How Different Airlines are Managing Fuel Costs Part Two
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One of the primary reasons many investors are skeptical of airline stocks is the volatility of expenses, specifically fuel costs. The industry lost a combined $20 billion in 2008 as a perfect storm of economic recession and record fuel prices pushed airlines into the red. But airlines are determined not to let this happen again and they are taking action to protect their bottom lines.
Algae in the air
For anyone who's ever tried to keep a fish tank clean, algae can be quite an annoyance. However, biofuel and chemicals manufacturer Solazyme (NASDAQ: SZYM) relies on algae as a source of fuel. Literally. While the oils producer has nutrition, chemicals, and health businesses as well, the biofuels component of their company is what is of most interest to fuel slurping airlines.
A little over a year ago, airline giant United Continental (NYSE: UAL) flew a Boeing 737-800 on a 40/60 mixture of Solazyme's Solajet fuel and standard petroleum based gasoline. In the same announcement referring to the Solazyme powered flight, Solazyme announced it had signed a Letter of Intent with United to sell the airline up to 20 million gallons of Solazyme produced biofuel. Solazyme also has inked deals with Qantas Airways for an even larger purchase of Solazyme fuels.
Will Solazyme make the airline industry fossil fuel independent? If it ever does, it won't be anytime soon. Even if United decided to supply every gallon of fuel from Solazyme today, Solazyme would still need time to ramp up production which is expected to happen over the next few years. The Solazyme deal is more long term symbolic than short term profitable. It shows there is a developing viable alternative to fossil fuel derived jet fuel, a fuel that could possibly be used as a way to insulate against fuel price spikes.
Delta goes vertical
A major trend in the airline industry has been horizontal integration through airline to airline mergers. Examples of this include Delta Air Lines' (NYSE: DAL) takeover of Northwest Airlines in 2008, United's acquisition of Continental in 2010, and widespread expectations of a US Airways American Airlines merger on the horizon.
However, Delta's latest move takes it outside of its industry. The carrier rescued an oil refinery in Trainer, Pennsylvania due to be shut down. Delta expects the refinery to save the airline $300 million annually by cutting down on the refining spread. Not a bad deal considering one year of these savings would more than recoup the entire initial investment.
The story has not been perfect so far, but the latest is due to events beyond Delta's control. As an airline, one has to accept inclement weather as a risk and it can be particularly damaging to the bottom line when it arrives in hurricane form. Hurricane Sandy's effects on the Trainer refinery are projected to cause the refinery to post a $50 million loss for the fourth quarter, but savings are expected for the next quarter as the refinery gets up and running.
The refinery potential could be interesting for long term investors who would best be able to realize the full benefits of the refinery savings. However, the refinery buy only cuts refining costs, not oil prices. Delta will still be forced to live in a world of fluctuating oil prices which Delta tries to level out with a series of jet fuel hedges. All in all, the refinery is more of a fuel price management tool than a permanent solution and investors should not mistake the refinery as an end all to potential fuel woes.
An important cost
Every time you see oil prices go up, you can know somewhere an airline is hurting. All of the current fuel hedges will not fully protect the airlines in the event of a prolonged price spike. But airlines are showing action on tackling this volatile input cost. Whether it be through diversifying the fuel source, or through constant savings at the refinery, we are seeing airlines deal with at least one of the issues that keeps many investors away. So if fuel prices were the only thing keeping you away from the airlines, maybe it's time to look again. As always, risks do remain but the mitigation of those risks is beneficial for shareholders, a benefit that may translate into a broader gain among airlines.
TulipSpeculator1 owns shares of Delta Air Lines. The Motley Fool owns shares of Solazyme. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!