Fuel costs represent one of the most important expenses for the aerospace and airline industries. On average, fuel costs account for approximately 25% of all airline expenses, which translates to approximately 20% of operating revenues.
Fuel Costs of Airlines Worldwide from 2011 to 2019, as Percentage of Expenditure
Source: Statista Jet Fuel Expenses
Other major costs also include labor, airport rentals, maintenance, depreciation, marketing, and other, which are typically booked as operating expenses. While 25% is only a quarter of the total expenses, fuel costs are often a great concern because of their volatility, which is usually tied to the volatility of oil prices.
Source: EIA Jet Fuel Tracker
From 2018 to 2019, jet fuel fell approximately -7.3%, down from $2.027 to $1.879. This decrease accrues favorably to the airline industry's bottom line. If there is complete pass-through with all other factors remaining constant, the -7.3%% decline in the cost of fuel could help to reduce total operating expenses by approximately 1.5%, leading to an approximately 1% improvement in both operating profit margins and net profit margins.
The extent to which the declining fuel cost affects profitability in the airline industry depends on the proportion of fuel cost in the total airline industry's revenues. In 2018, jet fuel costs accounted for approximately 20% of the airline industry's operating revenue, while the operating profit margin was 9% in North America. If there is an immediate pass-through of fuel cost savings to the airline industry, the -7.3% decline in jet fuel costs result in a -1.4% decrease to operating expenses and a 1% increase to operating profit margin and net profit margin.
Jet Fuel Cost Strategies
It’s also important to note that airline carriers often sign forward purchase agreements that help fix fuel prices a few years in advance. This activity can be especially advantageous when fuel prices are at new lows, which leads to increased involvement in the futures markets to lock in lower prices for longer. Airline carriers may also trade in the oil markets where they may have ties with refinery operators refining oil into jet fuel. Oil is the main component in the production of jet fuel, so the price of oil and the price of jet fuel are positively correlated. As the price of oil declines, so does the price of jet fuel. Any activities in the futures market when prices are falling can lead to an extension of lower fuel cost expenses, which can spread out the positive effects on profit margins for a longer time frame.
Another way companies can seek to lower their overall costs of jet fuel can involve more direct partnerships with jet fuel producers. In 2012, Delta Airlines invested approximately $150 million into an oil refinery in Philadelphia, bypassing the jet fuel market and taking full control over its fuel production. Ranked second in the airline industry by traffic, Delta is the only airline to make such a large investment. Since 2012, Delta’s partnership has not only helped provide fuel for its own business but also played a part in reducing the cost of jet fuel for the industry overall, especially in the Northeast where production is primarily distributed. Taking such a strong move was forecast to help improve their profitability in comparison to standard long-term hedging strategies.