Rising Oil Prices Hit Airline Industry Hard

| January 4, 2008 | 0 Comments

In America, we have a desire for big cars and even bigger homes.  In the recent past, many rarely wrestle with the cost of running these items . . . . but all of that is changing.  The energy we use is now more expensive than ever.

There’s no other way to say it:  Americans are energy pigs.

I am, you are, we all are.  Compared to the rest of the world we consume tremendous amounts of oil.  On a per capita basis we consume twice what the Britons, Germans, and French consume.  Amazingly, we eat up more than 13 times the oil when compared to the Chinese.

According to the Wall Street Journal, America consumes more than a quarter of all oil produced in the world!  One out of every 4 barrels.  This level of consumption is a problem.  Just a few days ago oil traded for the first time over $100 per barrel.  It was the trade heard round the world, so to speak.

The fear is that the price will continue to rise beyond $100.  In the late 1970s and early 1980s America was hit with high oil prices. . . adjusted for inflation it peaked at $102.81 in April of 1980.  That was a time of tremendous economic turmoil.

OK, enough statistics, what does this all mean?

For one thing, the phrase “this time it is different” really rings true. Record oil prices in the early 1980s were caused by political turmoil and OPEC . . . today it is being driven by something entirely different, demand.

Indian and China are growing rapidly.  Their exploding middle class is hungry for a better lifestyle.  One that includes buying automobiles and using consumer goods like plastics that are made from oil.  Couple this new demand with already sky high consumption in the US and growth in Europe and we have a problem.  Demand that far outstrips supply.

This demand for oil is not going away.  If anything, it will get worse.  All it will take is some turmoil in Venezuela or another oil producing country and you have a recipe for oil at $200.

Some will suffer from high oil prices more than others.  Some experts point to the automobile industry as one that will suffer the most.  No doubt they will be impacted, but I think the airline industry is headed for much worse.

Alternative power sources for cars are available, though not widespread. They can be run on bio-diesel, ethanol, or battery power.  Cars have also been run on solar power, flywheels, and even fuel cells.

You can’t run a Boeing 747 aircraft on any of these.

The airline industry is tied to the price of jet fuel and higher oil prices means higher jet fuel prices.  The airlines are already suffering.  United Airlines (UAL) announced today an increase in domestic fares by $10 each way to offset rising fuel prices.

Some industry insiders believe that this is only the first round of price increases.  Amazingly, the only major airline that focuses on hedging its fuel needs is Southwest Airlines (LUV), and their hedges are expiring.  The rest of the industry (and LUV very soon) continues to operate with significant exposure to oil prices.

If the economy slows, as many experts predict, demand from consumers for flights will fall.  The rising costs of fuel and the falling demand from consumers will result in big losses for the airlines.  Last year was a terrible one for the airlines, but I’m not convinced this is the bottom.

To profit from this mess, I would look to eliminate any holdings you may have in the airline industry.  Those with a more aggressive approach could look to buy puts on some of the larger domestic airlines such as United or Delta (DAL).

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Category: Commodities

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