By Brian Nelson, CFA
In "Get Ready for $150 Oil," Barron's predicts an oil shock will occur in spring 2012, with the black commodity reaching a record average monthly price of $150 per barrel, with spikes to $165 and $170 along the way. If this prognostication proves correct, airlines are in for a world of hurt. Before we get started on just how painful this shock could be, we invite airline stock speculators to take a read of our industry primer on the airline industry.
Jet fuel prices generally represent the largest component of an airline's cost structure, and we estimate that for every $1 increase in the price of crude oil, it costs the global airline industry about $1.5 to $1.7 billion more. And while airlines have been layering on additional fees (checked baggage, etc.), we still believe that even with such measures (coupled with some fare hikes from the low-cost group under this scenario), airlines would at best recoup about 75% to 85% of the higher cost of jet fuel. That means, for every $1 sustainable increase in the price of black gold, we can probably expect the global airline industry to lose an additional $240 million to $400 million. Click here to read our views on the 2012 hedge positions of the major network carriers, which have direct implications on their exposure to rising crude.
The IATA estimates that airlines would earn about $4 billion under a scenario where the average price of crude oil is $110 per barrel. By extension, and based on our analysis, if crude oil rose to a sustainable price of $150 per barrel (as Barron's suggests), the global airline industry could lose as much as $12 billion in 2012, and that assumes demand is not choked off due to the residual impact of lower consumer discretionary spending caused by a higher gas bill to fill up the tank--let alone the negative impact higher ticket prices would have on passenger demand (airlines would have to hike fares to recapture 75% to 85% of their higher fuel costs).
In our analysis of the fleet ages of the major carriers, we outline which airlines [out of US Airways (LCC), United Continental (UAL), AMR Corp. (AMR), and Delta (DAL)] are flying the most fuel-inefficient planes (and therefore would be most impacted by this predicted rise). That said, however, a sustainable increase to $150 per barrel would likely send the entire group back toward their 52-week lows, in our opinion. At this time, we are currently evaluating long-term put options on the Guggenheum Airline ETF (FAA) as an addition to our Best Ideas List.