Winning The Fuel Wars

As I blogged in an earlier post, in the past few years, fuel has become quite the dominating force in airlines' cost structure. Fuel, as a percentage of airlines' operating expense, has almost doubled from ~13-14% in the first half of the decade to ~ 25% in the next. In terms of actual dollars, this means jumping from an average of ~1.5 cents per ASM to ~ 3.4 cents. No doubt, when asked recently to name the greatest risk for airlines in 2010, Gary Kelley, Chairman and CEO, Southwest Airlines said “That's easy. It's energy prices.”

Naturally, airlines have grown increasingly creative in managing their fuel needs with hedging fuel prices being a key component of this strategy. Fuel hedges, in fact, are considered the primary reason why Southwest continued to remain profitable even as other airlines struggled with record losses  -  clutching to every possible fee to keep them from drowning. In fact, some reports estimate that between 1998 and 2008, Southwest saved approximately $3.5 billion over what it would have spent had it paid the industry's average price for jet fuel. The following graph shows the price paid by the industry (all US carriers with revenue/yr > $20 Million) and that paid by Southwest for a gallon of jet fuel.  Notice the wide gap between 2003 and 2008.

The influence of Southwest's fuel hedges on its profitability can be gauged by comparing its 2008 domestic operating performance with that of other major carriers - Southwest was one of the only 3 major airlines to be profitable that year when fuel touched highs of $120/bbl.

But 2008 is history and the airline industry has certainly turned a corner in terms of profitability and business discipline – raising ancillary revenue, cutting capacity and consolidating. Lower fuel prices too have helped the airline industry get back to its feet. It would be interesting to see how airlines are doing on their fuel expenses in this new environment and which ones are winning this new round of fuel wars - just as Southwest did with 6 straight years of the lowest fuel costs among all the major carriers.

Comparing the average domestic fuel prices paid by the industry and the major players throws up some interesting results. Southwest, in fact, has the industry's highest domestic fuel cost at $2.39/gallon while US Airways has the lowest at $2.11/gallon – a difference of 28 cents. For an industry that consumed around 5,389 million gallons of fuel in the first 6-months of the year and paid $2.23 on average for a gallon of jet fuel that's a difference of $650 million – more than a billion dollars for the year.

In the first 6 months of 2010, American could have saved ~ $106 million had it bought jet fuel at US Airways' price/bbl, Delta $130 million, and Southwest about a whopping $200 million – now that's a lot of pocket change.  

  

Indeed, the sharp turn in fuel prices has thrown up an interesting winner – US Airways. Whether US Airways will be able to sustain this lead as Southwest did for 6 straight years from 2003 to 2008 remains to be seen. For now, US Airways sure is doing something right and the industry ought to take notice.