[Rhodes22-list] Energy Policy - Oops!

[Hank]

Bill,

When Brad mentioned airlines selling hedged positions it was because
they needed the cash to continue operating, not because it was a good
investment.  They lost money in the long run but gained needed short
term cash.

Hank


On Wed, 23 Feb 2005 08:43:20 -0500, Bill Effros <bill at effros.com> wrote:
> Brad,
> 
> I just googled oil prices and one of the top hits was this one:
> 
> http://www.wtrg.com/oil_graphs/oilprice1947.gif
> 
> It is in 2000 dollars, but there wasn't enough inflation between 2000
> and 2004 to explain the difference.
> 
> I understand you can't always be on the right side of a hedge, and I
> think hedging is important for commodity businesses, but I think it's a
> mistake to think hedging will make you more profitable.  You are right,
> that is confusing hedging with speculating.  Airlines that sold hedged
> positions when the market was high were also hedging.  They believed
> they would be able to buy the fuel at a later date at a lower price.
> I'm sure Southwest sells hedged positions as well as buys them in an
> attempt to drive down its fuel cost.
> 
> What you pay your pilots is not the point with regard to labor costs.
> It is how much useful work you get for what you pay, and Southwest has
> apparently been effective in this area.   I say  "apparently" because I
> question the notion that the country as a whole has become more
> "productive", and I don't know the specifics of the Airline industry.
> (Southwest also cherry-picks its routes--something that by definition
> becomes more difficult as you grow.)  Companies are decimating their R&D
> abilities by firing entire departments, and then claiming more
> "productivity" because they are producing the same number of widgets
> with a smaller labor force.
> 
> In effect, they are hedging their labor forces, speculating that they
> will be able to buy a less expensive R&D department at a later date that
> will be able to bail them out of the fact that they currently have no
> new widgets in the pipeline.
> 
> If the Chinese, and other lower priced manufacturers drive them out of
> the widget business entirely, then hedging the R&D department will prove
> to be a brilliant move that prolonged the ability of the company to
> remain in business and gainfully employ the remaining staff.
> 
> Of course I know that the Pension Guaranty Board is bailing out the
> people who thought they had secure pensions with Airlines and other
> major employers.  And, of course I know that this pension system, funded
> by you and me, is unsustainable, and will fail a long long time before
> Social Security.  And, of course I know that all of the big industry
> players are gaming the system by dumping their obligations on everybody
> else.
> 
> I assume you know that the "privatized" social security proposal is
> exactly the same scam.  That it can't possibly work.  That the numbers
> don't add.  And that as soon as the "winners" and "losers" emerge, the
> losers will outnumber the winners and they will legislate themselves a
> bailout.
> 
> Bill
> 
> brad haslett wrote:
> 
> >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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> >
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