Airline Energy Q&A

How much jet fuel do U.S. airlines consume annually?
In worldwide operations, U.S. passenger and cargo airlines require more than 18 billion gallons of jet fuel annually, or more than 430 million barrels.

Are synthetic fuels an option?
While there are many questions that need to be addressed about the widespread use of synthetic fuels to propel commercial aircraft operating in the United States, A4A is actively monitoring, and encouraging, efforts by the U.S. Department of Defense, NASA, the Federal Aviation Administration, airframe and engine manufacturers, and various academic institutions to bring synthetic fuels to the marketplace. Any incremental fuel supply, especially if both environmentally friendly and economically viable, is worth pursuing.

So with no alternative source of energy, what's the best way to curb consumption?
Beyond the numerous, diverse, successful measures that U.S. airlines have taken and continue to explore to conserve fuel, the single biggest advance in fuel conservation, and emissions reduction, will come from reform of our nation's air traffic control (ATC) system, devised using 1950s technology. The FAA "NextGen" suite of solutions could improve system fuel efficiency by as much as 12 percent. For more information, visit our "Airspace Reform Concepts" at smartskies.org.

So how do fuel price increases translate to higher airline operating expenses?
At a consumption rate of more than 18 billion gallons per year, every penny increase in the price of a gallon of jet fuel drives an additional $180 million in annual fuel costs for U.S. airlines. So if the price were a dollar higher over the course of one year, that would translate to about $18 billion more in operating expenses. According to the A4A quarterly airline cost index, fuel has overtaken labor as the industry's top cost.

What is the "crack spread"?
The term "crack spread" refers to the simultaneous sale of crude oil against the sale of refined petroleum products. These spread differentials, which represent refining margins, are normally quoted in dollars per barrel by converting the product prices into dollars per barrel and subtracting the crude oil price.

What has driven rising fuel prices over the last few years?
Fuel prices are influenced by a myriad of global factors, but are closely linked to the price of crude oil, which is being driven principally by a robust global economy, increasing supply tightness, geopolitical insecurity, rampant speculation in the commodity futures markets and unique production and demand factors. The technical specifications for jet fuel make it more complex to refine. U.S. buyers have also been somewhat disadvantaged in recent years vs. their foreign counterparts, due to a relatively weak dollar. Beyond the price of crude oil, the price of jet fuel has risen sharply with overburdened refineries, competition with other products in multi-product pipelines and refinery outages. Recently, low inventories of heating oil in the northeastern United States and surging European and Asian demand for diesel and other middle distillates have contributed substantially to the widening jet fuel crack spread.

Why don’t airlines pass on the cost of higher fuel to passengers?
Though consumers have increasingly seen airlines attempt to raise fuel surcharges, those surcharges often fail to "stick," particularly in the fragmented domestic air-travel arena. This is due to the demand for air transport being highly price-sensitive, or "elastic." It is also the case the price elasticity of demand for air travel increases when the disposable income of the traveler falls -- typically when the economy softens. As longtime airline credit analyst Philip Baggaley remarked in a March 28, 2008 Standard & Poor's research note, "The rapid increase in jet fuel prices will add substantially to airline costs at a time when a weakening U.S. economy will make it more difficult to offset those costs with higher fares."

People are willing to travel by air these days, but it's with the expectation of far lower prices than once paid — largely because, in addition to intense inter-airline competition, travelers may opt for other forms of transportation, carpooling, videoconferencing, or not traveling at all. This has played out in particular on shorter-haul routes, where the airport experience has become more uncertain and substitutes such as buses, cars or trains abound. Even where successful, fare increases have paled in comparison to the magnitude of the sustained rise in jet fuel prices.

