The Tycoon Report

Target: Net Fuel Cost of Zero

This little treatise was prompted, in the beginning, by recurrent published stories having to do with the airlines’ difficulties in coping with extraordinarily high, and “volatile,” jet fuel costs. Even so, it applies with equal force to users of Heating Oil and Diesel fuel, which of course also are refined products derived from Crude Oil, and which are somewhat similar to jet fuel, which itself is most akin to kerosene. User groups other than airlines would include railroads, trucking companies, garbage collection companies whether public or private, school districts which operate school bus fleets, taxicab fleets, bus lines, courier services which operate airplane fleets, Governments, shipowners and cruise lines, hotel and motel companies, and owners or operators of office buildings, industrial buildings, and apartment buildings. For the moment, however, let’s focus on the airlines, about which most has been written and spoken, by themselves and by others.

Historically, the airlines’ greatest single cost has been the cost of labor. However, in recent years – especially during the great price advance of jet fuel in 2007 and 2008 – the equation was turned on its head, whereby the cost of fuel became the single largest line item of operating cost. That still holds true, we are told, in spite of the massive decline in fuel prices following their peak in the summer of 2008.

Some airlines were (relatively) prepared for the price spike in 2008 by virtue of certain hedging programs, which had the effect of reducing their net cost of fuel. Others had no hedging programs at all, and were left exposed when prices surged.

Some airlines have fuel price-hedging programs in place right now. One wonders whether they are purely defensive, or whether an effort is being made to positively realize trading gains. One large airline has announced a fuel hedge loss of close to $400 million for the latest quarter. Do we rightly read that to mean that the actual cost of fuel was in addition to the hedging loss? If the program is entirely defensive, it isn’t working very well; and if it contains elements of an offensive-type strategy, it isn’t working very well, either.

It occurs to me that, in order for a fuel hedging strategy to be truly successful, it must be geared not only to a strategy of defense against catastrophic fuel price increases, but also to a strategy to make a profit on fuel trading. A basketball game cannot be won by playing defense only; you actually do need to put the ball in the basket at the other end of the floor once in a while. It also occurs to me that it is necessary to understand our probable location within the wave cycle at any given time, which in turn requires a knowledge of the wave principle in the first place.

The whole aspect of an airline’s fuel hedging department has to change from that of a necessary evil which consumes dollars in a purely defensive effort to that of a profit center.

The profit center’s stated target, its Mission, would be a net fuel cost of Zero.

It is not reasonable to expect that a target of Zero would be attainable. Such a result, while theoretically possible, might well require an allocation of funds wildly beyond the realm of possibility. Even so, and even if the investment were to be scaled down to a realistic level, the principle is still valid. The profit center would be graded on measurable results monthly, quarterly, semi-annually, and annually, based on several criteria, among which might be (1) Return on Investment and (2) Attained Percentage of the Target for the Period, the target being Zero. For example, if the fuel bill for the month were $10,000,000 and trading profits (in Heating Oil, for example) for the month were $1,000,000, the Attained Percentage of the Target for the Period would be .10. It might be that an Attained Percentage of .10 would be considered to be a good result. It might also be that an Attained Percentage of .010 would be considered to be a good grade. The important points are that there would be a target at which to aim, month by month by month, and that the results would be measurable and subject to comparison, period by period.

Of course, such an approach would likely entail turning an airline’s present fuel hedging approach upside down and inside out. It would necessitate a reversal of the thought process. Some people could do it; some could not. It might well require the importation of different trading skills. The transition might be difficult. It would require the total commitment of Management.

I hear the sound of applecarts being upset. But before the word “can’t” comes to the fore, perhaps we could find a voice or two who say “maybe.”

Respectfully submitted.

William Kurtz

July 30, 2009

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