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Home | Blog | The ABC’s of Bias: Puma, Crude Oil, and You

The ABC’s of Bias: Puma, Crude Oil, and You

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11/05/2009

Attention airline passengers: Not only do you have to pay extra for your luggage, your meal, and your headphones, you now have a dress code on United Airlines. But that shouldn’t surprise you. The airlines industry in general has been mismanaged for decades, including being overwhelmed with high labor costs and being laden with debt…just like the Big 3.

As far as I can see, the airlines have never been a good investment. Most of the publicly traded equities are under $10 save one or two. They’re cheap for a reason: no one wants them.

On Monday, ABC News ran an article on increasing energy costs and tried to tie it in with guesses of impending CFTC rules and position limits. They quoted a few sources: a family-owned heating oil company executive, the head of an airline, and a spokesman for the ATA.

As a Commodity instructor and trader, I was quoted for my opinion on the reasons for the increase in prices across the board. I gave them 2 pretty good quotes, one they ran, but the most telling one was edited out:

“Stable prices and cheap fuel are not our birthright,” argues the L.A. trader/instructor Martin. “This recent run up has everything to do with U.S. monetary policy and nothing to do with Wall Street speculators” was how the article was to have ended, but it was
edited out. Instead, they went with a syrupy, Michael Moore sob story to pull on your heartstrings.

The weakness of the US dollar can cause crude oil and heating oil prices to rise. Jet Fuel A, heating oil, and gasoline are derived from crude oil. Lower crude production has caused a decrease in supply, as shown in this graphic from Gregor Macdonald.

View image

I’m generally not a conspiracy theorist, but not mentioning that there could be just one other reason why heating oil is going higher, looks like ABC News has an agenda or are pandering to their readership. To worsen the matter, since the article was published, ABC has linked an archived video from July of 2009 that features an equity hedge fund manager who’s testimony was thoroughly refuted by both Jim Rogers and Nobel Economist Paul Krugman, among others.

Heating oil is derived from crude oil through a process known as cracking and producers make sure they have enough supply to sell to consumers for the colder fall and winter weather. As you might expect, the demand for heading oil is higher in the colder weather than warmer and this creates a seasonal tendency.

The chart below is based on 26 years of data and shows that heating oil prices (aka Fuel Oil #2) bottom out in the summer and rise to peak prices in late September and October. (Chart courtesy of Jerry Toepke @ Moore Research Center Inc.)

MM091105.pdf

The fact is, we’ve been spoiled with cheap fuel costs, at least I have, for most of my adult life. America’s policy toward drilling for new oil will guarantee you skyrocketing fuel costs and alternative fuels are, although intriguing, years and years away from being practical and affordable for the majority of Americans.

US Airways Chairman and CEO Doug Parker was quoted as saying, “we believe unchecked speculative trading of oil futures is distorting the normal market dynamics of supply and demand.”

I think what Mr. Parker meant to say was, “we know we can pass higher fuel costs on to Americans if we don’t hedge, and ultimately blame speculators for the higher costs.”

Then David A. Castelveter, a spokesman for the Air Transport Association (ATA), said that “speculators have been causing such volatility in the market that it is hard for airlines or other oil users to make appropriate business decisions.”

Really? Scott Topping over at Southwest had crude locked in at $51 / barrel when oil prices were high by utilizing several hedging techniques.

Effective hedging is an ongoing process and needs to cover many years into the future.

Castelveter attests that “every $1 increase in the price of oil adds about $430 million to airlines’ annual operating costs.” An effective hedging program that will offset EVERY $1 increase in the price of oil will run you but a few percentage points of the $430 million number quoted. (Note to Mssrs. Parker and Castelveter and ATA members: Read all the Nassim Taleb you can get your hands on. He can also help you with some hedging techniques.)

American CEOs, including those in the airline industry and ATA, are focused on one thing: hitting their quarterly earnings number…a chicken shit way to run a company. No one is taking any good risks these days: they’ve lost their balls. They don’t hedge b/c they will pass the costs onto Americans.

I think they don’t hedge fuel costs because it costs money and that affects their quarterly earnings which in turn affects their share prices and the CEOs’ collective net worth.

Tie airline CEO compensation to how effectively they hedge higher fuel costs I say and we might be on the right track to a higher fiduciary standard in that industry…I don’t think we are anywhere near that now. And if they do a good job and ensure we can travel for a reasonable fare while they can be profitable entities, pay them twice what they’re getting now. They will deserve it.

Americans and everyone in the ATA need financial literacy and education, not the blame game and lazy corporate attitudes, nor further regulation. There are already some very stringent position limit rules for commodity futures traders. Any large trader will tell you it’s easy to get into a position, but hard to get out of one.

As commodity expert Barry Siler said, “Being unhedged is the ultimate short position,” he says. “You’re betting every day that the price of fuel won’t go up.”

I think the CEO’s of America’s airline companies are the real gamblers in the energy markets. They’re betting that world is continually stable and there will be no shocks to the global energy markets. This scenario has the potential outcome of leaving (Puma-clad) Americans stranded at the airports around key travel days while absorbing higher costs for less service.

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