Wednesday, July 09, 2008

The Worst is Yet to Come

A few weeks ago I wrote my thoughts on the ricockulousness (*ri-cock-ulous-ness* -that's something that's 10x crazier than ridiculous) of blaming speculators for high oil prices. Today, I was very surprised to get an email from Delta Airlines titled "An Open Letter to All Airline Customers" - from 12 Airline CEO's.
The contents of the letter are as follows:
Our country is facing a possible sharp economic downturn because of skyrocketing oil and fuel prices, but by pulling together, we can all do something to help now.

For airlines, ultra-expensive fuel means thousands of lost jobs and severe reductions in air service to both large and small communities. To the broader economy, oil prices mean slower activity and widespread economic pain. This pain can be alleviated, and that is why we are
taking the extraordinary step of writing this joint letter to our customers.

Since high oil prices are partly a response to normal market forces, the nation needs to focus on increased energy supplies and conservation. However, there is another side to this story because normal market forces are being dangerously amplified by poorly regulated market speculation.

Twenty years ago, 21 percent of oil contracts were purchased by speculators who trade oil on paper with no intention of ever taking delivery. Today, oil speculators purchase 66 percent of all oil futures contracts, and that reflects just the transactions that are known. Speculators buy up large amounts of oil and then sell it to each other again and again. A barrel of oil may trade 20-plus times before it is delivered and used; the price goes up with each trade and consumers pick up the final tab. Some market experts estimate that current prices reflect as much as $30 to $60 per barrel in unnecessary speculative costs.

Over seventy years ago, Congress established regulations to control excessive, largely unchecked market speculation and manipulation. However, over the past two decades, these regulatory limits have been weakened or removed. We believe that restoring and enforcing these limits, along with several other modest measures, will provide more disclosure, transparency and sound market oversight. Together, these reforms will help cool the over-heated
oil market and permit the economy to prosper.

The nation needs to pull together to reform the oil markets and solve this growing problem.
We need your help. Get more information and contact Congress by visiting
Ok folks, now here's the truth: most airlines didn't do what they were supposed to do - which is to hedge their fuel costs by locking in prices (buying futures) in the oil futures market. Southwest, on the other hand, hedged the majority of their costs, and is doing well comparatively. The airline industry as a whole made some poor business decisions and they are begging for you to try to help blame their way out of it by complaining to congress, and labeling speculators as the Evil Doers.
"Southwest Treasurer Scott Topping, considered the guru on hedging for the airline, said the carrier jumped into hedging in “a big way” in 1999 when oil was at $11 a barrel.

Since then the airline has hedged 70% to 80% of its anticipated fuel use every year, more than any other airline. The airline said it saved $727 million last year by locking in lower fuel prices in prior years.

So far, the carrier hasn’t had a year when it lost money on fuel hedges." (quote from the LA Times)
I was almost surprised to see Southwest's CEO's stamp on the bottom of the letter (along with Delta, American, Midwest, Jetblue, Hawaiian, Continental, US Air, United, Northwest, Airtran and Alaska) - I was hoping he'd be sitting there laughing at the other airlines for being ignorant douchebags, but I guess he didn't want to break ranks with the Airline Mafia.
Let me reiterate some important points again, in case they missed their mark the first time: 1) Oil is a global asset - its price is not set by a few rich guys in NYC, New Jersey, or Texas evil-ly "speculating" and fucking the whole world over. 2) Free markets result in the most efficient and accurate pricing of assets. 3) Oil prices are going up because there is demand for oil! Prices are forward looking, and future demand looks to be quite strong, on account of massive growth in India and China.
Now, one reason all commodities (from oil, to gold, to paladium, to wheat and corn) have gone up in price is that commodities have become an ASSET CLASS over the last 10 years - which has resulted in billions of dollars of money from pension funds, insurance companies, retirement accounts, and hedge funds flowing into the sector. Whereas many years ago people though in terms of 85% stocks, 15% bonds, or some other asset allocation, now it may look more like 60% stocks, 20% commodities, 20% bonds. But again, the reason it became an asset class is because people realized that there were ways to invest in it and that emerging markets economies would likely drive demand for many commodities, which in turn would drive prices higher. Just as during the internet bubble it didn't make sense to forbid people from buying stocks, it doesn't make sense to forbid people from buying commodities right now. And oh, by the way - this is exactly why the stock market had such a big run over the last 25 years too - eveyone in America started investing in mutual funds, instead of just clipping coupons and redeeming savings bonds - but you don't see people complaining about speculators driving the price of stocks higher.
What concerns me, again, is that when the airline industry resorts to this lame duck crybaby attempt at blaming others for their own failures to hedge their costs of doing business, it's a clear sign to me that things are still going to get worse.

1 comment:

Stephen Pace said...

I don't disagree with anything you say here, but now that the legacy carriers are sufficiently weakened, from what I understand (I could be wrong) they aren't able to execute hedges to the extent that Southwest can (with their stronger financial position).