The stock markets have slipped considerably again today (Friday October 10, 2008) and things continue to remain very volatile and probably will for another 10 days or so.  The consequence is that oil prices are plummeting.  Why?  Because a lot of speculative money was invested in oil as the value of the dollar dropped and inflation began to increase over the past 2 years.  Oil was an investment that preserved some value and for the past year has yielded some high profits for investors.

Now those same investors need their cash to cover other investments and they are selling their oil futures like crazy to recover their liquidity.   Today oil is selling at about $80 / barrel and that means much cheaper gasoline and jet fuel for the near future.    For airlines without fuel hedges or with few fuel hedges, that’s good news.

Oil could decline to as little as $60 / barrel but most likely will stabilize between $70 and $90 / barrel over the long term.  By the way, most airlines operating models are currently built to make a very decent profit with that oil price. 

For airlines who got a bit aggressive over the last year and bet on oil continuing its hurried rise towards $200 / barrel, that’s bad news.  You see, some airlines have already been reporting fuel hedge losses because of the slow decline in oil prices.   To better understand hedging and what has been going on, you can read THIS.

United Airlines appears to be particularly vulnerable to the fuel hedge losses.  It’s a good news / bad news thing for them.  For the near future, fuel should be cheaper and if revenue stays about the same, they should be fine.  They’ll be hit by fuel hedge losses but they’ll recover some of that loss in better profits from running an airline. 

If, on the other hand, revenue declines, then airlines like United (and there are others) will suffer from both fuel hedge losses as well as a decline in profits.    I suspect most airlines of any size will weather that problem because it is unlikely that they are hedged at high prices for very far in the future.  Maybe a year to a year and half. 

For those of you wishing evil on Southwest Airlines, don’t.  They’ll largely be unaffected one way or another.  They might experience some slight fuel hedge losses (unlikely) but more likely they simply will make less money from fuel hedges and more from profit.   Their revenue is far less dependent upon the high priced business class fares and that means their demand is more inelastic than most airlines.  They might see a slight decline in leisure travel but I suspect that that will hold more or less as people who want to travel transition from a legacy carrier to an LCC such as Southwest.

We live in interesting times.  At least gasoline will be cheap for a while.

Filed under: Airline News by ajax