[Rhodes22-list] Energy Policy - Oops!

[brad haslett]

Bill,

I'm out in the field hedging my own financial future
so this will be quick.

The $25/barell number is correct and prior to 2004 was
the benchmark number analysts used to discount cash
flow from a well for valuation.  I don't have the
original sources on my laptop but I can get them for
you.

Constantly being on the right side of a hedge is not
the point.  If you hedge just to make money its called
speculating.  You may as well send the CEO to Atlantic
City with the payroll.  Hedging only makes sense for
those with a product to sell, oil/soybeans/etc., or
companies who must buy the same commodities to
operate.  Hedging only protects from wild cost swings
and allows firms to stay on budget.

Southwest, contrary to popular belief, does not have
the lowest labor costs.  Their employees are nearly
100% union and their pilots are among the highest paid
in the industry for the equipment they fly
(airlinepilotpay.com).  However, their employees are
the most productive in the industry and that has made
all the difference.  

If you were to remove all labor costs from the
industry and the airline employees worked for free as
a hobby, competition would center around equipment
aquisition costs, utilization, and fuel.  Bad
management could still screw themselves into
bankruptcy with stupid decisions.

BTW, you are now supporting airline pensions through
the Pension Guaranty Board.  The PGB was never
intended to cover companies that shed their
obligations through Chapter 13, only Chapter 7, and
now faces its own solvency problems.

Thank god for freight!

Brad
--- Bill Effros <bill at effros.com> wrote:

> Brad,
> 
> While I agree with you that hedging is important for
> flattening spikes 
> in commodity industries, (as usual) I question some
> of your underlying 
> assumptions. I do not believe that the pre-1973
> inflation adjusted price 
> for oil hovered around $25/barrel. It seems to me it
> was much closer to 
> $15/barrel.
> 
> There are lots of other numbers I would question.
> Saying that Southwest 
> hedged 80% of its oil at $26 a barrel tells us
> nothing about what it 
> paid for oil. If it bought the other 20% at $60 a
> barrel then its fuel 
> cost for the year would have been $32.80/barrel.
> 
> I would guess that anyone could have averaged around
> $32.80/barrel on 
> the open market during 2004--the problem was that
> none of them could 
> have predicted it would have been that high, based
> on an average world 
> price of slightly less than $20/barrel inflation
> adjusted for the past 
> 100 years. So they all did less well than they
> thought they would, and 
> they can all anticipate more problems if they can't
> tack on fuel costs 
> without losing passengers in the future.
> 
> All the airlines hedge to a greater or lesser
> extent. In a sense, going 
> bankrupt is a hedge, and getting a government
> bail-out is a hedge. 
> Paying late is a hedge. Each effectively allows you
> to buy fuel for less 
> than the market rate. No one is always on the right
> side of a hedge 
> (Except Ivan Boesky because he was cheating.)
> 
> So if Southwest did well some years, it will do
> badly in other years. 
> That is the nature of hedging. They must hold down
> their largest cost -- 
> labor -- to do well year after year. The legacy
> airlines signed labor 
> contracts that were not sustainable. They hedged
> their labor contracts 
> by providing future pensions that were so
> unsustainable that they wound 
> up reneging on them.
> 
> The airlines would have had this same set of
> problems with or without 9/11.
> 
> Bill
> 
> brad haslett wrote:
> 
> >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
> >for services.  When Contential and United airlines
> >tried to add fuel surchages to ticket prices,
> airline
> >passengers sought other carriers without the
> >surcharges and both airlines quickly recinded the
> >charges.  The US passenger market remains extremely
> >price sensitive and fuel surchages of as little as
> $10
> 
=== message truncated ===



		
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