Oil shock after attack on Saudi facility
Crude futures briefly soared almost 20% higher after the news broke of Saturday's drone attacks on Saudi's key oil facility, and Brent futures in London saw the biggest one-day percentage jump since 1988. The sudden halt in oil supply was also the worst in history.
Worsening matters, Saudi officials poured cold water on prospects of a swift recovery, with Aramco officials telling a senior foreign diplomat they face a "severe" disruption that may last months.
According to Bloomberg, global spare capacity currently available can only offset 70% of lost Saudi production.
This is not happy reading for airline companies.
Indeed, the Qantas Airways Limited's (ASX: QAN) share price finished this Monday 4.5% lower. America reacted to the news in a similar vein, with the world's largest carrier – American Airlines – closing Monday down 7.6%.
That being said, the Qantas share price has rebounded over the subsequent few days and is currently trading 2.6% higher.
Growing revenues offset by rising fuel costs
Qantas' recent full-year results showed underlying earnings before interest and tax (EBIT) down 14.9%, even though total revenue was up 4.9% at $17,966 million. Importantly, operating margin was down 18.6%, at a lowly 8.3%.
Qantas reported that fuel costs rose by $614 million compared to last year, a 19% spike.
Air New Zealand Limited (ASX: AIZ) saw this year's earnings before tax down from 2018's $540 million to $374 million, a massive 31% drop, even though, similarly to Qantas, operating revenue was up 5.3%.
In its report, Air New Zealand listed increased fuel prices as a key headwind factor. In fact, it reported a NZ$191 million increase of the price of fuel that saw its total fuel bill jump from NZ$987 million last year to NZ$1.27 billion in FY19.
Following the pattern, Virgin Australia Holdings Limited's (ASX: VAH) full-year results revealed total revenue up 7.6% but an underlying loss before tax of $71.2 million, down a stupefying 210%.
In its full-year report, Virgin Australia attributed this result to a $158.8 million fuel/foreign exchange headwind. The underlying loss before tax may not be overturned quickly, as Virgin Australia still forecasted $100 million worth of fuel and foreign exchange headwinds in FY20.
Temporary jolt or long-term shakeup?
Investors will not only ponder the speed of Aramco's salvage of its Abqaiq plant but also the long-term geopolitical implications of the attack.
Saudi Arabia came out on Wednesday with a statement that it has partially restarted its damaged facility, yet full output capacity of 12 million barrels a day is still only expected to be reached by the end of November.
Even in the best-case recovery scenario, investors must now live with the reality that the oil pricing equation has a new, steep variable – geopolitical volatility.
Speaking to the BBC, Royal Bank of Canada's global head of commodity strategy Helima Croft went so far as to pronounce the drone attacks are a "game changer in the escalating Iranian regional standoff."
Airlines will have to contend with the material impact on Saudi production but also with the immaterial shift in market sentiment. Many observers will fret that it can only take one drone attack to disable 5% of the world's oil supply.
The exposed Saudi vulnerability to debilitating disruptions in oil delivery coupled with escalating tensions in the region may manifest as sustained high prices for crude.
Airlines may very well have to pay an extended and hefty geopolitical risk premium for their largest expense. Airlines with low profit margins and weak fuel hedging will likely suffer.
Uncertainty is expensive.
