Falling fuel prices are a double-edged sword for this airline

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Energy companies may not be the best investments these days, but the aviation industry has by and large benefited from low oil prices. Now that oil prices are rising, some airlines are rushing to lock in fuel prices. Oilprice.com called Ricardo Sanchez Baker, the CFO of Aeromexico in Mexico City to see how his company is faring in the current market.

Oilprice.com: Our readers are interested in oil markets and how oil prices might affect different industries. And the airline industry is one industry that is particularly affected by the price of crude oil. A major part of the costs for airlines come from crude oil and I was wondering if you could put that into context - how much of Aeromexico's costs come from fuel?

Ricardo Sanchez Baker: Yeah, traditionally it’s around one-third of our costs that comes from fuel. In recent months it has been lower, lower than 30 percent...between 25 and 30 percent. Fuel costs as a percentage of total costs has decreased in recent months; in the last 18 months I would say.

OP: And the fall in crude oil prices...how much money has Aeromexico saved from that?

RSB: Well, unfortunately, not as much as we would have liked. The problem that we have seen is that fuel prices, and in particular oil prices, have an inverse relationship with the exchange rate, particularly with the peso behavior in the market. When fuel prices go down, usually we see a depreciation of the peso. Therefore, what we have seen is, particularly in the last few months and last year, is that the exchange rate depreciation consumed most of the savings that we had from fuel. Just to give you some figures, we estimate that the peso depreciation actually had a negative impact on costs of more than 4 billion pesos; 3 billion if we exclude fuel. So in non-fuel items we have a negative impact of 3 billion. So basically more than 80 percent of the potential savings from fuel were consumed by the exchange rate depreciation.

OP: The depreciation of the Mexican peso outweighed the savings from lower oil prices?

RSB: No, certainly we have seen some savings. So, to give you some numbers – roughly, for example, we had fuel savings last year of around 3.5 billion pesos, but excluding fuel we had a negative impact of 3 billion pesos [from the depreciation]. So instead of saving 3.5 billion [pesos] we just saved 500 million pesos.

So when you see other airlines, for example, in the U.S., savings are substantially higher because they didn't pay pressure from the exchange rate fluctuations.

OP: Is that because Aeromexico's revenues are in Mexican pesos?

RSB: We have some revenues in dollars, but what we observe is that because of the volatility of the exchange rate it has taken time or it becomes difficult for us to pass through all these exchange rate fluctuations to the consumer very quickly. It takes some time to absorb. That's why the impact on costs is immediate and the impact on revenue has a substantial delay.

OP: I read recently that some major U.S. airlines are starting to hedge their oil for the next year or so, now that oil prices are rising. I was wondering if Aeromexico has done the same?

RSB: Yeah, we have a consistent hedging policy since, I would say, 2010 or 2011. The policy that we have is that we hedge 50 percent of the expected consumption of fuel for the next 12 months. We look at it more as insurance so we pay a premium for these options. If the fuel price goes up, we get the benefit from the insurance. If the fuel price goes down or stays relatively flat, we lose the premium but we have our losses capped at the premium rate for such options. We have been consistent in this approach in the last few years and that's what we have for the current year.

OP: Do you hedge beyond 12 months?

RSB: Sometimes, but we haven't done that recently. Only if we see a particular opportunity and if the time value of money makes sense. But in general we focus on that 12-month period. But it’s a running 12-month, not just an annual period.

OP: And at what prices do you hedge your fuel?

RSB: Right now the average that we have for the next 12 months is around - the strike price of the spreads starts at $2.06 per gallon and the cap is around $2.75 per gallon. So that's the spread that it is hedged. If the price goes above these levels, the excess above $2.75 would not be hedged in our hedging structure.

OP: The readers of Oilprice.com are always very interested in the price of oil. I was wondering if Aeromexico had an outlook on what prices would do in the very near term.

RSB: Well, haha…that is a very good question.

OP: Nobody really knows, but...

RSB: Nobody really knows. We try to be conservative in the way that we plan. We had a meeting just a couple of days ago and we were reviewing forecasts for fuel from a lot of analysts for next year and there was a lot of variance. Some analysts said that fuel prices would go to $80 while some others say it would go to $25.

