Airline Handbook Chapter 10: Energy and Environmental Matters

 

The price of crude oil has risen in recent years, because worldwide demand has increased in response to global economic growth – and supply has not fully kept pace. In 2008 world demand for petroleum liquids averaged 85.4 million barrels per day. Military conflict, civil unrest and labor strife have triggered supply disruptions on a more consistent basis in various parts of the world, and growing demand in China, India and other emerging markets has added to the global appetite for crude oil.

Producers sell oil through a variety of arrangements, including private bilateral contracts and market contracts that are priced through a commodity exchange. Air carriers buy fuel from multiple suppliers and at differing rates. Not every supplier operates at every domestic airport that a carrier may serve, so multiple arrangements are necessary. Since airline schedules make fuel demand generally predictable, carriers can purchase fuel months or years in advance in order to receive a discounted rate from the supplier.

Locking in the prevailing price for future deliveries of a commodity like jet fuel is called a hedge. Hedging allows airlines to limit the uncertainty over future costs by mitigating volatility and improving financial planning. However, hedging is a gamble that requires a relatively healthy financial condition, a willing counterparty and often a sizable upfront transaction cost. This makes hedging an increasingly difficult proposition for many carriers. Hedging also can be financially risky, because an airline could find itself locked into paying more for fuel if the market price drops below what it has agreed to pay in a hedge contract. As Standard & Poor's remarked in a March 28, 2008 research note, "...hedging high and volatile fuel prices is expensive and may require posting cash collateral."

 

The difference between crude oil and jet-fuel prices, commonly known as the "crack spread," historically averaged about $5 per barrel. In the weeks following hurricanes Katrina and Rita in 2005, however, the crack spread widened dramatically when major oil-supply disruptions prompted refiners to focus their operations on producing gasoline. As a result, airline demand for fuel far exceeded the available supply, causing the spot price of jet fuel to spike at more than double the spot price of oil. At its peak, the crack spread added the equivalent of $60 per barrel to the final cost of jet fuel, which surged to $131.47 in the Gulf Coast on October 5, 2005.

Just as motorists pay different prices for gasoline in different parts of the country, airlines pay different prices regionally for jet fuel. West Coast prices traditionally run higher, because of limited refining capacity as well as inferior storage, logistics and distribution capabilities. In addition to the mountainous terrain, which limits trucking capability, the West Coast lacks the more robust pipeline network of the East, although the latter is becoming increasingly strained by today’s demand and competing product needs (i.e., gasoline vs. diesel vs. jet). Much of the product on the West Coast is imported, often from countries with even higher prices.

Airlines constantly strive to improve jet-fuel efficiency, because unlike other modes of transport, they have no alternative source of energy. Airlines conserve fuel in many different ways, including reducing and more accurately measuring onboard weight; cruising longer at higher altitudes; employing greater use of flight-management systems; and conducting more in-depth analyses of weather conditions. In addition, airlines are modernizing their fleets with more fuel-efficient airplanes; investing in winglets to reduce aircraft drag and thereby increase fuel conservation; redesigning hubs and schedules to alleviate congestion; and pooling resources to purchase fuel in bulk through alliances with other carriers.

 

The technical specifications for jet fuel make it more complex to refine. U.S. buyers also have been somewhat disadvantaged in recent years when compared to their foreign counterparts, due to a relatively weak dollar. Beyond the price of crude oil, the price of jet fuel has risen sharply with overburdened refineries, competition with other products in multiproduct pipelines and refinery outages. 

Existence of the futures market and other derivative instruments allows any participant to “lock in” the prevailing price for future deliveries, such as home heating-oil prices for the winter season. Such a strategy, called a “hedge,” involves a series of transactions, offsetting profits or losses on a futures transaction against losses or profits on the physical purchase or sale of oil. By limiting the uncertainty over future costs, the hedge allows companies to mitigate volatility and thereby improve financial planning. A hedge instrument may or may not accompany the actual (physical) delivery. In most cases it does not. An airline could hedge volume at a fixed price, but most frequently hedges occur in paper markets or on an exchange, typically settled on a monthly or quarterly basis between the airline and an oil company or bank. 

The primary means by which airlines purchase jet fuel is through “term contracts” based on a projected volume for a given period. For example, ABC Airlines might agree with Supplier X to supply its requirements in Chicago for a one-year term from Feb. 1, 2012, through Jan. 31, 2013, estimated at five million gallons per year on a Platts Gulf Coast index (based on the week prior to delivery) plus or minus a fixed differential (usually stated in cents per gallon). After term contracts and hedging, spot-market purchases constitute a minute portion of the industry’s jet-fuel consumption. These purchases tend to be limited to larger, more sophisticated airlines that have become integrated into the supply chain for reasons of price or supply surety. And even those airlines only tap the spot market for well under 10 percent of annual purchases. 

