What Does the Oil Recovery Mean for Airline Stocks?

The global airline industry has enjoyed an across the board windfall over the past 12 months, as both the price of crude and jet fuel have collapsed. In the past six weeks, however, both have recovered, with West Texas Intermediate (WTI) crude up close to 50% on its February lows and jet fuel (Platt’s) not far behind.

With the windfall, and concurrent to falling fuel prices, common sense suggests airlines should benefit from a boost in market capitalization. Conversely, that the late February-early March recovery should put pressure on airline share prices.

A look at the charts of some of the major U.S. airlines, however, reveals a different picture. Alaska Air Group Inc. (NYSE: ALK), Delta Air Lines Inc. (NYSE: DAL) and American Airlines Group Inc. (NASDAQ: AAL) all declined throughout the 2015 to 2016 crossover, before bottoming out on February 8, 2016 (true for all three) — just days before WTI followed suit and also bottomed out around the $25 mark. As oil has recovered, so have all three of these stocks.

This seems counterintuitive, but its reasoning is pretty simple. When airlines save money so publicly, travelers expect to benefit from the savings. These expectations can quickly lead to price wars and, as we’ve seen numerous times in the past, price wars will negatively affect airlines.
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In effect, the rise in oil and jet fuel, and the wide-scale media coverage associated with the rise, reduces pressure on airline stocks to pass cost savings on to consumers in the form of lower airfares. This reduced pressure reduces the likelihood of a damaging price war.

The decreased likelihood of airlines having to reduce airfares enables them to derive benefit from low oil longer term. Of course if it gets too high, it will hurt airlines, but there is a sweet spot between extremely low oil that pressures airlines to reduce fares and extremely high oil that eats into profits. Yes, oil may be up 50% on last month’s lows, but it is still pretty cheap, and it looks set to remain so for at least the remainder of 2016 and likely into 2017.

OPEC is set to meet with Russia and freeze output at current levels (or January levels, if reports are to be believed), but even this won’t reduce oversupply any time soon. Saudi output is just off all-time highs, and U.S. stockpiles are at their highest level for this quarter in at least the past 80 years.

In short, oil is probably not going back near its highs, so neither are ticket prices. That makes 2016 look like a strong year for airlines.

By Matt Winkler