Business Irish

Sunday 21 January 2018

No hiding place from rocketing oil prices

With fuel prices soaring, the world's economies are spluttering. Brace yourself for a bumpy ride, warns Louise McBride

DALLAS: Patrick Duffy, Victoria Principal, Barbara Bel Geddes, Larry Hagman, Charlene Titlon, Jim Davis and Linda Gray
DALLAS: Patrick Duffy, Victoria Principal, Barbara Bel Geddes, Larry Hagman, Charlene Titlon, Jim Davis and Linda Gray

ANYONE who has ever watched Dallas, the epic shoulder-padded soap opera, will remember how oil money tore a wealthy Texan family apart.

The main character in the series, JR Ewing, pulled every stunt he could think of to keep control of his family business, Ewing Oil, including the sale of worthless Asian oil leases to the family banker.

Dallas may have been off the airwaves for about 17 years now, but with the price of oil rising above $135 a barrel last Thursday -- double its price this time last year -- businesses and households alike are experiencing their own oil-fuelled dramas.

Air France-KLM warned last week that its operating profit could fall by a third this year because of the surge in fuel prices. And shares in Silverjet, the British business-class airline, were suspended this weekend after the airline failed to secure some necessary funding. Like most airlines, Silverjet is grappling with rising fuel prices.

So too are Irish consumers. A year ago, the average price of petrol at the pump was €1.16 a litre, while diesel cost €1.08. Petrol prices are now moving towards an average of €1.30 a litre and some petrol stations are already charging almost €1.40. The average price of diesel is now almost €1.40 a litre -- about a third more than it was last May. And there could be worse to come.

Earlier this month, the investment bank, Goldman Sachs, warned that oil prices could hit as much as $200 a barrel over the next six months to two years.

Although some are dubious that oil prices could ever soar so high, in February 2000, when oil prices hit $30 a barrel, would anyone have believed they could climb as high as today's $135?

"Anything is possible," said Ryanair boss Michael O'Leary, when asked if oil could soar to $200 a barrel. "But do I think it's sustainable? No. No-one

'Whatever the forces driving oil prices up, $150 per barrel looks more likely than $100 over the next few months'

believes oil prices will stay at about $130 a barrel. Long-term investment decisions are being made at $70 a barrel. But the price won't drop to that level this week."

The truth be told though -- no-one knows what's coming next. Most of us are hoping that the latest surge in oil prices is a short-term spike.

While this could be true, so too could a scenario where oil prices continue to rise for the next two or three years, eventually hitting that D-Day of $200 a barrel. So what kind of carnage could we expect on the forecourts if oil prices hit that level?

Drivers would pay €2.04 a litre for petrol and €2.10 a litre for diesel if oil hit the $200 a barrel mark, according to Pat McArdle, chief economist with Ulster Bank.

"Much would depend on what happened to the dollar -- some recent oil price rises have been associated with a weakening dollar," said McArdle. "A rise to this level would probably trigger a major slowdown and so might not last long as demand would fall off and oil prices would then weaken."

As well as triggering a worldwide recession, an oil price of $200 a barrel would force many to change their behaviour. "It would probably be cheaper for consumers to buy a fur coat than to buy heating oil," said Tom Noonan, chief executive of the Maxol Group. "People are already ordering smaller quantities of heating oil."

Cash-strapped consumers could also be facing a colder winter. Bord Gais wants to increase its prices by between 17 and 19 per cent from October. Increases in wholesale gas prices are also likely to push up electricity bills.

"There will be an electricity price increase this October," said Tom Reeves, chairman of the energy watchdog, the Commission for Energy Regulation (CER). Neither Reeves, nor the Electricity Supply Board, elaborated on the extent of the upcoming increase.

We could also see a return to the days of thatched cottages and beehive huts if oil hit $200 a barrel, said Tom Parlon, director general of the builders' lobby group, the Construction Industry Federation (CIF). "We would have to investigate our traditional means of construction," said Parlon.

The cost of materials for modern houses and roads has rocketed over the last year. Oil, which is used to produce cement, tar and steel, is a major factor in this. The price of steel and copper has risen by 62 per cent within the last year while PVC plastic has doubled in price, according to Parlon. "The cost of gypsum has gone up by 21 per cent, asphalt by 12 per cent, insulation materials by 11 per cent and timber by 12 per cent," said Parlon. "Concrete prices have jumped by 7 per cent over the last three to four months."

