The Dow Jones US Airlines index was the best-performing index in the US last year. Delta Air Lines, Inc. led gains among US carriers, seeing its stock price more than double in 2013. In a continuation of the airline industry’s strong performance last year, the AMEX Airline Index (XAL) has risen nearly 18% so far this year, even though the S&P 500 Index (SPX) has managed to gain only 2%.
Even though the International Air Transport Authority (IATA) had lowered its outlook for the airline industry’s profitability earlier this year expecting higher fuel prices, it said it expected global traffic to rise to over three billion passengers in 2014 on the back of growth in Asia and the Middle East. Its estimates for the industry’s net profits put them at slightly over $18 billion, a $1 billion downward revision from prior expectations.
United Continental Holdings Inc. (UAL), Southwest Airlines Co. (LUV), and Delta are the three largest carriers in the US market in terms of the number of passenger miles flown. Consequently, analyzing these three can give us a pretty good idea of how fuel costs can affect the rest of the industry.
North American airlines spent a combined $47.95 billion on fuel last year, 4.5% less year-over-year (YoY). Jet fuel prices had averaged $2.96 per gallon, compared to $3.10 per gallon in 2012. Fuel and wages are the airline industry’s two largest expenses. Fuel accounted for nearly 28% of carriers’ sales in 2013, while wages had equaled roughly 19% of sales.
Over the same period, the average spread between jet fuel prices and the price of crude also shrank from 48.5 cents to 39 cents per gallon, with a 2% decline in crude prices pushing jet fuel prices down 5% on average.
On the back of the lower jet fuel prices, fuel costs as a percentage of sales for Delta dropped from 27.7% in 2012 to 25% in 2013. United Continental and Southwest Airlines also saw fuel costs as a percentage of sales decline, by roughly three percentage points each, to 32.3% and 32.6%, respectively.
But while IATA said it expected fuel costs to slightly increase this year, they were actually lower through the first four months. Fuel costs were consistent through the first quarter at $3.00 per gallon, but had declined to $2.90 per gallon over the month of April.
At the end of the first quarter, Brent crude prices were 4.3% lower YoY. There are many factors pulling crude prices in either direction right now. For most of the year, investors have been cautiously monitoring the slowdown in Chinese economic growth, a major reason behind the more or less constant pricing for crude. That could change though, following the crisis in Ukraine and a pickup in economic activity in Europe.
The average monthly spread between jet fuel and crude oil prices since 2010 has been $0.40. The two are positively correlated by a factor of 0.84. However, the spread had narrowed at the end of April to $0.30 as jet fuel prices dropped to $2.90 per gallon but the price of crude oil remained stable at $2.60 per gallon. Typically, a 10 cent increase in the per-gallon price of crude oil should result in an 8.4 cents increase in the price of jet fuel.
While the prices of WTI have been rising since the beginning of the year as inventories deplete, the Brent crude price has remained subdued. As a result, jet fuel prices have been stable, and US airlines continue to enjoy better margins. If and when the price of Brent rises, airlines may see their margins squeeze and profits fall.
*Brent crude is the benchmark used to derive jet fuel prices.
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