Airlines are massive consumers of jet fuel and, therefore, oil. In fact, fuel is one of the largest expenses at virtually all airlines, and the volatility of oil prices is one of the top risks of owning airline stock as an investment. But an expected increase in supply could drive oil prices sharply lower over the next couple years, and that potentially means big gains for airline shareholders.
Recent reports by Libyan officials suggest that the African nation could soon vastly increase its oil exports. Political instability has rocked the nation over the past few years and estimates have often proved too optimistic in the past. This time officials have raised hopes that a major oil field shut down by protesters last year may begin production again.
The message was heard loud and clear among oil traders as the Libyan news contributed to a drop of around 5% in various oil benchmarks. Lower oil prices provided a boost to airline shares the same day helping to push shares of Delta Air Lines (NYSE:DAL), American Airlines Group (NASDAQ:AAL), and United Continental Holdings (NYSE:UAL) all up around 5%.
Restrictions on foreign investment in Mexico's oil fields are expected to be lifted and the result could be a major increase in North American oil production. Citigroup forecasts that the effects could be the equivalent of adding an amount of oil production equal to that of Nigeria. Bloomberg notes that there could be regulatory and infrastructure delays stemming from the new regulatory environment and the current shortage of pipelines.
Although increased Mexican oil production is not being felt in prices now, it could mean a significant supply increase in the future. It will likely be at least a couple years before Mexican oil production is fully up and running but for long-term investors, it could be a major positive.
One of the biggest stories of North American oil production is being seen in shale oil in North Dakota. Large amounts of Bakken crude are helping to reduce the total oil imports of the U.S. while increasing the total oil supply available.
Stories of explosions from rail cars carrying Bakken crude have come out lately and the issue will need to be addressed. However, while it may put near-term pressure on production expansion, I do not see it halting production in the long-term. For now, regulatory agencies are investigating and putting pressure on rail companies to better label and contain shipments of Bakken crude.
Bakken crude is particularly important for Delta Air Lines which looks to capitalize on its cheaper price compared to other oils. Since Delta acquired the Trainer oil refinery, the airlines is now able to refine oil into its own jet fuel. Since Bakken crude trades at a discount to other oils, Delta can boost profits at Trainer by using Bakken crude to refine into jet fuel.
Airline stocks fall into a category of investments that can be sharply driven up or down based on the cost of oil. With increases in supply expected to come on line from Libya, Mexico, and the United States, oil prices could slide in 2014 boosting airlines' bottom lines. Potential risks still exist including natural disasters and civil unrest but, barring these events, I see lower oil prices as another factor benefiting airlines in 2014.
Alexander MacLennan owns shares of AMERICAN AIRLINES GROUP INC and Delta Air Lines and has the following options: long January 2015 $22 calls on Delta Air Lines, long January 2015 $25 calls on Delta Air Lines, long January 2015 $30 calls on Delta Air Lines, long January 2015 $17 calls on AMERICAN AIRLINES GROUP INC, long January 2015 $40 calls on Citigroup, and long January 2015 $45 calls on Citigroup. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.