Rare good ‘shock’ for airlines

Southwest Airlines expects per gallon jet fuel prices to be as low as $2.30 in 2015.

Airlines have learned to expect the unexpected, but usually the “shock” is bad news leading to carriers’ bottom lines taking a hit. But a rare surprise has occurred in recent months that likely will result in airlines making more money: the relatively sudden and steep drop in oil prices.

“I quite frankly was taken by surprise by the decline in oil prices,” Southwest Airlines chairman, president and CEO Gary Kelly told The Wings Club in New York.

Dropping oil prices played a large part in IATA boosting the projected 2014 collective net profit of the world’s airlines by 10.6% compared to its June forecast. And IATA is forecasting a more than 25% year-over-year increase in airline net profits in 2015.

Kelly said he expects per gallon jet fuel prices to be as low as $2.30 in 2015, but cautioned that things could change quickly. “I don’t think we’ve ever anointed ourselves the czars or seers of what the future is,” he said, adding that “the fundamental question to answer” regarding the airline industry in 2015 is “where are fuel prices going to be? Nobody knows.”

Noting that the recent drop has been both surprising and fast, Kelly warned, “Logic tells you the opposite can happen and we certainly have to be prepared for that.”

According to its third-quarter financial release, Southwest has about 40% of its fuel consumption hedged for 2015, 2016 and 2017, though the company is exploring adjustments to its fuel hedging contracts. Kelly acknowledged Southwest is not getting the full benefits of lower oil prices because of its hedging program, but he said its 2014 “fuel bill all-in including hedging will be down dramatically” compared to 2013.

Fuel hedging has benefited Southwest in the past and Kelly said he doesn’t regret hedging even when oil prices dip unexpectedly. “Hedging is not intended to be a money-maker,” he said, calling it a form of “insurance” that, like all insurance, comes with a cost. “Our hedging program is designed to prevent catastrophe,” he explained.

Kelly said the bottom line is that fuel is one-third of an airline’s costs and “with these oil prices, if they continue, our operating costs will be lower than we thought they would be and lower than they have been the last couple of years.”

Aircraft manufacturers and aircraft engine producers have used the high fuel cost environment of recent years to promote (and sell a large number of) fuel-efficient aircraft to airlines. Boeing chairman, president and CEO Jim McNerney said in October that he doesn’t think falling oil prices will diminish airlines’ huge appetite for fuel-efficient aircraft such as the 787 and 737 MAX. “Our analysis is the price of oil could fall a long way before our planes are anything but compelling,” he said, adding that fuel costs would have to drop “a long way before you see even incremental impact” on aircraft sales.

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