How the 'Crack Spread' Is Killing Airlines

A day doesn't pass without someone complaining about the price of oil, but what really is the impact on the airlines? Well, let's do a little math.

Oil has been hovering around $110 a barrel as of late, but the airlines are paying far more than that. IATA keeps track of weekly changes in jet fuel prices, and you can pay attention yourself. For the week of April 4, the average price paid was $3.22 per gallon. There are 42 gallons in 1 barrel of oil, so that means the airlines are paying around $135 per barrel. Why the difference?

Well, you can't just take a barrel of oil and dump it into an airplane, just like you can't dump it into your car. It costs money to refine that oil and that's called the "crack spread." This spread has been rising, so while it used to be closer to about $3 a barrel, it's been as high as $30 in recent memory.

Airlines are dealing with a double whammy of a problem here. First, the price of oil is rising. Second, the crack spread is rising because refineries are putting the cost burden on carriers to make up for the lack of refining capacity. And that's why the airlines are feeling even more pain than you might have thought.

But what about hedging? It's not like everyone is paying that high price for fuel. Southwest, for example, is well known for its hedging strategy. It buys oil futures in advance at discounted prices and that has allowed them to keep their fuel costs lower. The problem, of course, is that the higher oil prices go today, the higher the cost of hedging for future needs. So even airlines that hedge are seeing their costs continue to rise as well.

For most airlines, fuel has become the number one cost, even ahead of labor. Any fluctuation in the price of fuel has a dramatic impact on the bottom line, and that instability makes planning in this industry very difficult.

(Fuel truck image by saga arpino, CC 2.0)