Although Parlon does not expect oil to hit $200 a barrel, he believes layoffs in the construction sector would be inevitable if prices soared so high, unless the industry explored traditional ways of building houses.

"It would become more expensive to build houses and builders would not build until they had secured a house sale," said Parlon. "This would lead to a scarcity of houses. When houses are scarce, prices go up."

Indeed, concerns about scarcity are behind the recent spike in oil prices.

"Several developments in the past month have highlighted concerns over the outlook for long-term oil supply growth," according to a report from Goldman Sachs earlier this month.

"In particular, integrated oil companies announced significant disappointments in oil supply growth, large producers such as Russia expressed real doubts about potential future oil production, a Mexican oil and gas privatisation attempt failed, and the civil disruptions in Iraq and Nigeria continued to impede oil flows."

The signals are confusing, however. Some believe oil prices could subside because of rising oil supply from unexpected corners of the world, including Saudi Arabia, Nigeria and Iraq.

Last Tuesday, the secretary general of the Organization of the Petroleum Exporting Countries (OPEC), Abdullah al-Badri pointed the figure for rising oil prices at market speculators and the weak dollar, arguing that record oil prices have nothing to do with supply and demand.

However, "whatever the forces driving oil prices at the moment, $150 per barrel looks more likely than $100 a barrel over the next few months," said Alan McQuaid, chief economist with Bloxham Stockbrokers.

Those businesses that attribute a large portion of their overall costs to fuel will be most vulnerable to rising oil prices, according to Reeves. Fuel accounts for about half of Ryanair's costs, according to O'Leary, while Aer Lingus said that fuel makes up about a fifth of its costs.

All eyes will be on Ryanair on Tuesday week when it announces its full-year results. Last February, O'Leary revealed that if oil prices remained above $85 a barrel and if the average amount of cash Ryanair extracts from each passenger fell by 5 per cent, after-tax profits for the year to March 2009 could halve to just €235m.

"Clearly our profits would be massively impacted if oil hit $200 a barrel," said O'Leary. "They already have been massively impacted. Our oil bill will double this year but we still expect to be profitable."

O'Leary said that only four airlines would survive on an oil price of $200 -- British Airways, Lufthansa, Air France and Ryanair.

"Such a scenario would be great for Ryanair as we would be one of the airlines that would still be in business," said O'Leary.

"Clearly a lot of airlines would go bust if oil hit $200 a barrel. It would also mean the world would hit a recession. People would get more price sensitive so they would choose to fly with us."

O'Leary admitted, however, that Ryanair's fares would "probably rise" if oil reached such a level. Despite this, he ruled out ever introducing a fuel surcharge, unlike Aer Lingus, which increased its fuel surcharges by as much as 30 per cent earlier this month.

This fuel surcharge, which could add as much as €180 to the cost of a return transatlantic flight with Aer Lingus, covers "less than half of the fuel costs for transatlantic flights," said Enda Corneille, corporate affairs director with the airline. Corneille added that an oil price of $200 would "seriously affect the business".

"A price like that would not just hit the bottom line of airlines -- it would affect demand," said Corneille.

"It would cost people twice as much to get into their cars so people would travel less."

If oil hit $200 a barrel, more airlines would be forced to ground flights and cancel routes, according to Corneille. "Airlines would have to look at their cost base and the routes they are flying," said Corneille. "$200 a barrel wouldn't just cause a blip. It would significantly change business."

This in turn could push up the price of flights. "Consumers will probably have less flights to certain destinations and this will make flights more expensive," said Stephen Furlong, an equity analyst with Davy.

Even if oil prices don't hit $200 but continue around the $130 mark, airlines will be under huge pressure.

"I don't believe any airline in the world can make a material profit at these oil prices unless they have a strong hedging position," said Furlong. With fuel-hedging, airlines buy fuel in advance to protect themselves against future price shocks. "Some airlines will take the full impact of today's fuel prices this year but all of them will be impacted next year."

It truly looks like we're heading into a winter of discontent. Let's hope it's not a long one.

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