial institutions supervised by the Fed while CFTC regulates trades between end users and non-bank dealers. The two entities are coordinating their rule making.
Federal Reserve Governor Daniel Tarullo indicated that the requirement for additional capital will be based on the overall impact an individual company’s default would have on the over all economy, given the fact that end-users did not drive the financial crisis. During last month’s hearing of the House Financial Services Committee, committee members advocated that end users be exempt from margin or other clearing-house requirements. Indeed, one representative said the cost of this regulation is nothing compared with the USD7 trillion lost by not regulating the derivatives markets.
Southwest’s legendary fuel-hedge advantage is now a thing of the past and, while most carriers have active hedging strategies, US Airways and Allegiant do not. Earlier this year, analysts indicated that the largest airlines decided not to further hedge prices in order to raise earnings and suggesting prices would correct. However, that has not happened, leaving the top global airlines at risk.
Analysts suggested the global economy is in better shape to weather the fuel hikes and the industry’s ability to raise fares without impacting demand, so far, indicates they are right. Delta CEO Richard Anderson said during his year-end earnings call that capacity would go before fares moderated, and, true to his word, was the first to modify capacity projections. Most airlines expressed confidence in their hedge positions during their conference calls and have since followed Delta’s lead. Analysts also suggested that airlines are leery of making the wrong bet, given the fact that Japan Airlines’ bankruptcy partially resulted from that.
Delta, say analysts, 39% hedged at USD85 a barrel for 2011, is in the best position as the carrier said fuel would be USD2.47 per gallon for the year. Southwest’s guidance expected USD2.70-2.75 per gallon, compared with the USD3 per gallon used by ATA’s Mr Heimlich in his cost projections.