Fuel: crisis, what crisis? October 2000

Spot jet fuel prices passed the $1/gallon mark in September, the highest level since the Gulf war and twice the level of a year ago. What sort of crisis are airlines really facing?

Unfortunately, there is little sign that the upward price trend will reverse this year. Even though crude prices will probably soften, as some OPEC countries increase output and the US release more of its strategic reserves, demand for all of the middle distillates — which comprise heating oil and diesel as well as jet kerosene — is strong and stocks are comparatively low.

This implies that jet fuel prices will stay at current levels or edge up during the winter.

For the longer term, however, we maintain our view that prices will not stay on a high plateau but will descend to, say, mid 99 levels. This view is based simply on observing how the oil market has evolved over the past 30 years — prices have spiked when OPEC has managed to cut or hold output in the face of rising demand and when industrialised countries have panicked about their stock levels. But the peaks have always been followed by long periods of price decline in actual and real terms.

One of the major differences between this oil price surge and that of the early 90s is that today almost all the leading economies are vibrant whereas then there was a severe recession, which resulted in a slump in air traffic. With continuing strong traffic demand, airlines have been able to lay off most of the fuel impact onto passengers, though that has not stopped their vociferous complaints about their added costs. For example, in the US domestic market unit revenues (per ASM) increased by 7.9% on an annual basis, continuing a pricing trend that has been evident for most of 2000.

Hedging activity has also increased. Again using the US market as an example, Majors such as American, Delta, Southwest and United have 50–100% of their requirement for the rest of the year hedged at the equivalent of less than $30/barrel of crude (currently $38). It should be noted, however, that reports of airline fuel hedging tend to suggest that the cost saving will be greater than it actually turns out to be because they disregard the expense associated with any hedging operation. Lufthansa, for example, hedged 90%of this year’s fuel requirement but its first–half fuel costs still rose by 65%.

It is interesting to look at the jet fuel market from the perspective of the oil companies. Consolidation in that industry has led to six suppliers (Exxon–Mobil, Shell, BPAmoco- Arco, Chevron, Total–Fina–Elf and Texaco) controlling just over 60% of global jet fuel supply, with the first three conglomerates having 42%. However, oil market analysts believe that whatever additional selling power this consolidation has generated has been negated by increased purchasing strength on the part of the main airlines.

They observe that at the spring round of tender negotiation airlines pooled their purchases using alliance structures, and also introduced electronic B2B buying techniques for the first time. The new battle tactics in the commercial war between airline alliances and the oil giants will be further honed at the upcoming autumn tendering negotiations.

The oil crisis of course does not affect all airlines equally. Indeed, in a strong pricing environment it the more fuel–efficient carriers should be able to exploit this advantage. As the table above shows, there is a wide variation in the fuel efficiency between the newer and older jets.

Below is a summary of the average fleet age of the ten key airlines in each main aviation region. Some observations:

• Despite retrenchment during the financial crisis, the oldest of the Asian airline fleets are still below the North American average;
• In Europe Swissair should be very well positioned with its ultra–modern fleet, but still it blames fuel for its current problems (see pages 14–17);
• Ryanair, whose fleet still comprises mostly elderly 737–200s should have been in trouble as a result of fuel price escalation but has apparently hedged all its fuel purchases;
• Southwest, as normal, heads the US ranking while Northwest (see pages 18–22) is very exposed.