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Patrick

Welcome back to the Barclays Brief. It's Patrick here. And today we're going to talk about jet fuel shortages and what that means for your holiday. And by now I'm sure you've read a lot of headlines around this, such as “Europe to run out of jet fuel in the next six weeks”. So to find out what's really going on, I'm delighted to be joined by Andrew Lobbenberg.

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He's our head of European Transport Research and one of the most experienced voices in the industry. Andrew, thanks a lot for being here with me today. 

Andrew

Patrick, thank you. It's lovely to be here. You just want to know if you can get away on your holidays, don't you? 

Patrick

I kind of do. I still haven't booked my holidays yet, and I'm reading these headlines, and my wife and I are nervous because just seeing about flight cancellations, prices surging.

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So, yeah, I do want to know about that. First of all, can you just sort of set the scene now? You've been an analyst for over a quarter of a century. You worked in the industry before that for a decade. When you read the headlines around jet fuel shortages and flights being grounded, is it a genuine risk or are these sort of headlines overstating the concerns that we should have?

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Andrew

The airline industry has lots of problems very regularly, and having done this job forever, yeah, we've seen lots of crises, you know, after 9/11 through Covid. This is another challenging moment. I've not, in my lengthy time following the industry, been in a place where we're wondering if we're going to have fuel for the planes to take off.

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So it's certainly serious, yes, but I don't think we're looking at another Covid where the skies are empty. 

Patrick

Okay. So can you just sort of start by just putting some numbers around this? If I think about, I don't know, the number of barrels that we use in Europe, how much we import, how much we refine ourselves. 

Andrew

So I mean, I think Europe uses about 1.6 million barrels of kerosene a day.

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There's only production for 1.1 billion. And frankly, refineries in Europe have been closing. So we've been becoming more and more reliant on imports. And Europe has, you know, historically imported large parts of its kerosene from the Gulf. So I think IATA is saying that about 25 to 30% of total kerosene in Europe is coming from the Gulf, and that's currently blocked.

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Patrick

Sure. And so that could be a prolonged blocking and a prolonged impact on the industry. So why is it that Europe's more exposed than other regions? And when you compare Europe to the US or Asia, as I know you do when you're talking to investors all the time, what's different in terms of the supply dynamics and consumer confidence in those regions?

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Andrew

So, I mean, we are different to other regions, but it's not necessarily worse, no. Relative to Asia we're actually in a better place. We produce quite a lot of crude in the North Sea. And there are, you know, a good amount of refineries in Europe, though, fewer than there used to be. So Asia is even more reliant on Gulf kerosene than we are.

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And there are shortages today in Asia of jet fuel. The US is fine. They've been working on energy independence and they’re long crude, they’re long kerosene, and they are exporting it. And indeed, both Asia and Europe are taking a lot of kerosene from the US now. 

Patrick

Yeah. What about consumer confidence in those regions? You know, you were in the US recently, weren't you?

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And did you see, you know, robust demand and the airlines, consumers, businesses feeling pretty good about booking? 

Andrew

Patrick, it's really bizarre. I don't think in the time I've followed the industry, I've seen such extreme differences in attitude. In the US, consumer confidence—particularly among the wealthier let's be clear— is riding high. And the US full service airlines are extremely confident about their revenue trajectories, really confident about how they're able to, you know, push through high prices and consumers are taking it.

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By contrast, in Europe, particularly the leisure-focused airlines are struggling and they're actually seeing falling prices despite the rise in kerosene. And, you know, it's because airline fares are set by the market, right? It's what happens to supply and demand. And, you know, people are not booking here because we are freezing in the headlines, not booking our travel like you and your Mrs.

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And you know, people are reluctant to book, they’re booking late, and therefore the airlines and holiday companies are having to incentivise with lower prices, not higher prices. And so yeah, it's really much more challenging in Europe than over in the US. 

Patrick

Preparing for this conversation, I've been reading a lot about what the airlines and the hotel companies are saying, and they're not saying much 

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right? They seem to be being very careful not to alarm consumers, presumably so they don't dampen demand further. What are they not saying that you think they will be saying in a few months’ time? 

Andrew

Totally agree with what you said. I think there's a confidence game going on because if they were to clearly say there's a risk of flights going to be cancelled in July, people wouldn’t book and they'll have an even bigger problem than the one they have at the moment.

