Taking A Flight Soon? Prepare To Pay More As Oil Prices Rise

• Many airlines have been chasing customers with fare sales, but rising fuel costs are likely to soon change that
• A recovery in air travel demand has triggered a quick rebound in jet fuel prices
• U.S. airlines expect a strong rebound in passenger numbers as the U.S. finally lifted pandemic travel restrictions last week

President Joe Biden has just signed the $1.2 trillion bipartisan infrastructure bill into law at the White House, with attention now shifting to the multi-trillion dollar economic bill that will expand the nation's social safety net. The Biden administration has lately sought to soothe fears that runaway inflation could hurt the U.S. recovery and undermine his multi-trillion spending plans after inflation hit a 31-year high in October with consumer prices increasing at a torrid 6.2% Y/Y clip. Amongst the commodities seeing the biggest price increases are oil and gas, with U.S. average gasoline prices up 60% Y/Y to levels last seen in 2014, while gas prices in California recently hit an all-time high at $4.69 per gallon. Experts consider $4.00 per gallon the true pain point for most motorists.

Any administration will feel alarmed by the turn of events because fuel prices tend to have an outsized impact on the psyche of the American consumer.

The White House may consider selling inventories from the nation's Strategic Petroleum Reserve in a bid to tame the oil price rally though analysts have warned that this would make little difference. There are a few more tools at the government's disposal, and the Biden administration is expected to address soaring prices as early as this week.

Travelers who prefer flying are finding some respite, but probably not for long.

Despite a massive surge in inflation and a 25% jump in jet fuel prices to $2.27a gallon, airfares in  October were actually down 4.6% from a year earlier, though they did rise 3.5% from September to October.

Related: The Energy Crunch Is Adding Billions To Oil Tycoons’ Net Worth Many airlines have been chasing customers with fare sales, but rising fuel costs are likely to soon change that.

Last month, Delta (NYSE:DAL) said that higher jet fuel prices would weigh on its bottom line while Frontier Airlines has forecast a fourth-quarter loss on an adjusted basis due to higher fuel costs. Fuel cost is one of the biggest line items in an airline's balance sheet, typically accounting for ~20% of operating expenses. The U.S. airline sector booked a staggering $35B in losses last year at the height of the pandemic due to travel restrictions but are, ironically, now losing money because many economies have reopened.

Source: CNBC

High air travel demand

A week ago, the U.S. finally lifted pandemic travel restrictions that have barred many international visitors from visiting America. The reopening of the border comes with a new set of rules, but is being looked upon as aiding in the economic recovery. International visitors will be required to show proof of vaccination by a jab approved by the FDA or listed by the World Health Organization.

Airlines are celebrating the latest development, with United Airlines (NASDAQ:UAL) saying it expects a 50% surge in international inbound passengers; Delta also anticipates strong demand over the next few weeks, while American Airlines (NASDAQ:AAL) has forecasts international capacity for November and December to be more than double that of a year ago. Indeed, according to airfare-tracking site Hopper, international flight searches to the U.S. have more than quadrupled since the Biden administration announced it would lift the restrictions back in September. Overall, U.S. carriers are expected to fly just 6% less in November and December compared with 2019, before the pandemic hit.

But the deluge of arrivals is also likely to translate into squeezed margins for most airlines.

With demand for air travel on the rise ahead of the holidays, airlines are in a race to hire thousands of  pilots, flight attendants, reservations agents, baggage handlers and many other employees in order to meet growing demand. Many are offering premium perks and benefits to crews to work several shifts over the holidays. For instance, Southwest Airlines (NYSE:LUV) is boosting its ranks of backup crews with new hires and more staff coming back from leave while offerio 120,000 frequent flyer miles, worth more than $1,400, to work several shifts over the next two months. Southwest, alongside American Airlines and Spirit Airlines (NYSE:SAVE), have had mass cancellations since late July due to severe staff shortages.

Unfortunately, the airline sector has nearly run through much of the $54 billion in government payroll aid that helped cover their labor bills during the crisis, which coupled with high fuel costs, means many companies will see a surge in operating expenses.

No hedging

To compound matters further is the fact that many airlines have chosen to forego fuel hedging after suffering catastrophic losses a year ago due to low oil prices.

Commodity price hedging is a popular trading strategy frequently used by oil and gas producers as well as heavy consumers of energy commodities such as airlines to protect themselves against market fluctuations. During times of falling crude prices, oil producers normally use a short hedge to lock in oil prices if they believe prices are likely to go even lower in the future, while heavy consumers like airlines do the exact opposite: Hedge against rising oil prices which could quickly eat into their profits.

However, hedging is far from a silver bullet that is guaranteed to protect anybody from volatile markets, something that many airlines are now feeling keenly.

Related: BP: Oil & Gas Will Be Needed For Decades

Many large carriers use hedges to lock in years of fuel costs in a bid to smooth out turbulence in highly volatile energy markets. But many big carriers pulled back from oil hedging after suffering massive losses due to low oil prices.

Indeed, some of the world's biggest airlines recently ditched or shrunk their mammoth fuel-hedging programs after losing billions of dollars in derivatives.

British Airways parent IAG SA (OTCPK:ICAGY), owner of iconic European airline brands such as British Airways, Iberia and Aer Lingus, announced that it would cut its year-ahead fuel hedging to about 60% of its requirements down from 90% hedged for the comparable period when the pandemic began. 

Similarly, Deutsche Lufthansa AG (OTCQX:DLAXY) said they would cut hedging volumes by about 20 percentage points.

But now, these airlines are probably cursing their luck after the oil price rally added billions of dollars to their fuel costs.

By Alex Kimani for Oilprice.com

More Top Reads From Oilprice.com:

• Chinese Crude Oil Imports Drop To Three-Year Low In October
• Natural Gas Prices Soar As Putin Punks Europe
• Why Uranium Stocks Are Soaring