[Rhodes22-list] Energy Policy - Oops!

[brad haslett]

Roger,

As I explained to Stan, I'm a bit tight on time today
so this will be a gross over-simplication.  Northwest
canceled my flight to Detroit and re-booked me on
Continental through Newark.  They then canceled my
flight to Manchester.  To make matters worse, they
stamped my ticket SSSS which meant I had to go through
a full security search twice.  The retired rocket
scientist from the TSA kept asking why I had a pilot
uniform and airline ID in my bag.  DUH?  We didn't get
to MHT until midnight and had to delay our departure 1
1/2 hours this morning to be legal.  Anyway, here
goes.

The airlines and the mid-level oil companies both want
the same thing; stable cash flow.  The airline wants
protection from rising prices and the oil company
wants protection from falling prices.  The large banks
and brokerage houses that write hedges act somewhat
like a bookie.  They take bets from both sides and
don't care who wins or loses, they make their money on
the "juice".  If they get to far out of balance, then
they themselves are at risk.  The farther out in the
future you hedge, the more expensive it gets because
of the risk.  Your question about who would write a
contract for $26/barrel oil is valid.  Right now, no
one, but Southwest made their hedges months and in
some cases years ago.  You have to have a strong
balance sheet to play the game on either side so the
broker (bookie) doesn't get stuck with the bill.

Brad
--- Roger Pihlaja <cen09402 at centurytel.net> wrote:

> Ed & Brad,
> 
> Interesting article!  However, I am left with one
> question.  Given the huge
> amounts of jet fuel and money being exchanged in
> these hedge contracts and
> the long term trend of crude oil price ever upwards,
> who is willing to sell
> anyone a contract that locks in the price of jet
> fuel at the equivalent of
> $26/barrel of crude oil?  Is the investment income
> from the time value of
> money which must be paid up front to purchase the
> hedge contract sufficient
> to offset the disastrous effect of a doubling of the
> price of crude oil?
> Given the currently low interest rates and poor
> performance of the stock
> market, that seems hard to believe.  Are there some
> commodity exchange
> brokers that have been bankrupted by having to make
> good on some of these
> hedge contracts when oil prices went up?
> 
> I realize the oil companies are in a box because
> they must sell all the
> products that come from their refineries.  By that I
> mean, they can only
> catalytically crack and reform a small amount of the
> jet fuel fraction into
> other products and they have limited storage
> capacity.  If they don't sell
> the rest of the jet fuel fraction as fast as it is
> produced; then, they will
> run out of storage capacity and the refinery would
> have to shut down.   In
> effect, are the oil companies willing to take a loss
> on jet fuel at a time
> when airline travel is down in order to sell as much
> gasoline and diesel
> fuel as they can produce at a huge profit.  Is this
> what drives these hedge
> contracts?
> 
> Roger Pihlaja
> S/V Dynamic Equilibrium
> 
> ----- Original Message -----
> From: "brad haslett" <flybrad at yahoo.com>
> To: <rhodes22-list at rhodes22.org>
> Sent: Monday, February 21, 2005 6:48 AM
> Subject: [Rhodes22-list] Energy Policy - Oops!
> 
> 
> > Ed, forgot you couldn't attach MS Word documents.
> > Here's a cut and paste version.  Brad
> >
> >
> >
>
______________________________________________________
> >
> >
> >
> >
> >
> >
> > Passenger Airline Profitability in the Post 9/11
> > Environment - How Southwest has Controlled Fuel
> Costs
> > by Hedging and Why Other Airlines Should Hedge
> Fuel
> > Purchases
> >
> >
> >
> >
> >
> > Brad Haslett
> > Managerial Finance BA-518
> > Embry-Riddle Aeronautical University
> > Winter 2004
> >
> >
> > The Search for Profits Post 911
> >
> > The US passenger airline industry was in trouble
> in
> > 2001 prior to 9/11. A slowing economy and the
> bursting
> > dot-com bubble suggested substantially slowed
> economic
> > growth. With a softening economy and a recent
> round of
> > tough labor negotiations, most major airlines were
> > facing a bleak profit outlook. However, industry
> cash
> > reserves totaled $11 billion at the end of the
> first
> > quarter of 2001 and operating revenues had been
> > growing nearly 7 per cent annually since 1995. 
> The
> > 9/11 terrorist attacks eliminated any hopes for a
> 2001
> > profit for all but a handful of carriers, and
> three
> > years later, only a rare few have achieved
> positive
> > financial results.  One key to the success of
> those
> > that have not only survived, but also prospered,
> is
> > keeping fuel costs under control. Every one-cent
> > increase in the cost of a gallon of jet fuel costs
> the
> > industry $180 million per year. This paper will
> > examine the history of airline fuel costs, what
> > techniques are available to control and predict
> jet
> > fuel prices, and what the most successful in the
> > industry, primarily Southwest Airlines, are doing
> to
> > control fuel costs and maintain profits by using
> fuel
> > hedging strategies.
> >
> > Oil is a commodity that has always had a volitale
> > price history, however, prior to 1973, the
> inflation
> > adjusted price tended to hover around $25 per
> barrel.
> > The rise to power of the OPEC oil producing
> nations in
> > 1973 changed the dynamics and the volitality of
> crude
> > oil prices. OPEC mandated cutbacks in production
> in
> > 1973 and 1979 created substantial rises in
> worldwide
> > crude oil prices.  Airlines suffered substantially
> as
> > a result but the industry was still regulated in
> 1973
> > and de-regulation was in its infancy in 1979. 
> Crude
> > oil prices reached their highest point in nearly
> two
> > decades in 2004. The sudden rise in crude oil was
> due
> > to a complex set of factors including uncertainty
> > about the stability of production from the Middle
> > East, but few in the oil industry predicted it.
> > Almost no US air carriers were financially
> prepared
> > for it. US based airlines were already suffering
> > heavily from the post 9/11 environment. The 2003
> > industry debt level stood at $100 billion while
> the
> > value of all the outstanding stock of passenger
> > airlines was only $3.2 billion. The sudden rise in
> oil
> > prices eliminated all hope for an industry profit
> for
> > the remainder of 2004 and perhaps for the next
> several
> > years for all but a few.  Those carriers that have
> > remained profitable, namely Southwest Airlines,
> have
> > done so largely because thay have controlled fuel
> > expense through a sophisticated system of hedging
> jet
> > fuel costs.  We will examine why Southwest has
> been so
> > successful and why the other competiters haven't
> > followed their example.
> >
> > Most major air carriers have retired their older,
> less
> > fuel efficient jet fleets for aircraft that burn
> less
> > fuel. Today's jet fleet is nearly three times more
> > fuel-efficient than the fleet that was operating
> at
> > the time of the first OPEC fuel crisis. However,
> fleet
> > modernization requires major outlays in capital
> and
> > heavily affects profits when passenger traffic
> > declines.  Despite improving fuel requirements,
> jet
> > fuel expenses still account for 12 to 18 per cent
> of
> > operating costs, second only to labor expense. 
> Fuel
> > costs nearly doubled in 2004 and unlike other
> > industries, the airline industry was unable to
> pass
> > the expense to the consumer.  Cargo airlines such
> as
> > FedEx and UPS tacked on fuel surcharges to
> customer
> > invoices and consumers accepted the price
> increases
> 
=== message truncated ===



		
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