OP: Right.

RSB: So in general what we try to do in our plan, not only next year but also our five-year plan, is to be conservative. We are anticipating an increasing price of fuel consistent with I would say the median of these projections...roughly around $60 to $70 per barrel.
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OP: Does your airline have any fuel efficiency policies?

RSB: We have been working the last few years on different policies. The most important is the renewal process. We have significantly renewed our fleet. Five years ago the average age of our fleet was close to 12 years. Now it’s around 8 years. We have very efficient aircraft. Together with that we have done different type of initiatives as part of regular operations. For example, taxiing with one engine, limited use of auxiliary power meaning that when we are at the gate we try to use more electricity than using the engine. So we have been doing a lot of different initiatives that have been quite successful in terms of reducing consumption in operations.

OP: Over the long-term, is Aeromexico looking at alternative fuels, like say, biofuels.

RSB: We have a program to work with biofuels that we have been using in the last few months. We actually did the first trans-Atlantic flight to Madrid. And we have regular flights, like say to Costa Rica, that use biofuels. It's still very limited in the way that we use it because it is still not the most economically efficient alternative. But we think that it is something that is worth supporting.

OP: Switching gears, I was wondering if you see any long-term threats to aviation travel. Obviously for long distance flights there are very few options but for shorter intercity flights...do you see high-speed rail, for example, as a threat to aviation over the long-term.

RSB: There are a lot of threats. Rail might be one. We try to have a strong and flexible airline. Having flexibility in the fleet that we have in terms of being able to grow or adjust the size of the fleet in terms of market conditions. Having a strong balance sheet, having an efficient cost structure. All these allow us to have a flexible and strong airline and that's the best way to face uncertainty. We never know what is going to happen but the best way to be prepared is to have a strong and flexible airline and that is what we are trying to do every day.

OP: I know that some American airlines have some downstream assets to ensure the stability of their fuel supply. Does Aeromexico have any refining assets?

RSB: No, we don't have that. And actually until very recently in Mexico because of regulation there were not really a lot of possibilities to do other things in terms of fuel. We just had one supplier and we had to buy it from that supplier.

That has changed with the new energy reform. We are now evaluating potential opportunities for the future to have other type of cooperation in the fuel chain. Perhaps at least providing ourselves for plane-to-plane service...that is something that we couldn't do a couple of years ago. So there are some alternatives that are now open and we are evaluating. But definitely in terms of having a refinery we think that given the size of Aeromexico it is not something that would be attractive to us. But other types of operations within the fuel chain could be.

OP: From the standpoint of the stock market and investors, have you seen a shift in interest towards airlines because of the collapse in oil prices, or to Aeromexico in particular?

RSB: Yeah, definitely we have seen more interest from investors. Things have also been happening together with our enhanced relationship with Delta Airlines. That is also something that has created more interest from investors. As both things have happened at the same time. Fortunately we have seen our share price behave in a positive way in the past couple of years. But I think it is associated to these two factors: mainly the Delta relationship, but also the fact that fuel prices have been at these levels in the last few months.

OP: Are airlines a sort of a hedge against oil prices?

RSB: Yes, they have been. But I believe more and more airlines are being valued by their merits and their structural opportunities. I think that perhaps the behavior of airlines is different than what we had a few years ago when everything was just a hedge against fuel. Really airlines are now seen as valuable asset classes that are attractive to investors.

OP: How has Aeromexico responded to this low oil price environment in terms of your business strategy? Has it given you an opportunity to become more aggressive or are you sort of streamlining costs and planning for the next uncertainty?

RSB: We try to be really conservative in these situations. In the airline industry you might create some flexibility...adjusting supply in the very short-term is complicated. For example, if you make a business case for opening a new destination with today's fuel prices it might be attractive. But the problem is that if you bring in additional aircraft, that aircraft will operate with you for a long time. So what we are not doing is taking a long-term decision with the current environment. We are taking long-term decisions using what we believe is a long-term scenario.

OP: Makes sense since the oil markets can change in a few weeks.

RSB: Exactly. That is what we have seen in the past. We don't want to bring online a lot of aircraft and then see that fuel prices have gone up significantly.

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