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Jet-Fuel Prices Outpace Crude

Posted on: Monday, 15 August 2005, 21:00 CDT

With crude-oil prices soaring, refiners are taking advantage of tight supplies to fatten the margins that they earn from turning oil into jet fuel. And cash-strapped airlines are picking up the mounting tab.

The widening gaps between the price of crude oil and various types of fuel - known in the industry as crack spreads - are dealing a one-two punch to an industry that can ill afford it, where fuel is the second-biggest expense after labor. The average crack spread for jet fuel topped $11 per barrel in the first half of this year. That is up from an average $2.59 per barrel in 2002, with the biggest jump occurring in the past six months, said Mike Lovett, chief executive of Muse, Stancil, a Dallas global-energy consulting firm.

Gasoline-hungry motorists are feeling the pain of a widening crack spread, too, but the effect has been less pronounced. From 2002 through June of this year, the gasoline crack spread nearly doubled to $7.75 a barrel from $4.14 - but the average jet-fuel crack spread more than quadrupled.

Oil prices are continuing to rise. U.S. light, sweet crude for September delivery rose to a record of $67.10 a barrel before closing up $1.06 at $65.80 on the New York Mercantile Exchange on Friday.

Adjusted for inflation, this is the highest crude has traded at since November 1982. However, it remains well below its inflation- adjusted peak price of $94.77 set in April 1980.

Tight refining capacity has played a role in the price run-up. The industry has a shortage of capacity to refine heavy oils, which has pushed up the price of lighter oils, like the benchmark West Texas Intermediate.

To a reeling airline industry, the widening crack spread couldn't come at a worse time. For nine of the nation's largest airlines, the second-quarter fuel bill totaled a combined $4.34 billion, said Bear Stearns analyst David Strine. Had the crack spread held at year- earlier levels, the fuel would have cost $3.92 billion, a difference of more than $420 million. That is more than enough to erase the $227.4 million those airlines collectively lost in the period.

"Those of us in the airline industry are being doubly hurt," said Gerard Arpey, chief executive of American Airlines, whose annual fuel costs rise by $29 million for each 1-cent rise in the cost of jet fuel per gallon.

Through June of this year, the price of West Texas Intermediate crude oil rose an average 39.7 percent per barrel from a year earlier to $51, while jet fuel rose at a much faster 49.1 percent a barrel to more than $62, said Mr. Strine of Bear Stearns. Continental Airlines says it now spends $12,202 for fuel to fly a Boeing Co. 757 cross-country from Los Angeles to Newark, N.J.

The bottom line: About one-fifth of the increase in jet fuel prices is coming from a widening crack spread, while the other four- fifths reflect higher oil prices.

The widening crack spread is another factor weighing on the stock prices of airlines. Since December 2003, the Standard & Poor's Airline Index has fallen 20.35 percent while the broader S&P 500 stock index has risen 11.15 percent.

Blame diesel cars in part for the widening crack spread. Jet fuel and diesel fuel have similar components, and soaring demand for diesel-powered vehicles, particularly in Europe, is pushing up prices for both fuels. Greater industrial demand for diesel in China also has played a role. Airline executives complain that refiners, which in the past decade came off a long period of weak profit margins, have been slow to add new refining capacity, which is contributing to the high prices.

Gene Edwards, senior vice president of supply, trading and wholesale marketing for refiner Valero Energy, said the higher profit margins are simply being dictated by the laws of supply and demand in a "feast or famine" refining market. He estimates his industry's return on capital has risen to the 20 percent range from 5 percent during weaker times in the 1990s, and he expects it to stay there.

While Edwards expects refiners to add more capacity - Valero will spend $4 billion to do so over the next five years - "it takes time" and won't produce enough overall supply to equal growing demand, he said. He added that higher oil prices, not refining margins, are the primary factor driving up jet-fuel costs.

Fereidun Fesharaki, a senior fellow and downstream-petroleum expert at the U.S. government-funded EastWest center in Honolulu, sees the crack spread continuing to widen because of tight supplies.

But Bob Sturtz, head of fuel purchasing at UAL's United Airlines, disagrees. He thinks that today's spread will be viewed in the future as a historic high. He expects refiners will add jet-fuel capacity nearer-term because of the thick margins, though he acknowledges it could take time for the spread to narrow.

Source: Sunday Gazette - Mail; Charleston, W.V.

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