Area business leaders weigh in on cheap oil
It has been short and very sharp, so crude oil’s plummeting price has had little time to impact industries that rely indirectly on the stuff. But surprised as they may have been by the pace and duration of the decline, many analysts now predict a protracted period of cheap oil.
The World Bank’s latest forecast predicts years of prices well below the $100-plus per barrel levels that persisted for more than three years prior to a decline that began in late June and accelerated in November. It calls for an average spot price of $53 a barrel this calendar year, followed by a slow annual rise to $74 a barrel in 2020. Even that 2020 figure is more than 25 percent below the average of the last three years. If anywhere close to correct, the World Bank’s long-term forecast would at least mean a windfall for American drivers. What else could such an extended trend mean – for airline prices, the grocery industry, trucking and paving, among others?
With the price of oil impacting many facets of the economy, the Business Journal thought it worth asking players in a few industries what impact cheap oil would have on their sectors, and how that might or might not translate to consumers. We spoke to Danny Herman Trucking owner Joe Herman, Tri-Cities Regional Airport Executive Director Patrick Wilson, Summers-Taylor Inc. President Grant Summers, and Food City CEO Steve Smith. The short answer: lower prices will be good for business, but with fuel-price hedging common in businesses their size and some hangover remaining from years of recession and slow recovery, direct pass-throughs to consumers will be slower in coming.
Airfare wars not necessarily in the offing
The jets taxiing around Tri-Cities Regional Airport use a lot of fuel. Wilson says jet fuel typically accounts for about 40 percent of airlines’ total operating cost. The airlines hedge against market swings, buying fuel in long-term contracts, but, “as those hedging contracts come to an end, they’ll start to see more gains from the fuel price reductions.”
But before the big four of Delta, American, United and Southwest start lowering fares significantly, Wilson said they have more pressing matters to attend to. Wilson said the industry suffered some very difficult years when the global recession came on the heels of an oil price spike. Both events pummeled an industry that had excess capacity. The management of airlines that survived a wave of bankruptcies and acquisitions managed to reduce capacity by about 15 percent from 2008.
“As the airlines reduced that capacity and brought their load factors (percentage of sold seats) up to 80 to 85 percent, it helped them return to profitability, and it’s also allowed for higher fares,” Wilson says.
To position themselves for a stable future, though, the airlines need to shed some debt and invest in the newer, much more fuel-efficient planes being produced today. “As they make those investments they kind of protect themselves against the volatility of fuel pricing,” Wilson says.
So where does that leave airline passengers?
“The first thing consumers will see is a stabilization in airfares, and fewer increases,” Wilson says.
He says the folks at TCRA monitor about 50 markets, and fares here, “have been very competitive.”
“The good news is we don’t expect those airfares to increase significantly, and may start to see some slight decrease. But with what the airlines have seen from high fuel costs and now some lower costs, they’re not going to manage to the lower end of that (with respect to fare pricing) – they’re going to be conservative on how they work.”
As far as TCRA passenger traffic goes, 2014 was a good year, and the second half (as pump prices were dropping) was much better than the first. The airport ended the year with total passenger carrier traffic up 6.4 percent compared to 2013, after it had been up just 0.6 percent through June. There were 431,519 passengers (including a few thousand charter fliers), compared to 406,222 in 2013.
The 2014 number isn’t high historically. The airport topped it in 2011, 2009, 2005, and from 1998-2000. But Wilson says TCRA has seen an increase in load factors, and Delta is flying larger aircraft into the market – 110 and 130-seaters as opposed to inefficient 50-seaters that were more common a couple of years ago. As airlines see their ability to fill those planes at Tri-Cities, “the more attractive we are for additional service in the future.”
Wilson, who stays actively engaged with local economic development and government leaders, knows the airport’s ability to attract competitive fares and additional carriers and destinations can go hand in hand with economic growth in the metro area. He’s hoping the incremental growth continues, and the fares, choices and attractiveness to carriers not currently serving TCRA all strengthen.
“The more service you have, the easier it is to attract industry, and then the more industry you have, the easier it is to attract service. Those are the kinds of things you try to incrementally grow together.”
Cheap oil paving the way to growth?
One might expect the paving industry to see a boost from lower oil prices. Asphalt is petroleum-based, and Summers-Taylor trucks run through a lot of diesel.
“Obviously, cheap diesel is nice,” says Summers Taylor Inc. President Grant Summers, but overall it’s not quite so simple. Labor and equipment account for the lion’s share of cost for the company whose highly visible road projects are scattered throughout the Tri-Cities. Fuel totals about 5 percent of budget, Summers says, and while asphalt may account for somewhat more, advances in refining technology have de-linked asphalt prices from those of a barrel of crude.
