US Airlines Take-Off As OPEC Maintains Its Stance

While many market experts were anticipating some respite from the ongoing oil slump after the Organization of the Petroleum Exporting Countries’ (OPEC) December meeting in Vienna, their hopes seem to have been in vain. The OPEC, on Friday, announced that it will maintain oil production at record high levels of more than 30 MMbopd, in order to guard its market share in the oversupplied oil market. This suggests that the cartel will not be ruled by an official production target, at least until its next meeting in June 2016. Thus, we figure that the free fall in oil prices is now anticipated to last longer-than-expected. An immediate and obvious impact of this decision was visible on the global benchmarks for crude oil – Brent and WTI – which slipped by 2% and 3%, respectively, within a single trading day. In hindsight, the key beneficiary of this news was the US airline companies, whose stocks recorded a jump of almost 4% on average on Friday. In this article, we briefly discuss the implications of this move on the US airline industry over the next few quarters.

Source: Google Finance

Since July of last year, the crude oil prices have plunged from over $110 per barrel to multi-year lows of under $40 per barrel in August this year. This drop was driven by the weak global demand for crude oil, led by the slower growth in the Chinese economy, and surplus tight oil production in the US.  In addition, the OPEC, which has historically maneuvered its spare capacity to adjust to oil prices, has continued to pump high levels of oil rather than pulling back production. Consequently, the global oil markets have faced an oversupply of oil, resulting in a steep decline in commodity prices over the last few quarters.

Source: US Energy Information Administration (EIA)

In the past, the US airline industry has always been associated with a stigma of being a loss-making investment. However, the plummeting oil prices over the last 15-18 months have enabled these airlines to recover from their heavy losses and deliver extraordinary profits. This is primarily driven by the fact that jet fuel costs constitute more than one-third of an airline’s total operating expenses. Due to the high correlation between jet fuel and crude oil, the 60% plunge in oil prices has resulted in a significant reduction in the airlines’ fuel expenses, which has, in turn, bolstered their bottom line growth.

Source: Company filings

The 12 member cartel, OPEC, produces about 40% of the world’s crude oil ^[1]. Due to its high market share, the OPEC plays an important role in determining oil prices globally. The cartel last met in June 2015 to discuss their production targets in order to balance out the excess supply of oil in the market. However, it decided to maintain its market share and to refrain from cutting down its production to improve oil prices. This led to a persistent fall in oil prices over the last six months, which created a further dent in the pockets of major oil and gas companies, particularly in the US.

But, with time it started becoming difficult for smaller OPEC members to sustain their production at multi-year low oil prices. As a result, investors and commodity traders around the globe anticipated that the oil prices had bottomed out and started foreseeing a change in OPEC’s stance, and an eventual recovery in oil prices. However, to everybody’s dismay, in their meeting last week. the poorer OPEC members were unable to convince Saudi Arabia, the single biggest oil producer in the OPEC, to alter its current strategy and to squeeze its production levels. This clearly indicates that the oil glut is not expected to lessen anytime soon. Consequently, the market estimates of a mid-2016 recovery in oil prices may need to be revisited soon.

See Our Complete Analysis For Southwest Airlines Here

Although this might be bad news for the oil and gas industry in general, it is likely to bring cheers for the US airline industry. The US airlines that have been flourishing over the last one year due to notable fuel cost savings will continue to enjoy lower fuel costs, at least for the next 3-4 quarters. Moreover, these airlines have been efficiently utilizing their increased cash flows to enhance their existing fleet, improve their balance sheets, and returning value to their stakeholders. Thus, we expect the US airline companies to fly high on the back of weak oil prices and make an attractive proposition for investors over the next few quarters.

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1. US Energy Information Administration (EIA [↩]