More Depressing News....


Sep 11, 2002
For Airlines, War Fuels Panic
By Eric Gillin
Staff Reporter
03/05/2003 07:00 AM EST
Click here for more stories by Eric Gillin
The long-suffering airline industry has always had its burdens: high labor costs, huge government taxes and inventory that's extremely difficult to manage in a downturn. But the rising price of jet fuel could be the straw that breaks the industry's back.
Wars cause the price of jet fuel to go up. Six weeks after Iraq invaded Kuwait in August 1990, the price of jet fuel more than tripled. It's no coincidence that Eastern Airlines, Pan Am and Midway Airlines ceased operations in 1991. And this time around, a convergence of global events has caused jet fuel prices to double in the past year.
Last time, when Saddam invaded Kuwait, the price of oil spiked, said David Swierenga, economist at the Air Transport Association. This time, oil is already sharply higher, but not due entirely to Iraq. The Venezuelan strike has as much, if not more, to do with it, and with the very cold winter, we're seeing an increased demand for heating oil, which moves in lockstep with jet fuel.
Moreover, after losing nearly $20 billion over the last two years, the airline industry isn't as well equipped to handle a fuel price increase as it was in 1991. Balance sheets have become so weak that Standard & Poor's has cut debt ratings on the entire industry. The situation is so bad that the second-largest and the seventh-largest airlines, US Air and UAL's (UAL:NYSE - news - commentary - research - analysis) United Airlines, are in bankruptcy and the nation's largest, AMR's (AMR:NYSE - news - commentary - research - analysis) American, is sitting on the verge.
The airlines aren't powerless, however. To control costs, the airlines hedge their fuel expenses, buying a contract to purchase a set amount of fuel in the future at a fixed price. While the amount of hedging varies from airline to airline, analysts say that carriers have between 40% and 60% of their fuel costs hedged for the year.
Of course, the airlines will have to go into the open market and buy fuel to cover whatever needs they haven't met through hedging. And that's gotten extremely expensive over the past year.
Right now, we're facing a spot price of $1.30 a gallon for jet fuel, which is double the long-term average. To some extent, carriers are hedged, but nonetheless, we're expecting that jet fuel prices, net of any hedging, will come in at $1 a gallon in the first quarter, said Swierenga. That's sharper than it has been, with the first quarter of last year coming in at 62 cents a gallon.

The effect the rising price of fuel has on an airline can vary greatly, but James Corridore, industry analyst for Standard & Poor's, says a good rule of thumb maintains that for every 10 cents the price of fuel rises, it adds $20 million in expenses. He is quick to add that this formula doesn't work for low-cost carriers and should merely be used as a barometer to handicap the older legacy names, but the example drives home the importance of fuel costs.
Hedging fuel prices requires a lot of cash to buy the various swaps and caps, meaning the carriers with the worst balance sheets have had the most trouble doing it. In many ways, it's possible to handicap who is best positioned to survive the downturn just by looking at who is best positioned to handle a spike in fuel.
It should come as no surprise that Southwest Airlines (LUV:NYSE - news - commentary - research - analysis), the only major to remain profitable after the events of Sept. 11, is an industry leader when it comes to hedging fuel.
As of last month, the company had 85% of its fuel needs for the first quarter of 2003 hedged near $23 a barrel. That's quite a discount from the current price of oil, which is hovering around $35. Going forward, Southwest is 87% hedged in the second quarter and 75% hedged for the rest of the year.
It's a different story at most of the other legacy carriers, which generally have half their needs hedged and the other half tied to market conditions.
Northwest (NWAC:Nasdaq - news - commentary - research - analysis) is one of the better positioned carriers, with more than 50% of its needs for 2003 hedged at a cap between $24 and $25 a barrel. In its fourth-quarter conference call, the company revealed it was already $80 million in the money due to its fuel hedge position for 2003. Likewise, Delta (DAL:NYSE - news - commentary - research - analysis) has hedged 63% in the first quarter and about half of its jet fuel needs for 2003. And while Continental (CAL:NYSE - news - commentary - research - analysis) said it was 95% hedged in the first quarter, that's at a cap of $33 a barrel, which is on the high side.

Delta's in good shape. Northwest is well hedged. Continental is OK, said Corridore. I would say that AMR is probably in the worst shape of those guys. They're not well hedged, with just 40% hedged in the first quarter and 32% for the full year. Obviously that's not so great.
At AMR, which recently warned that it may have to seek bankruptcy if it can't control costs, the fuel issue could become part of a wider problem. When taken along with the company's labor woes, sinking demand and inability to slash costs to meet demand, higher fuel only will exacerbate the issue.
I don't think it will push the company into bankruptcy. I don't think it will be the final indication the company will file Chapter 11. There are so many other factors involved, said Ray Neidl, airline analyst at Blaylock & Partners.
Indeed, but at the bankrupt airlines, United and US Air, rising fuel costs will be an even bigger drag on business. Because of the financial issues that led both to seek Chapter 11, neither carrier hedged fuel costs in 2003, leaving them both exposed to the vagaries of the market. While there's no way to say if a spike in fuel prices would force both into total liquidation, given the current market conditions, none ruled the possibility out.