At the federal level, airlines pay 4.4 cents for every gallon consumed on a domestic flight. Of that amount, 4.3 cents goes to the Airport and Airway Trust Fund while 0.1 cents supports the Leaking Underground Storage Tank Fund. In addition, in most states airlines pay a flat rate per gallon or an ad valorem sales tax on the purchase of fuel. In California, for example, airlines pay a fuel tax in excess of 8.0 percent of the price of jet fuel. So if the price of jet fuel purchased in California were to double, the airlines’ fuel-tax burden would double as well.

 

Beyond the numerous, diverse, successful measures that U.S. airlines have taken and continue to explore to conserve fuel, the single biggest advance in fuel conservation will come from reform of the U.S. air traffic control (ATC) system, which continues to rely on 1950s technology and procedures. Efficiency gains could reduce unnecessary fuel consumption by as much as 400,000 barrels a day by 2030, according to Securing America’s Future Energy (SAFE), a nonpartisan organization working to reduce America’s dependence on oil. And every drop of fuel saved results in emissions reductions.

 

Airlines have developed many different operational and planning techniques aimed at conserving fuel, reducing emissions and optimizing fuel purchases. On the operational front, airlines are:

In terms of planning for fuel usage, airlines are:

A4A provides assistance to member airlines via the FAA Command Center in Warrenton, Virginia, working collaboratively with member airlines and FAA to optimize routes and provide subject-matter expertise. Specifically, they:

Soaring fuel prices have continually intensified the airline industry’s efforts to increase fuel efficiency – the most effective means of reducing emissions. By employing more fuel-efficient aircraft and operational procedures, reducing aircraft weight, cutting marginal routes and matching capacity more closely with demand, U.S. airlines continue to carry more passengers and cargo with substantially fewer gallons of fuel. These voluntary measures have resulted in significant reductions of greenhouse gases and more localized ozone-forming pollutants. As the industry continues to replace older aircraft with quieter and cleaner jets, per-operation noise and air-quality impacts will continue to diminish.  
 
A4A members also continue to support noise-abatement measures consistent with the safe and efficient operation of aircraft. Improvements in navigation technology facilitate compliance with noise-reduction measures and help diminish noise impacts on communities. Area Navigation (RNAV) and Required Navigation Performance (RNP) procedures and improvements in positional accuracy from Automatic Dependent Surveillance – Broadcast (ADS-B) permit aircraft to operate more closely at optimal altitudes and follow more precise flight tracks, thereby enabling tailored noise management. However, some noise-abatement procedures require longer flight paths, which increase the amount of fuel-related emissions, and such conflicting goals must be considered in each situation. Many new operational procedures, such as the Continuous Descent Approach (CDA), also offer the potential for significant reductions in both noise and emissions.  

 

While future advances in air traffic management promise to further reduce noise and emissions, it is important to remember that the converse is also true. In the absence of critical investment in our air traffic control (ATC) system, worsening congestion threatens to overtake hard-earned gains in fuel efficiency and environmental compatibility. Advancing ATC reform is critically important to mitigating aviation environmental impacts.  

 

Through collaboration with industry, agency and intergovernmental partners, A4A is engaged in many approaches to address environmental issues. A4A experts play key roles in the International Civil Aviation Organization (ICAO) Committee on Aviation Environmental Protection (CAEP). CAEP is responsible for environmental measures affecting international aviation, including noise and emissions standards for aircraft and aircraft engines, and measures to address greenhouse gas emissions. In addition, A4A serves on the Advisory Board for the Partnership for Air Transportation Noise and Emissions Reduction (PARTNER), a research center sponsored by the Federal Aviation Administration (FAA), NASA and Transport Canada. Moreover, A4A represents its members on the Joint Planning and Development Office (JPDO) Environmental Working Group (EWG), which works to ensure that environmental concerns will not constrain the planned expansion and modernization of the U.S. ATC system. At the same time, in coordination with industry and government partners, A4A is playing an active role in efforts to develop and deploy commercially viable, environmentally friendly alternative fuels.

 

A4A and its members are working hard to identify measures that will continue to lessen the environmental impacts of aviation and better manage environmental constraints on aviation growth.