Airlines continue to prosper, but darker clouds on the horizon

Attendance was greater than ever at the recent 76th International Air Transport Association (IATA) Fuel Forum in London. Ease of location was no doubt a factor, with fuel procurement teams flying in to London from all over the world. However, another factor is the current robust health of the airline industry... for now at least.

In 2017, German airline group Lufthansa -- which also includes Eurowings, Swiss, Brussels Airlines and Austrian Airlines -- recorded record profits of $2.92 billion, up 33.1% on the year. Lufthansa's European rival IAG, the parent company of British Airways and Iberia, saw an increase in profits of 18.9% in 2017. Jet fuel is typically the largest single cost for airlines, though its percentage of total costs fell significantly from 2013 to 2016 as crude oil and jet fuel prices plummeted.

According to IATA, fuel as a percentage of operating costs fell from 32% to 19% during that period. Europe's major airlines are typically some of the more hedged, with Lufthansa, IAG and Franco-Dutch Air France-KLM all having around 60% of their fuel purchasing for the remainder of 2018 hedged, according to their most recent disclosures. By contrast, three of the largest US airlines -- Delta, American and United –- re-iterated their strategy of not hedging earlier this year.

By the end of May, crude oil and jet fuel prices had surged by close to 20% from the start of the year, before edging lower in recent days. The mood at the IATA forum was somewhat nervous, with one upcoming oil event the focus of many of the presentations. A change in shipping fuel sulfur specifications at the start of 2020 may not seem an obvious area of concern for airlines, but industry experts are predicting that the ramifications for diesel and jet fuel prices could be substantial.

Under the new global cap, ships will have to use fuel oil on board with a sulfur content of no more than 0.50%, against the current limit of 3.50%, which has been in effect since January 2012. Ships may continue to use 3.50% fuel, but use exhaust gas cleaning systems, or "scrubbers," that "clean" the emissions before they are released into the atmosphere.

However, current forecasts are for relatively few ships to install scrubbers by 2020, meaning it's likely there will be a substantial increase in middle distillate demand from the shipping sector to blend the new required 0.5% fuel. Some experts expect this change to provide a substantial boost to diesel and jet fuel cracks as demand soars, with the impact on jet potentially exacerbated as refiners tweak units to maximize diesel production for blending.

Concern over this change in marine fuel sulfur levels was an obvious area of interest for fuel buyers at the IATA event, with many questions fielded by those presenting. A poll posed by IATA on the impact of the sulfur level change on jet fuel prices drew audible gasps from the audience as a huge majority of those participating answered that the change would have a "major" impact on jet fuel prices.

IATA's next fuel forum is scheduled to be held in November in another aviation hub -- Singapore. At that point, fuel buyers will have a better idea whether today's stronger price environment will be prolonged. However, it won't be until events in 2019 and 2020 that they'll begin to decipher what the real impact is of the marine fuels change.