Will Airlines Begin To Post Losses If Oil Prices Rise In Coming Months?
U.S. airlines have benefited enormously as global crude oil prices have tanked from over $100 per barrel in September last year, to about $50 per barrel (Brent) in January this year. As jet fuel costs constitute nearly a third of an airline’s total operating expense, this sharp drop of about 50% in global crude oil prices has lifted profits of all airlines. For instance, American Airlines (NASDAQ:AAL), the largest U.S. airline by passenger traffic, reported a record profit of $1.1 billion in the fourth quarter as its fuel expense fell by $534 million or 20% annually. For the full year 2014, the carrier reported a solid profit of $4.2 billion, excluding special items. [1] Other major U.S. airlines including United (NYSE:UAL), Delta (NYSE:DAL), Southwest (NYSE:LUV), JetBlue (NASDAQ:JBLU), and Alaska (NYSE:ALK) also reported record profits in 2014 on gains from lower oil prices.
However, if crude oil prices rise to $70-80 per barrel or higher in the coming months, will airlines begin to post losses? We don’t think so. All U.S. airlines have undertaken large scale cost cutbacks over the past five to six years. The three large network carriers – American, United, and Delta – slashed their operating costs through restructuring enabled by bankruptcy proceeding. Alaska has steadily reduced its costs over the past many years, and low-cost carriers such as Southwest and JetBlue have always maintained a focus on keeping their costs low. As a result, major U.S. airlines of today are much better positioned to weather persistently high crude oil prices. In the second and third quarters of last year, when crude oil (Brent) persistently traded above $100 per barrel, most major U.S. airlines reported healthy profits. Given that airlines have been able to reduce costs for another four to five months since then, we figure that airlines will not report losses if crude oil rises to about $70-80 per barrel in the coming months. Surely, airline profits will fall if oil prices rise, but we will likely not see airlines beginning to post losses.
The chart below shows how fuel cost as a percentage of passenger revenue has fallen for American Airlines over the past few years.
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This decline is the result of lower oil prices as well as healthy revenue growth driven by higher fares and higher passenger traffic. A similar trend can be observed for other major U.S. airlines. Effectively, this decline in fuel cost (when expressed as a percentage of passenger revenue) means that airlines today have more room to profitably absorb a hike in oil prices.
Airlines’ cost-cutting measures, which include headcount reduction, and savings in maintenance and sourcing heads, have also lowered their non-fuel costs. This is highlighted by the chart below, which maps American’s non-fuel costs as a percentage of its passenger revenue.
Lower non-fuel cost (as a percentage of passenger revenue) again shows that airlines have greater room to profitably absorb a hike in fuel prices. All in all, in our view, if oil prices rise in the coming months, airline profits will fall, but airlines will likely not begin to post losses.
See our complete analysis of American Airlines here
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- American’s 2014 Q4 earnings form 8-K, January 28 2015, www.aa.com [↩]