Why don’t airlines join forces to buy fuel in bulk?
Some have questioned why the airlines do not co-buy fuel with the U.S. Air Force or with other airlines. The military, like the airlines, buys fuel principally through term contracts, indexed to Platts' spot prices, so it does not obtain superior pricing. As for bulk purchasing, the key underlying economic factor is that demand for jet fuel exceeds the supply of jet fuel. Therefore, there is no incentive for jet fuel suppliers/marketers to "clear" inventory -- i.e., to unload surplus jet fuel by encouraging airlines to buy more at discounted prices. In other words, the suppliers have no incentive to lower the price because the airlines require a sufficiently large amount of jet fuel for their operations, so they must buy at the undiscounted price. Airlines have tested the market in certain instances and found that in practice that could not obtain offer-prices favorable to what each airline could buy individually. The other important factor on bulk purchasing is that at large (i.e., hub) airports, an individual airline's fuel needs exceed the quantity that any individual supplier is capable of providing at that location. Consequently, the airline must split its purchase into separate tenders across more than one supplier. The advantage of a purchasing consortium for jet fuel is not discounted rates per gallon, but rather the spreading of risk across multiple carriers -- an option that may be attractive in the area of alternative fuels.

Don’t airlines use special purchasing practices to mitigate the impact of high fuel costs?
Traditionally, airlines have “hedged” a portion of their fuel requirements using financial derivatives such as calls, swaps or collars applied to crude oil, heating oil or jet fuel. Hedging requires a relatively healthy financial condition (i.e., investment-grade credit), a willing counter-party and often a hefty up-front transaction cost. In the past, some carriers have had to liquidate hedges as a result of court-organized bankruptcy restructuring or to meet immediate financial obligations. As Standard & Poor's remarked in a March 28, 2008 research note, "...hedging high and volatile fuel prices is expensive and may require posting cash collateral."

How exactly does hedging work?
Existence of the futures market and other derivative instruments allows any participant to “lock in” the prevailing price for future deliveries, such as home heating-oil prices for the winter season. Such a strategy, called a “hedge,” involves a series of transactions, offsetting profits or losses on a futures transaction against losses or profits on the physical purchase or sale of oil. By limiting the uncertainty over future costs, the hedge allows companies to mitigate volatility and thereby improve financial planning. A hedge instrument may or may not accompany the actual (physical) delivery. In most cases it does not. An airline could hedge volume at a fixed price, but most frequently hedges occur in paper markets or on an exchange, typically settled on a monthly or quarterly basis between the airline and an oil company or bank.

So if hedging is the exception, how do airlines typically purchase jet fuel?
The primary means by which airlines purchase jet fuel is through “term contracts” based upon a projected volume for a given period. For example, United Airlines might agree with supplier X to supply its requirements in Chicago for a one-year term from Feb. 1, 2009, through Jan. 31, 2010, estimated at five million gallons per year on a Platts Gulf Coast index (based on the week prior to delivery) plus or minus a fixed differential (usually stated in cents per gallon). After term contracts and hedging, spot-market purchases constitute a minute portion of the industry’s jet fuel consumption. These purchases tend to be limited to larger, more sophisticated airlines that have become integrated into the supply chain for reasons of price or supply surety. And even those airlines only tap the spot market for well under 10 percent of annual purchases.

Do U.S. airlines also pay fuel taxes?
At the federal level, airlines pay 4.4 cents for every gallon consumed on a domestic flight. Of that amount, 4.3 cents goes to the Airport and Airway Trust Fund while 0.1 cents supports the Leaking Underground Storage Tank Fund. In addition, in most states airlines pay a flat rate per gallon or an ad valorem sales tax on the purchase of fuel. In California, for example, airlines pay a fuel tax in excess of 8.0 percent of the price of jet fuel. So if the price of jet fuel purchased in California were to double, our tax would double as well, generating substantial revenue for the state's treasury.

Without the occasional hurricane, is fuel supply a big issue for the airlines?
Supply tightness has become a growing commercial challenge and frustration at many airports, quite obviously exacerbated by severe storms. Thanks to the extraordinary efforts and of and cooperation among airlines, ground service providers and fuel suppliers, flights have continued to operate as scheduled. By securing off-site storage, tankering fuel, or supplementing pipeline-transported supplies with shipments by land or sea, airlines have managed to keep passengers and shippers from experiencing palpable disruption. The airline industry is quite familiar with working fuel-supply issues simultaneously, and that experience has paid off.