Cheaper jet fuel likely to give airlines Q4 boost

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Oil price drop
Photo Credit: Pavel Chagochkin/Shutterstock

The recent steep drop in oil prices is sure to boost profit margins for airlines in the fourth quarter. Less certain, however, is if the decline will last long enough to have a noticeable impact on airline operations and bottom lines next year.

Crude oil was trading in the low $50s midway through last week, down about a third from its $76.40 peak on Oct. 3. 

The cost of jet fuel has followed suit. U.S. Gulf Coast pipeline jet fuel peaked at $2.34 per gallon on Oct. 3 before dropping 25%, to $1.75 per gallon, as of Dec. 12, according to the price reporting firm S&P Global Platts.

U.S. airlines have yet to offer specifics on the savings they've gained from the price drop. For the most part, those details won't be known until they report fourth-quarter earnings in January. Still, the carriers have offered some clues.

For example, in a Dec. 4 Securities and Exchange Commission filing, Delta said it anticipated 7.5% growth in year-over-year revenue for December, adding, "When combined with the benefits from the recent moderation in fuel prices and solid nonfuel cost control, the company is on track to expand pretax margins in the December quarter."

Other carriers, too, recently updated their guidance on fuel costs. On Nov. 26, Spirit estimated that its fuel will cost $2.27 per gallon in the fourth quarter, down from $2.36 per gallon in the third quarter.

The following day, Alaska reduced its fuel-cost estimate for the fourth quarter from $2.36 per gallon to $2.33 per gallon. Then, on Dec. 12, Southwest lowered its guidance on fuel cost for the fourth quarter to between $2.25 per gallon and $2.30 per gallon from its earlier estimate of $2.30 to $2.35 per gallon.

Drops in fuel expenditures at Alaska and Southwest should be less precipitous than at several other U.S. airlines, including United, Delta and American, because Alaska and Southwest hedge fuel, a mechanism that shields them from volatile leaps in fuel prices but can also result in their paying above the going rate in a bear fuel market.

The recent plunge in oil prices notwithstanding, airline fuel expenditures aren't likely to be down on a year-over-year basis in the fourth quarter. As of Dec. 7, jet fuel prices were 2.3% higher than a year earlier, according to IATA. 

Still, in an industry profit forecast it issued last week, IATA concluded that cheap fuel should bolster airlines' bottom lines during 2019. The trade group now predicts that global profits will total $35.5 billion next year, up from an expected $32.2 billion this year.

In a prepared statement, IATA general secretary Alexandre de Juniac said, "We had expected that rising costs would weaken profitability in 2019. But the sharp fall in oil prices and solid [gross domestic product] growth projections have provided a buffer. So we are cautiously optimistic that the run of solid value creation for investors will continue for at least another year."

IATA now predicts that jet fuel will average $81.30 per barrel next year, compared with $87.60 per barrel this year. As a whole, the group noted, North American carriers will benefit more from the price decline than carriers in other regions, because of low levels of hedging.

Nevertheless, there is doubt about how long jet fuel prices will stay low. One reason, S&P Global Platts data shows, is the futures market, where the price of jet fuel is steadily higher for each month between May and September. 

In addition, some stock analysts are predicting a significant price spike as the international shipping industry ramps up for stricter fuel-quality regulations that go into effect on Jan. 1, 2020. Those regulations are expected to increase worldwide demand for low-sulfur diesels, which compete with jet fuel for production at refineries.

"The industry will feel the impact of higher jet fuel prices," Cowen Research analysts wrote in a Dec. 3 investor note. "We expect the world's airlines to try and increase fares, and given this will impact all airlines, we expect fare increases to be successful."

Conversely, a weakening worldwide economy, combined with strong crude production, could keep oil prices low. 

If jet fuel does stay cheap for a lengthy period, airlines are likely to realize their biggest profits in the first half of next year, Airline Weekly editor Seth Kaplan said.

"Beyond that, if history is any guide, we'll see higher capacity growth and cheaper fares, which are great for travelers but dilute the benefits for airlines of cheaper fuels," Kaplan wrote in an email.

Wolfe Research analyst Hunter Keay made a similar case in a Dec. 7 investment note in which he downgraded Wolfe's rating of the airline sector from "market overweight" to "market underweight."

"Industry capacity, which was already tracking at high rates into [the first quarter of next year], is tracking incrementally higher since oil prices fell," Keay wrote. "We feel this growth is not likely to come down much, given the magnitude of the decline in oil prices and still reasonably strong demand."

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