First Cut Is Not The Deepest…

As predicted, OPEC’s new production cut of 2.2 million barrels a day will result in a higher trade price on the on the New York Mercantile Exchange triggering a new wave of frantic and wayward fuel hedges by a plethora of airlines the globe over.

OPEC’s decision making has been wrought with disagreements between key players such as Iran and Saudi Arabia.

“There was a time when the country managed on $9 a barrel. We can do it even if oil falls to $5,” stated Iranian President Dr. Mahmoud Ahmadinejad in Tehran last month. “In our view, $75 per barrel would be a fair price. Our budgets are not based on the earlier high price but on a lower one. What comes in excess goes to surplus reserves and sovereign wealth,” said Saudi Arabia’s King Abdullah.

Image courtesy of fintag

Crippled United Airlines and US Airways sported some blood-curdling losses in the third quarter with a whole host of  other airlines reporting near double-digit traffic drops for November despite the sharp drop in oil and fuel costs.

“You’ve got a commodity that people are buying less of because they can’t afford to buy more. People are fearful. They have a lack of confidence in the economy,” said Alaron Trading’s analyst Phil Flynn.

That lack of confidence is translating into fewer fare paying passengers despite cuts in fuel surcharges and other ancillary fees. In the next 6-to-9 months, sub-$100 per barrel fuel bills will be a welcome sight for planners, but the edge off prices from the July 2008 highs will be a short-lived affair in the longer term. Finite resources coupled with no tangible substitute for jet fuel means that the drive for efficiency will have no option but to contend with higher fuel bills than what we’ve seen over the last two decades.

“Given the still-substantial risks to demand and ongoing scepticism on OPEC compliance, it could take some time before prices recover materially above $50-55 per barrel,” states Collins Stewart analyst Gordon Gray.

“It’s no surprise that OPEC plans to further slow oil and jet fuel production in 2009, given the difficult global airline environment and the current speculation-free price of oil. Shadowing demand with appropriate supply adjustments as a means of influencing price has long been an OPEC staple but this latest slowdown-related move is as much an accurate barometer of the near-term activity outlook for airlines as it is a reflection of just how much OPEC thinks it can squeeze out of a stressed market. Which isn’t much compared to six months ago,” says Arran Aerospace’s Doug McVitie.

“When demand picks up, so will price and production, as usual,” he adds.

There’s little doubt Airbus and Boeing can do much, if anything to apply “band-aid” to assist carriers looking to ease up on their purchase obligations - 2009 will be a litmus test for them both.

Image courtesy of Tim Dauber

After securing over 900 orders each year between 2005 and 2007, both companies will be working hard to ensure that cancellations do not occur. Where possible, deferrals will be the order of the day.

For projects like the 787, which suffered its fourth major delay this month, Boeing has some breathing space given that the urgency for new fuel efficient airplanes has subsided.

Even as IATA forecasts warnings about declining traffic figures, things will get worse before they get better. Who knows, we’ll probably even see Airbus and Boeing cut output for post-2010 deliveries to better balance customers traffic/replacement needs.

The first cut is usually the deepest - in OPEC’s case that’s not strictly true.

In OPEC’s case, this is certainly not the last cut - there’ll be more emergency meetings in ‘09, of that there is no doubt.

“We did better than what you were expecting. I hope we have surprised you,” said OPEC president Chakib Khelil.

2009 will bring it’s own surprises after this turbulent year…

3 comments December 22nd, 2008