Every airline reporting on its quarterly financial performance last month cited fuel as a major impact to their bottom line.  Airlines saw significantly higher fuel prices this year compared to 2010 and it’s true that it’s a hit to profits.

On the other hand, it’s notable that fuel hedging contributed significantly to their losses on paper.  Why?  Because fuel prices did not go up high enough for those fuel hedges to provide benefit.  Instead, they went down.

The truth is, it isn’t high fuel prices that are killing airlines.  It’s the price volatility that hurts them.  Airlines haven’t been able to plan their costs very effectively for the past 3 years.  Hedging is supposed to “smooth” that volatility and it will except that it also causes paper losses which reflect negatively on the airline when it announces its financial performance.

Is it necessary?  I used to think so.  In fact, I was a big advocate of fuel hedging not because of the windfall profits it provided many airlines for many years but, rather, because it really did make costs stable.  US Airways has stopped fuel hedging and their financial results show that fuel hedging just may not be necessary anymore.  Their profits are not taking a hit from hedging contracts that “lose” money.

In fact, US Airways performance is exceptional when balanced against the challenges it has.  This is an airline that 6 years later is still effectively operating as two airlines (under one name).  It still doesn’t realize that kind of synergies it needs to from its merger.  It has serious impacts from labor groups who cannot agree on what day it is much less on who represents them with the company (this would be the pilots) and it still doesn’t have a combined seniority list with one agreement in place with both the pilots and the flight attendants. 

This airline also flies from far less popular hubs, contracts with far less ideal regional airlines and has far fewer international flights and even if it could fly more international routes, it lacks the equipment to do so.

But the airlines makes a strong profit.  As strong or stronger than the SuperLegacy airlines.  The one thing it hasn’t done is announce major paper losses as a result of fuel hedging.  It might be time for more airlines to roll with the punches.  It’s a highly complex, risky effort that doesn’t appear to be providing the benefits its supposed to.

Fuel price volatility will continue to be a problem.  Airlines need stable oil prices and, frankly, so do the world economies.  However, let’s not forget that fuel is a problem for *every* airline.  They all enjoy the same problem in this area. 

I expect that we will see airlines focus more and more on fuel economy over the next several years.  We’re already seeing it in some airlines such as American Airlines who has finally realized that if it dumps its MD-80 aircraft, it can not only enjoy double digit improvements in fuel efficiency, it can fly more people as well.  That doesn’t mean that airlines with Next Generation 737s or Airbus A320 series aircraft will be dumping their fleet for new aircraft.  They won’t.

It does mean that we’ll see older aircraft from the 70’s and 80’s going away.  Yes, that means MD-80s but it doesn’t mean MD-90s (which use a far better engine).  The other aircraft it points to are those that many may not have considered. 

The 767-200ER is already clearly a candidate for removal and the 767-300 isn’t far behind it.  These are 1970’s design aircraft and with engines of similar caliber.  There are no more improvements and as fuel climbs, these aircraft become quickly unattractive even when completely paid for.  The 757 is entering into this territory as well.  I would expect that we’ll see a number of these begin to be retired or sold off for cargo work.  Again, these are 1970’s aircraft and while their amazing performance lent them a lease on life, they’ve become very expensive balanced against other aircraft that can perform 90%+ of the same missions.

Say goodbye to the older 737s.  I’m talking about the 737-300/400/500 series aircraft.  These are efficient, for their time, but very inefficient when compared to the latest modesl coming off Boeing’s line.  They had a short extension to their usefulness but you will see these depart rapidly from US based fleets over the next 1 to 3 years. 

The oldest A320 series aircraft are now due for replacement as well.  Some are older than those inefficient 737-300 aircraft and no longer have the fuel efficiency that the latest Airbus offerings possess.  They *seem* like a new aircraft.  I’ll point out that the A320 aircraft started deliveries in the late 1980’s (1988) and several US airlines such as United own some of the oldest models. 

Look for airlines to “upsize” their aircraft.  Southwest is doing this by buying the 737-800.  For a tiny bit more in costs, Southwest can fly significantly more passengers on routes that are seeing enormous demand.  They can make more money for a tiny incremental cost in fuel and one additional flight attendant. 

Finally, buying blocks of the A320NEO and 737MAX will make an airline look smart.  It is universally recognized that while oil prices may one day stabilize, they won’t return to $20/barrel.  The airline with the most fuel efficient aircraft will see an advantage.  That’s why I honestly believe we’ll see a large order from Southwest Airlines for the 737MAX.  It’s a good evolution for the airline and it will continue to fit within its business plan for some time to come. 

Why no orders from Southwest yet?  Because Southwest is one hell of a good negotiator and recognizes that they have power in the simple fact that if Southwest buys the aircraft, it’s an endorsement that everyone will pay attention to.  I expect to see an initial Southwest order for 100 to 200 aircraft sometime in the next 6 months.  Southwest will get its deal and Boeing needs Southwest to stamp approval on the MAX.

Filed under: Airline Fleets by ajax