Airlines are scrambling to protect their businesses as the Iran war pushes jet fuel costs to multi-year highs.
The market is splitting into two camps as traders test the limits of pricing power, according to Morgan Stanley analyst Ravi Shanker. While heavyweights like Delta (DAL) and United Airlines (UAL) have the ability to raise prices without losing customers, others are falling behind.
Shanker noted that Delta has already raised its revenue target for the first quarter, expecting its profits to remain stable because its wealthy passengers are absorbing the costs. “That said, DAL’s refinery is expected to provide significant fuel cost coverage beginning in the second quarter,” Shanker said.
Unlike its competitors, Delta owns the Monroe Energy refinery in Pennsylvania, allowing the airline to produce its own jet fuel and profit from refining. This setup helps Delta offset high costs during industry-wide price fluctuations and is unique to the airline. Other carriers often purchase fuel from third-party suppliers, who often charge high margins.
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Meanwhile, circumstances for Alaska Air Group (ALK) are bleaker. “ALK continues to be at a disadvantage on the (West Coast) because of refinery margins,” Shanker said. West Coast refineries typically charge an extra margin compared to the rest of the country.
To avoid these high prices, Alaska is using a “tanker” strategy: buying cheaper fuel in Singapore and shipping it across the ocean to the Pacific Northwest. Although fuel prices in Singapore have skyrocketed since February, they started off so low that it is still cheaper to ship fuel from Asia than to buy it from a US supplier, according to Shanker.
Savanthi Syth, an analyst at Raymond James, warned that “quicker action is prudent, especially for airlines with previously high growth ambitions or weaker balance sheets.” He notes that without such action, disadvantaged operators will be forced to “tolerate margin compression” to remain competitive.
An imminent expense of $400 million per operator is expected this quarter due to the Middle East conflict.
Alaska offers the first test of this coup. The company’s shares fell about 6% after projecting a larger-than-expected loss in the first quarter. In an 8-K filing, the airline flagged a staggering 400% increase in refining margin costs (the fee refiners charge for processing crude oil into fuel) on its Singapore fuel since February. Refining costs in the United States increased by 140% during the same period.
