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Airlines Fuel

Airlines Fuel

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06/14/2009

Energy Matters: Combating the FuelRelated Challenges Facing U.S.

Airlines

John Heimlich — Vice President and Chief Economist

May 4, 2006

The Air Transport Association of America, Inc.
ATA Members Carry Over 90% of U.S. Airline Passenger and Cargo Traffic

Combination Services (13)
Alaska Airlines Aloha Airlines American Airlines ATA Airlines Continental Airlines Delta Air Lines Hawaiian Airlines JetBlue Airways Midwest Airlines Northwest Airlines Southwest Airlines United Airlines US Airways

All-Cargo Services (6)
ABX Air ASTAR Air Cargo Atlas Air / Polar Air Cargo Evergreen Int’l Airlines FedEx Corporation UPS Airlines

Associate Members (4)
Aeromexico Air Canada Air Jamaica Mexicana

© ATA May-06 -- 2

The Word on the Street

“Geopolitical risks prevail and are not going away in the short term. The risk to WTI* prices is therefore still skewed to the upside and even comfortable reserves and warm weather cannot compete against nuclear showdowns and sabotaged pipelines.
Deutsche Bank Commodities Research Commodities Weekly (February 3, 2006)

*West Texas Intermediate crude oil
© ATA May-06 -- 3

Aviation Fuel Efficiency Has Tripled Since 1971
Conservation Accelerated Post-9/11, Keeping Consumption Below 2000 Peak
22.0 70.0

Jet Fuel Consumption (Billions of Gallons)*

20.0 57.1 18.0 44.4 16.0

60.0

50.0

Miles per Gallon

40.0

14.0

30.0

12.0

20.0

N/A

10.0 1971 1980 Gallons
Source: Air Transport Association

10.0 1990 1995 2000 Available Seat Miles 2005

Revenue Passenger Miles

*Consumed by U.S. passenger and cargo airlines in worldwide operations
© ATA May-06 -- 4

Fuel Conservation Via Weight Reduction
In 2003, one large airline estimated over 17 gallons saved annually per pound of weight removed per airplane after shedding in-flight phones coach ovens, excess potable water, and some galley equipment on one of its older fleets In removing seatback phones from its MD-80s and B737-400s, another airline shed 200 pounds per airplane, translating into 3,400+ gallons saved annually Alaska Airlines indicated in March 2004 that removing just five magazines per aircraft could save $10,000 per year in fuel; also, the airline now counts the children aboard each flight to estimate passenger weight (and thus needed fuel) more precisely and has reduced the weight of catering supplies on its fleet Air Canada had considered striping primer and paint from its Boeing 767s to save 360 pounds (an estimated C$24,000 in yearly fuel expense) per airplane JetBlue and America West have moved toward a paperless cockpit Others have been able to remove ovens, trash compactors, or even entire galleys, due to the elimination of hot meals on selected flights Most have reduced excess fuel on international flights with FAA approval thanks to more precise navigation allowed by GPS and better wind forecasts Some even flush the lavatories more frequently during extended ground delays
© ATA May-06 -- 5

Fuel Conservation Through Operational Means
As reported in 2004, United, JetBlue, and then-America West lowered cruise speeds not only to reduce airborne consumption but also to avoid arriving too early and burning extra fuel while awaiting an occupied gate Alaska, American, Southwest, and others have added life vests on certain domestic routes (e.g., LAX-CUN, DFW-MIA, MIA-NYC, AUS-TPA) to enable pilots to fly over water, in cases where over-water routings are more efficient Many airlines ferry fuel to avoid filling up in the costliest locations AA redistributed cargo in the airplane’s belly to move the center of gravity forward Continental, Southwest, and others have installed winglets to reduce drag or increase range; Southwest estimated annual savings of $10 million for its Boeing 737-700s, or three percent fuel savings per mission More recently, American, Delta, and others have pared schedules on a temporary basis to reduce consumption in periods of sky-high prices Several airlines taxi on one engine when conditions permit American, Southwest, and others are using ground power to provide electricity and ground-conditioned air, rather than the plane’s auxiliary power unit (APU)
© ATA May-06 -- 6

