Oil has come down to about $57 a barrel compared with the lofty $147 that airlines were complaining of this summer.
Good news for the aviation industry, right? Not quite.
For a start, the airlines still have the crack spread to deal with. The effervescent Joe Gill (formerly Goodbody and now at Bloxhams) explained it well, around this time last year:
As well as watching oil prices and FX movements, airlines also keep an eye on an oddity called the crack margin. This is the cost of converting a barrel of oil into a barrel of jet fuel. When demand is strong, the margin tends to expand and in May 2007 it reached over $30.
The crack spread on jet fuel has been widening recently. In fact, UBS revised its estimates for some of Europe’s biggest network carriers today, based on $70 a barrel instead of the actual spot price of $57, for that reason:
We are now using $70/bbl in our forecasts, which is usually consistent with $700/bbl for jet fuel. We normally expect the jet fuel price paid by the airlines in dollars per tonne to be ten times the cost of the Brent oil price per barrel. This equates to a crack spread of 26%, which has been the long-run average. But, at the moment, the oil price is around US$56/bbl, while the jet fuel price is US$685/tonne. Therefore, our US$70/bbl assumption is the current spot price for jet fuel, but over time, we would expect the crack spread to normalise.
But even with a lower oil price, the effects are different for different airlines. For a start, those who had good hedging in place when oil was at something like $120 a barrel, are no longer in a position of strength — notably Air France-KLM and Iberia.
At left, is about the best table of the four airlines’ hedging posititions you’re going to get from public info — from UBS. You can see Air France has about 70 per cent of its fuel needs for next year hedged at $80 a barrel.
Iberia, meanwhile, has 30 per cent of next year hedged at an astonishing $120 per barrel. Ryanair pulled a similar trick this summer, resisting hedging at $90 a barrel, only to cave in and eventually hedge 80 per cent of the third-quarter at $120. It’s now 25 per cent hedged for the first half of next fiscal year (ending March 2010) at $77 a barrel.
Of course, the make-up of hedges (swaps, options, forwards etc.) means there may be ways to maximise downside potential but in the cases outlined above, it does somewhat lock airlines into cost rises (as well as providing some predictability on future expenses, which is much of the point of hedging any way).
That’s part of the reason we haven’t seen fuel surcharges come down just yet.
From UBS, again:
The fall in the oil price has left each of the airlines challenged on their respective fuel charges. As the oil price rose, fuel surcharges were added to ticket prices to recoup some of the higher cost. Airlines have been reluctant to take these surcharges off as the oil price has fallen back down. This is understandable. But it is also explainable through two different ways: 1) the oil price is quoted in US dollars. The dollar price has fallen significantly, but the impact in Sterling and Euros has been less; 2) airlines hedge positions still mean they are paying for fuel at higher levels than the spot price. So fuel surcharges remain for the time being.
Which brings us to the revenue side of things — still not looking pretty despite a number of capacity reductions and bankruptcies in the industry. BA, somewhat miraculously, was able to raise yields (a measure of average ticket prices) 10.5 per cent in the first-half of the current fiscal-year — though that was down to a mix of the strength of the US dollar in the period and more expensive ticket prices.
It will be interesting to see if that holds in coming months as the recession tightens.
Here the network airlines and discount carriers are somewhat at odds, with Ryanair et al argueing that customers will be “trading down” to low-cost flights as the recession bites, and British Airways claiming it will be able to manage up ticket prices as capacity exits the system amid an industry downturn. A bit of a flying contradiction here but time will tell who is right.
Related links:
A profits engine, or simple engineering at BA? – FT Alphaville
Jet fuel to hedge or not to hedge – FXStreet.com
The negative crack spread – FT Alphaville
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