Asphalt is derived from the thick bottom layer of a barrel of crude oil, and that thick, viscous mass used to be converted almost exclusively to asphalt. Now, Summers says, refineries have “cokers” that allow them to cost-effectively break the asphalt down into gasoline or diesel as demand requires.
“The price of asphalt now is more closely tied with the actual demand for asphalt than it used to be,” Summers says.
That said, his eye is more closely on what might happen with the funding source for most of the infrastructure projects that are his company’s bread and butter – the federal and state taxes on gasoline. Infrastructure budgets may get a small bump if people drive more because of low gas prices, but the bigger question, and one that’s been asked with greater urgency in recent years, is what states and the federal government will do about highway trust funds that are essentially going broke.
Summers says a period of low gas prices may be the best opportunity to increase gas taxes – which have been untouched for years as driving has decreased and fuel efficiency has increased – at a time when it will inflict less pain on consumers.
“They essentially will have to raise the gas tax to continue paying for infrastructure adequately. Hopefully that is a non-partisan issue on the federal side, and the conversation is ongoing. It’s nice that we’re trying to do this at a time when gas isn’t extremely expensive.”
Trucking set to benefit in multiple ways
Danny Herman Trucking (DHT) should see several benefits from any continued softness in oil prices, but they won’t be related to prices for the diesel that powers the Mountain City-based company’s 340 trucks.
“On diesel itself, we have a fuel surcharge for all our customers,” owner Joe Herman says. “This is adjusted weekly, and when our fuel surcharge falls, that’s less cost to the customer.”
That isn’t to say other costs won’t come down for DHT. Tires represent about 5 percent of the company’s expenses, and motor oil another 2-3 percent. Herman says tire costs should decrease if oil prices stay low. As for motor oil, “we’re negotiating with our providers on that to try to get the price of our motor oil down.”
Any changes will be a boon in a business like transportation, which Herman says operates on very thin margins. Those margins have improved some due to higher volumes the last two years or so for a company that made it through a brutal recession, unlike many counterparts at its relatively small size.
Herman said that growth isn’t all organic, though. He reckoned about half has probably come from DHT’s place as one survivor of that industry shakeout.
“Especially ’09 and the first half of ’10, when it was really bad, we saw a lot of carriers fall out of the industry due to bankruptcies and so forth, so a lot of capacity was taken out of the market.
“During the recession we were at about 230 trucks. Big carriers with 1,000 to 15,000 truck fleets were slashing rates to keep competing for the limited tonnage. We were bleeding. We got into a lot of our cash reserves and that allowed us to survive. We’ve always been a company that’s been responsible in our finances. We’re not sucking money out of the company for airplanes and yachts and stuff like that.”
The company has grown about 9 percent a year over the past three years, both in revenue and fleet size. Herman said DHT, which celebrated 50 years in business last year, recently set a 10-year vision of reaching a fleet size of 650-700 trucks.
If lower oil prices persist, perhaps the biggest impact to businesses will come if consumers – as Herman pointed out they often are wont to do – increase spending on other goods as they save at the pump.
“We know our society, a lot of them don’t always save that. They’re going to spend it so it’s going to go back into the economy.”
That could very easily translate to more trucks on the road carrying freight, more airline travel being booked, and more higher-margin items being plucked off of grocery store shelves. That last scenario would be just fine with Steve Smith, and it wouldn’t surprise him.
Food City CEO Smith says he would welcome a long run of cheap gas prices. “I think anytime people have more disposable income available, you have the possibility as a retailer, whether it’s grocery or otherwise, of being able to get some of that spending that people may have had to cut back on when gasoline spiked to $4 a gallon.
“It may be that they treat themselves to that extra steak dinner for their family during the week. It may be that they’re buying some new items they want to experiment with, some produce that they might cut back on if they were in a tight spot. So I think disposable income does have some effect on how people purchase for their family.”
To get those customers in a high-volume, low-margin business, Smith says Food City will have to adjust its prices if it begins to see a lower cost of goods, which he said is quite possible. One small area of cost is plastic bags, wrap, home trays and other “supply items” that are made from petroleum-based products. As inventory pipelines “get flushed out,” prices on those items may drop and be passed on to consumers. The agricultural industry is another area that could see enough change to affect store prices.
“The farmers save money on the diesel that goes in the tractor, they’re able to lower their cost. It costs less to get the product from the Midwest or California to the market. So any savings there can be hopefully passed along in the cost of goods of stuff that we have to procure, and again that takes awhile to get that pipeline filled up.
“I’m cautiously optimistic that if we see the oil prices go on for several months, that you would see things get more competitive and you could see the free market at work. And grocers, if they get a lower cost of goods, they’re going to try to entice customers into their store with better pricing or better promoted items. It may be very subtle, some kind of fraction of a cent, but those fractions of cents add up.”