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Why the rising oil price is bad news for Qantas Airways Limited

News overnight suggests that OPEC is close to an agreement to cut oil production, which should see oil prices rise.

In fact, the oil benchmarks, Brent Oil and WTI Oil gained 5% and 4.5% to close at US$48.27 a barrel and US$46.66 a barrel respectively overnight.

More gains could be ahead once OPEC’s final output details are worked out – but it’s all bad news for airlines, including Qantas Airways Limited (ASX: QAN).

In the last financial year, Qantas spent $3,235 million on fuel, down $664 million from FY2015. That was mainly due to lower oil prices. Qantas also saved $597 million in fuel costs in the 2015 financial year. In the 2014 financial year, Qantas spent $4,496 million on fuel.

And while Qantas hedges a large percentage of its fuel expenses, the airline will have to hedge at higher prices as contracts roll off if oil prices are higher. The company could also pass through the higher costs to customers that it can’t hedge against, although that is limited by what its competitors do.

If Virgin Australia Holdings Ltd (ASX: VAH) and Qantas’ international competitors don’t pass on higher fuel costs to customers and Qantas does, it could lose market share.

The good news is that oil price is unlikely to rise too high, because the higher the oil prices goes, higher-cost US shale drillers are encouraged back into the market. Shale drillers have also found some innovative ways to dramatically cut costs.

That has the effect of putting downward pressure on oil prices.

Foolish takeaway

Trading at $3.13, Qantas shares sport a P/E ratio of just over 6x earnings – evidence the market expects earnings to fall this financial year. That could fall further if oil prices continue to rise.

 

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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