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Some media pundits are warning the public that high oil prices will spark a repeat of the high-inflation era of the 1970s. High oil prices will feed through to inflation; however, the economic, monetary policy, and geopolitical environments of the 1970s are quite different from today’s. To wit, consider the following reasons for inflation in the 1970s:
- 1973 Oil Embargo- OPEC nations imposed an oil embargo on the US in retaliation for US support of Israel during the Yom Kippur War. Oil prices quadrupled almost overnight, from approximately $3 per barrel to nearly $12 per barrel, delivering an immediate and severe supply shock to the economy. At the time, we were importing about a third of our oil usage; today, our net imports are less than 5%.
- Iranian Revolution- Oil prices doubled between 1979 and 1980 as the Iranian revolution resulted in the loss of 2.5 million barrels a day of oil.
- Gold Standard- President Nixon abandoned the gold standard in 1971, resulting in a weaker dollar and higher oil prices.
- Wage Price Spiral- in a circular fashion, unions garnered wage increases, which resulted in higher prices, which led to higher wages, and so on…. Today, unions have much less power, and wage growth is not a problem.
Yes, the current oil supply is severely impaired due to conflict and the closing of the Strait of Hormuz. However, supply shortages and associated high oil prices are likely temporary, unlike during the longer-lasting embargo and Iranian revolution noted above. Also, the other major factors mentioned above aren’t issues we face today. Most importantly, the US is not dependent on foreign oil, and the economy’s energy dependence is much less than it was in the 1970s. The following graph and commentary are courtesy Ed Yardeni.
The US economy now requires significantly less energy per unit of GDP than in earlier decades, reflecting efficiency gains and a shift away from manufacturing toward services (chart). As a result, oil price spikes are less inflationary and do less damage to real economic activity than in the past when energy intensity was much higher.”
Airlines Hedge Jet Fuel Turbulence
With higher jet fuel prices, many consumers expect airfares to follow. To appreciate how higher oil prices impact airfares, consider that the standard industry metric for expenses is cost per available seat mile (CASM). Fuel typically accounts for 20% to 30% of CASM for major US carriers. However, when oil spikes to $100 per barrel, fuel can quickly represent 35% to 40% of total operating costs, which is why airline stocks are so sensitive to oil price movements and oftentimes hedge fuel prices.
Fuel hedging practices vary significantly and have changed since the 2014 oil price collapse. At the time, airlines were well hedged and accordingly locked into above-market fuel costs. Accordingly, the industry shifted away from aggressive long-term hedging toward shorter-term tactical coverage or no hedging. Consider how the four major US airlines hedge fuel costs.
- Southwest Airlines (NYSE:LUV) — Historically, they are the most aggressive hedger, building a significant competitive advantage through fuel cost certainty in the 2000s. After getting burned by hedges in 2014, Southwest scaled back and now hedges roughly 50% to 60% of near-term consumption with far less long-term coverage than its earlier strategy.
- Delta Air Lines (NYSE:DAL) — Takes a unique approach by owning the Monroe Energy refinery, which provides a hedge against jet fuel price spikes. It supplements that with hedges covering roughly 20% to 50% of near-term fuel needs.
- United Airlines (NASDAQ:UAL) — They largely abandoned systematic fuel hedging after the 2014 oil collapse. They now hedge minimally, relying instead on operational efficiency and fuel surcharges passed through to consumers to manage price exposure.
- American Airlines (NASDAQ:AAL) — The least aggressive hedger among the major carriers. They have operated largely unhedged in recent years, arguing that hedging costs more than it saves over a full market cycle. Like United, they prefer to manage fuel costs through surcharges and efficiency measures.
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