What About Air Traffic Control?
In early 2005, the introduction of RVSM* in U.S. airspace expanded altitude choices, mitigating congestion and enabling pilots to select more efficient paths Currently, ATA is advocating the following ATC measures, among others:
Accelerate RNAV** deployment at hub airports; delegate development of procedures Reconsider rule limiting speeds below 10,000 feet to 250 knots; some aircraft may operate more efficiently at higher speeds (especially on climb-out) but are prevented from doing so (note: also allows controllers greater flexibility to manage air traffic) Provide more timely information to flight crews to increase opportunity to avoid operating engines when departure delays are in effect Allow flights to maintain climb-and-descent profiles and “level-offs” prior to filed altitude; decreased controller issuances of direct aka “DCT” clearances to enroute flights Coordinate “HOLDING” alerts to operational degree possible and increase controller awareness of aircraft fuel consumption when holding at low altitudes Allow short ground delays or user-preferred trajectories in lieu of circuitous re-routes Offer re-route options whenever multi-route options are available
* Reduced vertical separation minima (see http://www.faa.gov/ats/ato/rvsm1.htm); enables vertical separation to be reduced between flight levels 290-410 (inclusive) from 2,000 feet to 1,000 feet; first implemented in North Atlantic Airspace in 1997 ** Area navigation (see http://www.faa.gov/ATpubs/AIM/Chap1/aim0102.html); developed to provide more lateral freedom and thus more complete use of available airspace; does not require a track directly to or from any specific radio navigation aid
© ATA May-06 -- 7

Can Airlines Hedge in this Environment?
“…Management of energy risk is an area that many carriers have neglected in recent years…. Most of the airlines…have not hedged their exposure for 2006 and beyond. In addition, a large percentage of the hedges were placed in crude oil as opposed to their actual exposure, which is jet fuel…. For airlines that did not hedge, or for those which liquidated hedges due to court-ordered instruction, the outlook remains very severe…. The airline industry…suffers from the burden of having to pay high prices without the flexibility of receiving higher fares.”
Testimony of Stuart R. Sokel, Director, Deutsche Bank, before the Subcommittee on Aviation, U.S. House of Representatives, September 28, 2005

“[H]edging is a risky proposition that requires an airline to put up millions of dollars of cash on the notion that jet fuel prices will be higher in the future. Cash-strapped airlines, then, can end up unhedged and vulnerable to high fuel costs that they can’t easily recoup through fare hikes.”
Keith Reed, The Boston Globe, “Hedging their jets,” June 10, 2004

“Financial problems have made it tough for some of the major carriers to make such arrangements. Poor credit ratings make it more expensive for them to borrow money to pay for hedge contracts.”
Harry R. Weber, Associated Press, “Lack of Hedges Hurt Airlines’ Bottom Line,” April 16, 2004
© ATA May-06 -- 8

Significant Exposure to Fuel Marketplace in 2006
Only Three U.S. Passenger Airlines Hedged >= 30% of Consumption
$70 $65 $60
Price of Hedge ($/bbl)
American Continental Delta Frontier Midwest JetBlue US Airways

$55 $50 $45 $40 $35 $30 0% 10% 20% 30% 40% 50% 60% 70% 80%
Fraction of Consumption Hedged
Southwest AirTran Alaska

Sources: ATA research, Bear Stearns and carrier reports

* Weighted average for crude-equivalent prices; estimated in some cases

© ATA May-06 -- 9

Could Oil Prices Go To Triple Digits?

