1) Price of crude (I’m treating crude as a homogeneous product – ignoring things like sulphur content)
2) Cost of refining the crude to separate oils, including jet fuel.

The cost of refining is really quite small compared to the cost of raw crude. Thus, predicting the price of jet fuel is almost the same as predicting the price of crude oil.

Because crude oil is such an important product to the world economy, markets are very good at pricing it accurately based on publicly available information – the possibility of easy arbitrage on simple crude oil futures is quite small.

The oil majors (Exxon, Shell, etc) by virtue of having both oil rigs and wholesale + retail marketing operations, are in a position to play the market on crude, since they have a natural advantage on information. Airlines simply don’t have this advantage.

An airline should certainly be involved in hedging jet fuel prices to smooth out their risk (and they are active players in this market), but should not be taking direct bets on oil prices. Shareholders buy airline shares because they are a transportation company. If you want to take a bet on oil prices, why not start trading in oil futures directly ?

@ David: I disagree on whether airlines should be in the business of predicting whether fuel costs will go up or down. They may not be the best at it, since they arguably have other things to do, but if they cannot focus some effort on something that is 30-50% of their costs on any given flight then they shouldn’t be operating an airline.

http://www.wanderingaramean.com/2008/05/jetblue-aborts-lax-service.html

Super Savers (as coined by AA) didn’t come into effect until around this time. Yield Management was birthed around this time. And I’m not just speaking on jet fuel itself….as Consumer Fuel prices probably did have some effect on consumer demand even as dereg took off…but whatever effect was quickly masked by falling airfares. Overall, the late 70s and early 80s were not economic highlights.

…and you see now that the industry’s business plan can’t survive the current operating environment. Unbundling, fuel surcharges, weekly fare increases…anything for more cash.

You know….come to think about, wasn’t PEOPLExpress (which started in ’81) kinda a proto model for the unbundled air service we’re beginning to see now?

But if this is true and airfares are expensive in the US because of gas prices, why isn’t this true for flights within Europe, where gas is even more expensive (hence the smaller cars, which also help navigate the narrower streets)? I mean, granted trans-Atlantic flights for this summer are $1000+, but I would have thought fares would be higher over there in general since $4/gallon is still “cheap” for most of the EU.

Dan – Thank you for the explanation. I think I’m confusing myself a little. While the price of fuel may not vary too much, as you say, the fuelers themselves may charge more for their services in some places and that is why sometimes people may look to tanker.

As to hedging of fuel, the main driver of the fuel is getting the empty plane from A to B. The passengers and their luggage by comparison weigh relatively little.

Assume an average person weighs 75 kg (165 lb) – children tend to balance out those who weigh over 200 lb, and that people carry an average of 20 kg (45 lb) of total luggage, the weight per passenger is about 210 lb. On something like a 737-800, with an 85% load factor, this means the passengers weigh about 13 or 14 tonnes.

The empty weight of a 737-800 is over 41 tonnes in comparison. Ignoring the weight of the fuel, this means takeoff weight of at least 55 tonnes, so the passengers cover no more than 25% of the weight. Of course there’s also fuel to add, so passengers in practice are maybe 20% of takeoff weight.

Even if the load factor is 10% different from airline expectation, this still has a negligible impact on the amount of fuel required to operate the flight. If an airline wants to reduce its fuel bill, the only answer is to change the type of plane operating the flight (so fewer seats, and reduced revenue), or cut the flight from the schedule altogether and thus cut out all revenue !

Things like fuel surcharges are useful and can be varied as the price of jet fuel varies over time, but they tend to be a fairly blunt tool for recouping the cost of jet fuel increases.
Airlines tend to oversurcharge on short haul flights and undersurcharge on long haul flights – adding $30 for fuel per short haul instead of $20 is not a major thing if your competitors do it as well, but consumers would not fly if they saw long haul surcharges of $400 per flight !

To hedge fuel requires having a good credit rating – so hedging is not available for airlines in Chapter 11 bankruptcy or similiar. Those that do hedge will tend to buy their fuel in advance over time – maybe 20% 9 months in advance, 40% 6 months in advance, 70% 3 months in advance and 90% 1 month in advance. Airlines are not in the business of predicting (and should not try !) when jet fuel will go up / down in price, but they can at least benefit from some sort of averaging of purchase price to in case jet fuel undergoes a sudden price change.

Gasoline for cars is taxed much more heavily in most countries in Europe compared to the USA – this tax difference is why the retail price is so different. Other local factors tend to be pretty insignificant in comparison.

Jet fuel on the other hand (by treaty ?) is always available either tax free or at a very low tax rate – this was designed specifically so that airlines would *not* tanker in fuel so as to arbitrage between the tax rates of different countries and thus create a jet fuel tax bidding war

The EU however is thinking about imposing an EU-wide jet fuel tax rate for flights that go purely within the EU in the interests of global warming – an example being a flight from Berlin to Madrid. If every airport in the EU charges the same tax rate, there’s no point in tankering fuel for shorthaul flights.

http://news.bbc.co.uk/1/hi/business/4273223.stm

Fuel tankering does still happen – but for reasons like lack of fuel availability (e.g. staff at a local refinery are on strike), doubts over the quality of the fuel at an airport (e.g. in countries with very low incomes), or if flying a multi leg trip on a tight schedule with each leg being very short. Tankering fuel means carrying excess weight, so increasing the fuel burn rate – something airlines are loath to do at $125 per barrel !

Jet fuel *does* vary a small amount in price between both countries and airports.
1) Crude oil has to be shipped to a refinery – meaning it’s easier to ship to a refinery in Kuwait or a major port than a refinery in Japan.
2) Lighter crudes produce more jet fuel, while heavier produce more useless gunk like tar. If heavy crude is available locally, but shipping costs of light crude are high, refineries will charge more for jet fuel. A refinery can do extra cracking, but this costs more money.
3) Jet fuel has to be shipped from the refinery to the airport – meaning that jet fuel at NY harbour / JFK costs less than jet fuel in a small airport in Montana. As an example, CDG (main airport in Paris) has a dedicated pipeline to the major port Le Havre on the French coast – meaning fuel transport costs are very low.

You can get a feel for this at:
http://www.iata.org/whatwedo/economics/fuel_monitor/price_analysis.htm