Oil supply shift is airline omen and chemical boon

September 16, 2010

A looming shift in oil supply heralds significant changes for two industries. Traditional crude output is forecast to plateau over the next five years with lighter liquids providing the bulk of supply growth instead. This should lower costs for chemical producers. It might also be a fresh ailment for just-recovering airlines.

Old-style oil is getting harder to find. Production growth should grind to a halt by 2015, according to Cambridge Energy Research Associates. From then, any extra supply will come from natural gas liquids and condensates, which were once discarded by oil producers.

Not all hydrocarbons are created equal, however. As voracious consumers of the growth variety, U.S. chemical producers stand to benefit from fatter margins. One of the best placed appears to be Westlake Chemical <WLK.N>, for whom ethane accounts for over half of input costs.

Yet it could turn into another festering problem for airlines. Natural gas liquids aren’t used to produce jet fuel. That means stagnant crude production could lead to higher prices. To make matters worse, as citizens in China and India increasingly take to the air, fuel demand is likely to outpace economic growth.

This is an ominous trend for beleaguered U.S. airlines. They have collectively lost $58 billion since 2001 and generated profit in just four of the past 10 years. True, having slimmed down and consolidated, the industry seems on track for its best financial year since the 1990s despite the anemic economy.

Still, every dollar rise in a barrel of fuel costs the industry close to $500 million, according to the Air Transport Authority trade group. And airlines historically have struggled to pass on the burden to penny-pinching consumers. Pre-tax margins, though improving, leave little room for error. Avondale Partners, for example, expects 2010 pre-tax profit margins of 3.8 percent at Continental Airlines, with a fleet heavy on antique gas-guzzlers, could be most vulnerable of all to a climb in fuel costs.

U.S. chemical stocks have outperformed the S&P 500 index by 13 percent this year. But airlines have done even better, ahead 22 percent. The oil supply effect suggests a change of fortunes may be in store.

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