“[A]s long as incremental supplies of oil continue to come from countries where availability is an issue, the potential for prices to stay high or go higher is, itself, very high.... After several years of very strong global economic growth and rising oil demand and a decade of under-investment in oil infrastructure, there is virtually no spare oil production capacity left in the world. In such circumstances, a sudden shortage in the markets can only be rebalanced through an extraordinary rise in prices.”
Commodities Weekly, Adam Sieminski, Deutsche Bank (April 28, 2006)

“Unforeseen disruptions to global oil supplies are becoming an increasing danger to world energy markets. Iraq, Iran, Nigeria and Venezuela threaten to heighten the markets’ concerns towards the ability of other oil producers…to respond to any negative supply shocks.”
“Bottoms Up,” John Kilduff, Fimat Energy Risk Management Group (January 27, 2006)

© ATA May-06 -- 10

Jet Fuel Cost Poised to Reach New Record in 2006
Crude Oil Average Expected to Approach $70-per-Barrel
$100 $90 $80
18.85 9.28 15.84 14.24 4.34 3.63 30.30 25.92 20.60

Jet Fuel Crack Spread Benchmark Crude Oil*
Average Price ($ per Barrel)
$70 $60 $50 $40
5.56

7.42

$30 $20

4.80

4.18

4.91

4.69

3.67

24.50

21.48

20.56

22.15

18.46

$0 1990 91 92 93 94 95 96 97 98 99 2000 01 02 03 04 05 1Q06 Apr06
© ATA May-06 -- 11

Source: ATA analysis of Energy Information Administration data

14.40

$10

17.19

18.43

* West Texas Intermediate (WTI)

19.25

26.10

31.14

3.55

41.44

5.10

3.13

56.48

63.27

69.44

7.49

5.90

High Fuel Prices “Eating the Upcycle”
“On a non-fuel basis, operating profitability…is as good as it was in the late 1990s.”

“…it would be a mistake to underestimate the effect high oil prices have already had on the world economy. [T]he…losses suffered by the airlines mirror the increase in their fuel bills. ‘We are not that far behind the high prices of the early 1980s even in real terms…’”
Daniel Yergin, Cambridge Energy Research Associates, Financial Times (Sept. 16, 2004)

“If fuel prices average $50 for 2005, the debt burden on…network airlines will grow by a number that rivals the[ir] entire combined market capitalization...”
Gary Chase, Lehman Brothers, “Fuel Eating the Upcycle” (Oct. 19, 2004)

“The airline industry has moved aggressively to reduce costs in the face of unprecedented challenges… On a non-fuel basis, operating profitability…is as good as it was in the late 1990s. While these facts are exciting…, they may also be totally moot if oil prices do not return to [historical norms]… [W]e see a materially greater chance for oil prices above $50 than below $40 over the next several years. Unfortunately, high fuel prices are consuming what would otherwise be an upcycle for the industry.”
Gary Chase, Lehman Brothers, “Industry Update” (Mar. 15, 2005)
© ATA May-06 -- 12

Jet Fuel Prices Outpacing Crude Over Last Few Years
Crack Spread Down from $30/bbl Peak, But Still Far Above $5 Historical Norm
$100 $90 $80 Crack Spread Jet Average Crude Oil

Average Monthly Price per Barrel

$70 $60 $50 $40 $30 $20 $10 $0
Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jul Jan-07

Sources: U.S. Energy Information Administration and the Air Transport Association of America

© ATA May-06 -- 13

Jet Fuel Approaching $100/bbl on Rising Crude
Crude Oil Broke $70 on April 17; Crack Spread Eclipsed $20
$55 Crack Spread $50 $140 $130

Average Daily Crack Spread ($ per Barrel)

Spot Price (Right)
$45 $40 $35 $30 $25 $20 $15 $10 $5 $0
7-Feb-05 24-Feb-05 16-Aug-05 18-Apr-05 4-May-05 20-May-05 8-Jun-05 1-Sep-05 13-Jul-05 29-Jul-05 3-Jan-05 6-Oct-05 24-Jun-05 20-Sep-05 20-Jan-05 24-Oct-05 14-Mar-05 31-Mar-05

NY Harbor Gulf Coast Los Angeles Crude Oil

Average Daily Spot Price ($ per Barrel)

$120 $110 $100 $90 $80 $70 $60 $50

Crack Spread (Left)
9-Nov-05 29-Nov-05 8-Feb-06 27-Feb-06 19-Apr-06 15-Dec-05 23-Jan-06 15-Mar-06 31-Mar-06 5-May-06 4-Jan-06

$40 $30

Sources: U.S. Energy Information Administration and the Air Transport Association of America

