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How low can oil go?
February 1st 2015
The travelling public is expecting the dramatic decrease in the oil price should quickly be passed onto them in the form of lower airfares, as cautiously predicted by the International Air Transport Association. Read More »
But buying jet fuel, and managing its volatility over the annual operating cycle is more complex than it appears. These swings, of which the most recent is the 50% collapse in oil prices since last June, has confronted airlines with a Catch 22 situation.
Do you hedge? At what price? For how much and for how long? There is no simple answer to these questions. Ultimately, for airline senior management, it comes down to a gamble, no matter how informed the process was that lead to the decision.
In the Asia-Pacific, different airlines are taking different approaches to managing fuel volatility. With jet fuel at its lowest level in more than six years, carriers with less hedging in place and buying at spot prices will be the biggest beneficiaries of the current price, at US$50 per barrel.
Those who have locked in their fuel requirements at higher prices will suffer, as long as the price remains low. Those who take a hedging position at today’s price will benefit significantly when fuel goes up.
Whatever happens, the fuel bill of low-cost carriers, who pay up to 50% of their operating costs for jet fuel, is in a sweet spot that AirAsia group boss, Tony Fernandes, described as “massive”.
To illustrate how risk laden hedging can be, the region needs to look no further than the experience of some of its best run airlines. It was not so long ago that big operators like Cathay Pacific Airways, Singapore Airlines and the major Chinese carriers suffered serious paper losses after making wrong way bets on oil hedging. It is more than likely that for some airlines, 2015 will repeat that bitter experience.
Generally, there is no doubt the drastically lower cost of oil is a huge bonus for the industry. Last month, the average price for jet fuel was around $1.71 per gallon, some 18.1% lower than a month earlier and down a phenomenal 43.2%, year on year.
But IATA is right in reminding everyone that several risks remain for airlines in the global environment, including political unrest, conflicts, and some weak regional economies that will influence the oil price.
The short term landscape for oil remains positive. Some forecast the price will go as low as $43 a barrel. Other industry analysts insist producers will adjust their output and prices will rise.
At the 2014 IATA AGM last June, airline bosses said they have found they could manage the high price of oil, but oil’s price volatility was a challenge to operations. How right they were.
