Wary eyes watch oil prices rise

By Michael Fabey

As gasoline prices at the pump reached an average of $2.43 across the nation by the end of May — a weekly increase of about 12 cents and a 76-cent jump since the first of the year — some in the travel industry were worried that this summer could become a repeat of 2008, when fuel prices reached historic highs.

Those fears only intensified as crude oil futures broke the $60-per-barrel mark.

Many industry and energy analysts predict that fuel prices will continue to rise, possibly even enough to force airlines and cruise lines to consider restoring fuel surcharges to ticket prices.

Yet analysts and economists do not expect a spike like 2008’s run-up, simply because the unusual convergence of economic and other issues that conspired to inflate fuel prices last summer does not exist this year.

"As with any other market or event, nothing is ever the same way twice," said Joe Duarte, an economic analyst, author and financial adviser.

Darin Lee, an airline analyst with consultant group LECG, said, "Although fuel prices are creeping up, it is hard to imagine that we will have a repeat of last year’s fuel spike this summer, given the still-dismal state of the global economy."

While even modest signs of economic improvement will likely push up oil prices somewhat, "a repeat of the roller coaster ride of 2008 is probably not in the cards," said Raphael Bejar, CEO of AirSavings, a consultant that helps airlines develop programs for boosting their ancillary revenue and for purchasing items like fuel.

Still, Vaughn Cordle, an analyst with AirlineForecasts, cautioned that predicting fuel prices can be as uncertain as picking stocks, because "the speculators can just step in."

Bejar noted that "fuel suppliers seem to expect fuel prices to approach some of the inflated levels we witnessed in 2007 and 2008 and continue to try and raise the bar to $75 to $85 per barrel," he added. "We think they will stay somewhere in the $60s."

Others feel that oil could inch toward the $99 average per-barrel price of last year.

"We could see $80 at some point in the future," Duarte said. "Speculators will likely pile on again. There are few places to make money where a trend could last for several months, and oil has proven that it can be that market."

Fuel pricing is essentially an exercise of supply and demand. But last year’s oil supplies were stretched beyond their limits by the sudden enormous growth in China’s appetite for oil as the country prepared to host the summer Olympic Games.

On top of that, the U.S. economy was in overdrive, fueled by easy credit and big spending.

The ripples disrupted the entire supply pool, affecting prices for travel-related fuels across the spectrum in unprecedented ways, from low-grade bunker fuel for ships to jet fuel and gasoline.

Perhaps the biggest impact was seen in the so-called crack spread, the difference between the price that speculators pay to buy crude oil futures and the price they get by selling refined oil products, such as gasoline or heating oil. The term derives from the "cracking" that oil refineries do to break down crude oil into various kinds of fuels.

Speculators’ profits are tied to the change in the crack spread differential.

As better grades of oil stocks were depleted last year, cracking heavier crude became more expensive and the crack spreads increased, causing major spikes in the prices of refined products like jet fuel, which had historically been insulated from the volatility of consumer gasoline price swings.

"Crack spreads went from $5 per barrel to $28," Cordle said. "For the full year in 2008, the crack spread was at $27 a barrel."

Marine fuel more than doubled, to $678 a ton for the third quarter of 2008. It was the same for jet fuel, which jumped to a high of $3.64 per gallon during the summer months. As both airlines and cruise lines saw their margins disappear, they tacked fuel surcharges to ticket prices to compensate.

Prices for both jet fuel and bunker fuel have returned to their pre-spike levels, and Cordle expects that jet fuel prices will average between $1.50 and $1.70 per gallon this year.

Unfortunately, however, airlines assumed that high fuel prices were here to stay and thus bought future oil contracts at prices even higher than the going rate. This year, they’ve had to report paper losses on the price differentials.

"The airlines have taken a $3.5 billion hit" because of hedging, Cordle said.

oil barrelAirline executives say they would rather deal with the paper hedge losses than skyrocketing oil prices. Fuel costs for this year are likely to be half of what they were in 2008.

"Last year, we faced a crisis in the form of fuel prices," American CEO Gerard Arpey told analysts in April. "Fortunately for us and our industry, oil prices and the crack spread have pulled back, and the decline in fuel prices has been significant."

A major reason for the price decline has been the falling demand triggered by the global recession. The sour economy has taken its toll on all travel, but especially on the airlines.

While carriers have been making deep cuts in capacity to deal with fuel prices and a drop in business, traffic declines have outpaced the capacity cuts. As a result, the airlines have had to reduce their ticket prices to fill their planes, not only wiping out any fuel price surcharges instituted last year but cutting deeper and deeper into base fares.

Even with oil prices inching up now, there’s no talk in the airline industry of reinstating fuel charges.

But there has already been some chatter in the cruise industry, since some lines have previously said that they might reinstate surcharges once the price of oil topped $65 per barrel (see report, this page).

In the meantime, the bottom line is that no one is willing to bet where prices will top out this summer.

"At this point, everything is in flux," Duarte said. "Economic statistics are quite mixed, and that colors everything. The supply of crude and byproducts is tightening. Even if the economy goes sideways, you could see oil, gasoline, diesel and jet fuel climb together."

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