© ATA May-06 -- 14

Higher Energy Prices: A Double-Edged Sword
Lower Disposal Income for Consumers Compounds Higher Fuel Cost
“The widening gaps between the price of crude oil and various types of fuel…are dealing a one-two punch to an industry that can ill afford it…. To a reeling airline industry, the widening crack spread couldn’t come at a worse time.”
“Ouch! Jet-Fuel Prices Outpace Crude,” Wall Street Journal (Aug. 9, 2005)

“Mother Nature often has a cruel way of delivering her fury at some of the worst times for the airline industry, and the devastation Hurricane Katrina caused…is no different as it will lead to millions of dollars of lost revenue for both the strongest and weakest major carriers.”
Steve Lott, Aviation Daily, and Aaron Taylor, Éclat Consulting, Aviation Daily (Sept. 7, 2005)

“As a rather poignant example of the strain airlines are under from the combination of cheap fares and high oil prices, we note that the gasoline costs of driving from NY to LA now surpass air fares for the same trip, in stark contrast to the parity we calculated early last year…. We believe these economics are unsustainable.”
David Strine and Frank Boroch, Bear Stearns, Oil Things Reconsidered–Where Do We Go From Here? (Sept. 12, 2005)

“If oil prices remain above $50/bbl, we will undoubtedly see further capacity cutbacks, bankruptcies and/or liquidations.”
Michael Linenberg and Lily Ng, Merrill Lynch, “Air Mail” Research Note (Sept. 16, 2005)
© ATA May-06 -- 15

Industry Fuel Expense Rose $10.4B in 2005
Higher Crude, Crack, Consumption All Responsible for Year-Over-Year Increase
$40
$36.0

$35
Fuel Expense ($Billions)—U.S. Airlines

$33.1

$30 $25 $20
$16.4

$22.7

$15 $10 $5 $0
2000 ($0.81)

$14.8 $12.7

$15.2

2001 ($0.78)

2002 ($0.71)

2003 ($0.85)

2004 ($1.16)

2005 ($1.66)

2006F
© ATA May-06 -- 16

Sources: Air Transport Association, Energy Information Administration, Department of Transportation

Fuel Surging Just as Labor Restructuring Showing Results
Work Rules, Operations, Downsizing, and Compensation Changes Kicking In

4.50

Unit Operating Cost (¢ per Available Seat Mile)

4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00

3.99

2.95

Labor Fuel

2.88

1.23

1990

1992

1994

1996

1998

2000

2002

2004

2Q05

4Q05

© ATA May-06 -- 17

Low Fares and High Fuel Prices Don’t Mix
An Assessment by Standard & Poor’s

"Fuel prices are an external factor that airlines cannot control. What can they do to react and minimize the damage? A comparison with other modes of transportation is revealing. Fuel represents a roughly comparable proportion of expenses for railroads and many trucking companies (in the mid-teens percent range), but they have not been hurt by higher fuel prices to nearly the same degree. Part of the difference is due to more active hedging programs by these freight transportation companies, but most is due to the fact that many of their contracts with corporate customers allow them to pass through higher fuel costs in the form of surcharges. Airlines have tried repeatedly to raise fares in response to high fuel costs, but with little success. [T]he problem comes back to a lack of pricing power in a very competitive market.”

Philip Baggaley – Managing Director, Standard & Poor’s (June 3, 2004) Testimony before the U.S. House of Representatives Committee on Transportation and Infrastructure

© ATA May-06 -- 18

Since 2000, Breakeven Load Factor Well Above Actual
Lower Prices, Less Cargo, Higher Costs = More Seats Must be Filled

85

Passenger Load Factor (%)—Majors and Nationals

84.1
Actual
80

Breakeven

82.4 81.4 79.6 75.4 76.3 81.3

75

72.4 70.5
70

73.7 71.8 70.0

70.8

71.1 69.3

69.4 67.2

65

66.0 64.3

66.4 64.9 64.9

60 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 YE 3Q05

Source: ATA research
© ATA May-06 -- 19

www.airlines.org

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