It is much clearer to work out what record low oil prices mean for Airbus and Boeing than for airlines, and it isn’t good news for their newest designs.
The sales merits of fuel saving new tech engines and airframes are reduced versus cheaper to buy current airliners which means they may have to discount their 787s, A350s, 777Xs, 737 MAXs and A320NEOs even more than they have been.
But it also means a serious workout for the crystal balls at the airlines, since what has gone down may be well and truly back up to fuel prices that will punish those carriers without new tech fleets before this decade is over.
The stage is thus set for airlines to tell airliner makers “We don’t need your costly new things”, even if they know they really do, adding a further layer to the massive poker game that goes on between Airbus and Boeing and the carriers when it comes to buying jets for expansion or replacement.
The replacement component is the more important the older an airliner becomes, as the costs of maintenance to keep airframes safe and commercially reliable rises markedly as they age.
But what does the US benchmark for crude oil dropping below $70 to $69.05 overnight mean? The critical issue as far from the US as the Asia-Pacific is that the price of Tapis Crude in Singapore, which has almost always in adjusted terms been more costly than the US benchmark prices, has lost much of its premium in recent times, although to get the full picture airlines have to constantly adjust their judgements based on changes in their home currency against the Singapore and US dollars, as well as the overall steep falls in oil sold on the key markets.
What looks like the situation one week can need significant revision the next. One of the attractions of hedging it is supposed to smooth out the variability in the cost of something as crucial as the jet grade kerosene refined from crude oil by guaranteeing a price that the ‘airlines are comfortable with’.
Except that no one is comfortable anymore with any price if the actual benchmarks for crude have fallen by around 30 percent in a few months. Oil and gas producers listed on the ASX lost seven percent in early trade this morning because a meeting of OPEC producers yesterday decided not to cap production of oil, apparently if some analysts are right, to drive the higher cost non OPEC producers or alternatives like shale oil and CSG producers broke by selling oil for less than those competitor’s break even prices.
(Which is a bit like BHP Billiton embracing plunging iron ore prices by expanding their outputs so that they can destroy, it is claimed, smaller, ‘independent’ iron ore miners.)
An interesting report on where $69 a barrel for crude oil in the US leads from a North Atlantic perspective is up on the BBC site this morning.
However for air travellers, including those who rely on Qantas and Virgin Australia, or for that matter own shares in them and salivate over the the thought of huge boosts to profitability, the short to medium term outlook is not quite that brilliant. Australia’s major airlines are like most carriers, holders of fuel hedging contracts that have locked them into previously ‘comfortable’ prices that are now highly uncomfortable, and it will take months, maybe running beyond the end of this financial year, for those now onerous hedges to expire.
If oil were to stay low, and lower than the adjustments to the value of the Australian dollar, the benefits to the Australian carriers will be substantial. The big losers will be the hedge issuing banks or financial institutions, a popular thought at any time.
This classic note from The Motely Fool about the US situation, particularly for American Airlines, is amusing, especially as it was published just over a month ago.
For most of the past decade, hedging jet fuel costs has been a standard practice at virtually every U.S. airline. Yet the American Airlines Group (NASDAQ: AAL ) management team — CEO Doug Parker, President Scott Kirby, and CFO Derek Kerr — have gone against the grain. In the past year at American Airlines, and in the previous five years at US Airways, they have refused to hedge fuel costs.
After having a bad experience with fuel hedging in 2008 and 2009, Parker and his top lieutenants decided to go cold turkey on hedging. Since then, they have developed a strong argument for why their competitors’ hedging strategies are misguided.
With oil prices having plummeted in the past few weeks, American Airlines’ no-hedging strategy is set to pay off in a big way this fall. That said, with oil prices at multi-year lows, this may be a good time for airlines to lock in future fuel prices by opening new hedges. Could American Airlines’ top leaders take this opportunity to reverse their long-standing opposition to hedging?
However in Australia it is much more difficult to work out who is going to have the last laugh, or how long that laughter might last.