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I mean, the straightforward truth is they don't know because there is so much uncertainty as to when the Strait will open. Even if the Straits do open, it's at least 40 days until new product can get to Europe, and we don't really know to what extent the infrastructure in the Gulf has been damaged as well. We know it's partially damaged, quite how badly we don't know.

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So some stuff will start flowing when it reopens, the Straits reopen, but there's 40 days to get here by boat anyway, right? So there's huge amounts of uncertainty. The Europeans don't know how much of the fuel from America we can get, how much the fuel from Africa we can get, because there are competing bids on that from Asia and from us.

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So yeah, it's an extremely uncertain situation. But you don't want to say that to consumers. 

Patrick

And what do you expect to happen? 

Andrew

So if we look at the different extremes, if the Strait opened tomorrow, then the price of oil would fall. But no new kerosene would arrive in Europe from the Gulf for 40 days. And we also don't know how much might arrive, because, you know, there has been damage to the infrastructure in the Gulf.

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So there is still going to be a tightness of supply and a risk of flight cancellations in the June-July period anyway. But the fuel price would fall, and so airlines would be less inclined to cancel flights for economic reasons. But they may cancel some for supply reasons. If, by contrast, the Strait stays shut for longer, then the risk of supply constraints gets bigger, but also the oil price in the future will be higher than the forward curve suggests today.

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So airlines will do more voluntary, economically motivated flight cancellations. So we'll have more flight cancellations, and consumers who were on cancelled flights will be reallocated to those that survive. In terms of the scale, in a benign scenario, something like a 5% cancellation for a short period of time looks possible. And indeed, we're seeing flights cancelled today already, though not blamed on fuel shortages ascribed to maintenance shortages that Air Lingus ascribed to economic decisions that Transavia and SAS.

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And, you know, we'll see more of those cancellations in the event of the worst outcome of the Straits staying shut. You know, the level of flight cancellations will increase, but the combination of fuel shortages and economic decisions and, you know, that could climb to 10% to 15%, maybe. But that's the sort of quantum that I think we're talking about.

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Patrick

Okay. And in that scenario where this the Straits stay shut for longer, what else happens to the industry? What other kind of dynamics you start seeing as an investor. 

Andrew

So the economics for the industry will be challenged, yeah? We're cutting capacity, so our non-fuel costs getting worse. Fuel is going up. Consumer confidence is going down. So unit revenues are not strong.

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And even the strong premium stuff that holds up at the moment will become vulnerable. So there will be failures in that scenario. There would be some mergers in that scenario. And airlines would accelerate the retirement of older aircraft. And heavens above, we've got so many old birds in the air at the moment because since Covid, Airbus and Boeing have struggled to produce at anything like the rate they intended to.

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Which is why, yeah, the airline fleet at the moment is pretty aged, and I suspect this would wash out the dinosaurs from the sky. 

Patrick

Yeah. Finally, what about consumers? In that scenario, a lot of people listening today won't have booked their flights. They’ll have read in the headlines as well, worried about cancellations, worried about higher prices. The airlines are going to struggle, as you say from an economics perspective, what happens to consumers, higher prices? 

Andrew

So consumers who've already booked their flights may find their schedules mucked around and put onto a different flight, but they'll probably travel.

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People who have not booked will probably, you know, see some pressure. And the fares will be higher because the remaining seats on those planes that are still going will be filled up by people moved off the cancelled flights, that the remaining share of seats available for sale gets smaller. And even with wobbly demand, the prices might be high, so

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I'd go and book a flight if I were you if you were fancying traveling.

Patrick

Understood, but with a bit more risk than, than there was six months. 

Andrew

Recognizing a risk. 

Patrick

Yeah, absolutely. Okay, Andrew, thanks a lot for being here. This has been great. 

Andrew

Thank you for having me. 

Patrick

Okay. Let me try and pull this conversation together with a few takeaways.

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Clearly, Europe is exposed because it relies heavily on imported jet fuel and has less buffer in the system than places like the US. And yes, this is a real supply squeeze, but not every alarming headline that I read will necessarily translate into planes being grounded. So for consumers, the most likely impact is higher prices, fuller planes and some targeted cancellations.

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But we shouldn't mistake that for a pandemic-style shutdown. It's more likely to be a tougher, more uncertain travel environment. Thanks a lot for listening to the Barclays Brief. We'll be back again at the same time next week and do hit subscribe.