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Alex Kimani

Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com. 

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Why The Oil Price Crash Won't Save Airlines

Under any other circumstances, air carriers would be happily popping champagne corks after the latest massive oil price slump. After all, fuel typically accounts for up to 20% of an airline’s operating expenses. Crude oil prices plunged below $30 a barrel early on Monday as the coronavirus pandemic continued to spread fear and panic in global financial markets. 

Yet, this time around, carriers have little to celebrate as many had locked in at far higher fuel prices, not to mention the ongoing drastic drop in air travel demand which has started claiming its first victims.

On Monday, Norwegian Air Shuttle announced an 85% reduction in flight schedules, including plans to lay off some 7,300 staff--a good 90% of its workforce--as the pandemic continues to wreak havoc on global air travel.

Fuel Hedging

Many airlines use hedging to mitigate the risk of fuel price volatility. Fuel hedging means an airline agrees to purchase a certain amount of oil in the future at a predetermined price. Airlines hedge fuel costs in a number of ways, including purchasing current oil contracts, buying call options or purchasing swap contracts. 

On the other hand, hedging helps aviation fuel market vendors like Shell, Air BP or Exxon Mobil to lock in future sales at a set price, thus providing them with stable, predictable revenues. In effect, by entering into futures contracts, both parties agree to give up potential profits in return for certainty. With fuel hedging, there is always a “winner” and a “loser”. 

Unfortunately, many airlines are finding themselves on the wrong side of the equation this time around. Related: Is $10 Oil On The Horizon?

Last week, the International Air Transport Association warned that airlines could lose a staggering $113 billion in sales in 2020 due to Covid-19. That’s nearly 4x more than its estimates only two weeks earlier. 

For some consolation, the organization said the oil price slump could cut airline costs by $28 billion. 

Not everybody will be able to enjoy the relief brought by low oil prices, though. 

Take the case of Irish carrier Ryanair which has hedged 90% of its fuel requirement for the year beginning April 1st an average of $606 per metric ton. That works out to about $77 a barrel, more than 2.5x the current oil price. Ryanair has historically used forward contracts that cover periods of up to 18 months of anticipated jet fuel requirements.

Or, the case of Air France-KLM, a big buyer of fuel oil having spent 5.5 billion euros ($6.3 billion) on fuel last year. The Dutch/French carrier is locked in at the even higher level at $619 per ton for 2020, or about $78.5 per barrel, for two-thirds of its needs. Meanwhile, Deutsche Lufthansa AG is hedged at a more modest $63/barrel for nearly three-quarters of its annual usage.

U.S. Carriers Favored

But as George Ferguson, a senior analyst with Bloomberg Intelligence, has revealed, most U.S. airlines do not hedge at all and are therefore likely to enjoy the low oil prices with cost savings in the 20%-25% range. Carriers like Southwest Airlines and JetBlue who focus on the domestic market hedge only lightly and could be better off for it.

Chinese and Indian airlines don’t typically hedge on fuel, meaning they are also likely to participate in the bounty.

But maybe everyone can do with a little biomimicry and learn a thing or two from Airbus. 

Last week, the British carrier tested its ‘fello’fly’ program where it flew a ‘flock’ of A350s in a bird-like formation in a bid to lower fuel consumption. In the fello’fly tests, two aircraft are flown in formation commonly observed in migratory birds with a separation of just 1.5 nautical miles, significantly lower than the current five nautical mile limit prescribed by the FAA. Airbus believes this could lead to 10-15% reduction in fuel burned in the follower aircraft. 

By Alex Kimani for Oilprice.com

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