A global oil glut caused oil prices to plunge between mid-2014 and early 2016. However, over the past two and a half years, oil has regained a lot of ground. This development has translated into steadily rising jet fuel prices, putting pressure on airlines' profitability.
The oil rally has cooled off this month, over recent reports that have alleviated investors' worries about a serious oil shortage. Lower jet fuel prices should help all of the airlines, but two could benefit disproportionately: Spirit Airlines (SAVE 0.25%) and Alaska Air (ALK 1.28%).
The oil rally takes a breather
Gulf Coast jet fuel prices averaged just $1.42 per gallon in July 2017. However, oil prices rallied dramatically in the second half of 2017 and continued to rise in the first half of this year. As a result, Gulf Coast jet fuel has been going for more than $2 per gallon this month.
Oil prices have risen significantly over the past year. Image source: Getty Images.
Declining petroleum stocks have contributed to the oil rally by eroding the big cushion of excess inventory that had held prices down since 2014. Meanwhile, renewed U.S. sanctions on Iran, plunging production in Venezuela, and civil unrest in other oil-producing countries have combined to pinch supply.
However, some of these supply disruptions have eased recently. Furthermore, U.S. petroleum stocks increased significantly in last week's report, defying expectations. This development caused the price of Brent crude to fall to around $70 per barrel, down from $78 per barrel as recently as July 10.
Gulf Coast jet fuel prices have retreated as well, falling to $2.02 per gallon by last Monday. That's down from a multiyear high of $2.22 per gallon in late May, but still up from $1.90 per gallon at the beginning of 2018.
Spirit Airlines could be the biggest winner
Jet fuel prices also plunged in February, before rocketing to new heights over the next three months. It's possible that the latest dose of price relief for airlines won't last long, either. But if the price of jet fuel remains near recent levels -- or falls further -- Spirit Airlines is likely to be the biggest beneficiary among U.S. airlines.
Lower fuel prices would be a big boon for Spirit Airlines. Image source: Spirit Airlines.
What distinguishes Spirit from its rivals is that it has very low non-fuel unit costs. Fuel is therefore a bigger part of its cost structure. Indeed, in the first quarter of 2018, Spirit Airlines spent 29% of its revenue on fuel, compared with less than 21% at No. 1 airline American Airlines Group.
As a result, changes in the price of jet fuel have a bigger impact on Spirit Airlines' profitability than that of other airlines, holding fare levels constant.
Spirit Airlines stock has surged this month, thanks to an upbeat investor update indicating that second-quarter earnings will be much better than previously expected. Spirit still needs to get unit revenue growing again to fully regain investors' confidence, but if its fuel-cost headwind moderates, it has a good chance of returning to EPS growth in the second half of 2018.
Alaska Air is also set to benefit
Alaska Airlines is much closer to its larger peers than to Spirit Airlines in terms of the role of fuel in its cost structure. In the first quarter, it spent a little more than 22% of its revenue on jet fuel.
However, in the span of two years, Alaska has gone from being the most profitable airline in the U.S. to below average, increasing the impact of small margin swings on its earnings. Its adjusted pre-tax margin was just 1.3% in the first quarter. Based on its most recent guidance, Alaska's Q2 adjusted pre-tax margin probably fell from 24% a year ago to around half that level this year.
Like Spirit Airlines, Alaska's unit revenue has been declining lately. But also like Spirit, Alaska Airlines has a good chance to turn things around starting in the second half of 2018. In the past few months, it has slashed some underperforming routes, with more cuts coming this fall. In addition, merger synergies and the introduction of a "basic economy" product should boost unit revenue growth over the next several quarters.
These moves should enable Alaska to stabilize its profitability within the next few quarters. But facing a smaller fuel-price headwind would allow the carrier to return to profit growth sooner -- potentially helping to lift Alaska Air stock out of the doldrums.
