by Tony D'Altorio, Investment U Research
Friday, March 18, 2011
The U.S. airline industry has raised rates repeatedly as of late, rolling out surcharges too.
American Airlines (NYSE: AMR), for one, recently boosted domestic round-trip airfare by $10, it's seventh such increase in 2011! That matches the total among major carriers in the past two years combined.
Contrary to some thinking, AA and its competition aren't hiking prices because they want to gouge passengers. Instead, they're trying to pay for more expensive jet fuel.
That, along with labor, is one of the industry's biggest costs. Even when oil is cheap, jet fuel represents some 30% of airlines' overhead expenditures.
And as oil prices rise, that percentage grows.
So far this year, jet fuel costs have soared nearly 28%. It now trades over other refined products, thanks to the situation in Libya, a major producer of the product.
Early this month, the airlines industry trade group – the International Air Transport Association (IATA) – downgraded its outlook for the year due to rising jet fuel prices.
Representing over 200 of the world's best-known airlines, it predicted in December that the global airline industry would make a $9.1 billion net profit in 2011. But oil only cost $84 a barrel back then and now it expects just $8.6 billion, about 46% below 2010's $16 billion.
With jet fuel over $3 a gallon, some industry insiders fear even worse. They're raising 2008's specter, when U.S. airlines lost billions of dollars amidst soaring oil prices.
Airlines Thought They Were Hedged
Amidst the chaos, it seems logical to wonder why airline management doesn't hedge their exposure to oil and jet fuel prices. The thing is, many thought they were…
They just didn't account for the U.S.-based West Texas Intermediate (WTI) crude oil contract no longer being a valid global benchmark, as I detailed last month.
Many of the problems stem from logistical issues at the U.S. oil hub located in Cushing, Oklahoma. There are simply too many pipelines bringing oil in and not enough infrastructure to get it out.
This has led to a glut of oil there, keeping the price of WTI lower than it should be.