This Industry Is Set To Post Record Profits On Lower Oil Costs by Frank Holmes

Everyone knows there are winners and losers in any bear market, including the recent commodity rout. Low crude oil prices have definitely hurt explorers and producers. Airlines, on the other hand, appear to be thriving.

According to the International Air Transport Association (IATA), a global airlines trade group, the industry is set to post a collective $33 billion in net profits this year—a record—on fuel cost savings and stronger passenger flight demand.

Want to know how significant a record this is? In 2014, profits came in at $17.4 billion—about half of what they are today.

What’s more, profits are expected to be even larger next year.

World demand grew 6.7 percent from a year ago, the IATA says, and is estimated to rise a further 6.9 percent in 2016. And with oil likely to stay relatively low, the group forecasts that airlines will spend $135 billion on fuel in 2016, down nearly a quarter from $180 billion in 2015.

This, coupled with improved fuel efficiency, is expected to contribute toward the group ending next year with estimated total net profits of $36.3 billion.

You can see below that global airline stocks have soared in recent years, especially in response to flagging oil, airlines’ largest expense.

Airlines Oil

In the past, airlines were notorious for their inefficiency and tendency to destroy capital. These claims were probably exaggerated, especially by Warren Buffett, who has repeatedly decried the industry as a money-loser. What a lot of people don’t realize is that Buffett didn’t do as bad as he claimed.

Former US Airways CEO Ed Colodny explained in 2013 that after Buffett’s shares didn’t appreciate, he wrote down his investment and got out when he could.

“I think at the end of the day, he got all his dividends paid and his principal back,” Colodny said.

In any case, airlines are now going into their third year of the present secular bull market. These often last much longer. We believe this cycle is different, in that the U.S. airline industry could easily create $20 billion of free cash flow this year and next. Low fuel costs have been the cherry on top.

Where Does Oil Go from Here?

Indeed, 2015 was not kind to oil and other commodities, with many of them slumping to multiyear and, in some cases, multi-decade lows.

Back in August, the cover of Bloomberg Businessweek featured a whole gaggle of bears, which delighted bulls. (There’s an old belief that the market will soon do the exact opposite of what the press predicts.) Yet here we are four months out, and the commodities rout has only extended itself further.

Crude oil is presently testing financial crisis support levels, making many investors wonder whether the bottom for black gold has been reached—or if more pain is to be expected.

There’s no shortage of analysts and experts right now sharing their (wildly divergent) predictions of where oil might be headed from here. Some are calling for $20 per barrel; others, such as legendary hedge fund manager T. Boone Pickens, $70 or more in the next six months.

We can’t say whether Pickens is right or wrong. It’s worth pointing out, though, that crude has pretty closely followed its five-year trading pattern, with 52-week lows reached in late November, early December. The short-term trend shows oil rallying sharply starting in January, according to Moore Research analysis.

Airlines Oil

Here’s another way of looking at it. The following heat map shows that, in the last five years, the oil price historically popped in February after months of losses. What this means is that January might be a good time to buy.

Airlines Oil

The oscillator below confirms that. Right now crude is down 1.2 standard deviations—already signaling a buy, but it might have further to fall, based on past incidences.

Airlines Oil

One of the more balanced perspectives comes from energy strategist Dr. Kent Moors, who tempers his optimism with a dose of reality:

Airlines Oil

We are not racing back to $100 a barrel oil. Absent the outlier of a geopolitical event that impacts supply, more subdued rises are in order. But we certainly do not need triple-digit oil to make some nice investment returns, especially in a sector that has been so oversold.

I agree. I’m not interested in adding my own forecast to the ever-lengthening list so much as I am in finding ways to make money at current prices.

As are other investors. Based on the most searched-for trends on ETFdb.com right now, you can clearly see what’s on their minds.

OPEC Members Revolt against Saudis as Oil Slips

One of the main reasons why prices are so depressed, of course, is that the world is awash in the stuff. The Organization of Petroleum Exporting Countries (OPEC), responsible for about 40 percent of global supply, just had its most productive month since 2012, pumping 31.7 million barrels in November. That’s 1.7 million barrels over its “official” production ceiling.

Crude slipped below $37 per barrel on the news, a seven-year low, which is about as low as prices can go for most American companies to stay profitable. (As of this writing, WTI crude sits at $35.36, Brent at $37.88.)

Airlines Oil

As expected, OPEC announced last Friday that it would keep oil production levels the same in its bid to force higher-cost producers (re: American frackers) to trim their own operations. Solidarity among its members has weakened further, however, as it becomes clearer and clearer to them that they underestimated the resilience of American oil producers.

Five OPEC members—Venezuela, Nigeria, Libya, Iran and Ecuador—are now in open opposition to the Saudi policy of unchanged production. That the cartel as a whole exceeded its production ceiling last month suggests that each member-nation is making its own rules up anyway, regardless of what was decided.

It’s estimated that OPEC is already pumping about 900,000 barrels a day more than is needed next year. And with international sanctions against Iran about to be lifted—in exchange for an agreement to halt its nuclear program—the country has promised to increase its own production from 3.3 million barrels a day to as many as 4 million barrels a day by the end of 2016.

This Industry Is Set To Post Record Profits On Lower Oil Costs

Venezuela in particular is in deep turmoil. Low oil prices have battered its currency and left its economy in tatters, with food shortages worsening every day. The International Monetary Fund (IMF) expects the South American country—which has the largest proven oil reserves in the world—to contract 10 percent this year and has declared it the worst-performing economy in the world right now.

In the recent parliamentary elections, rightfully fed-up Venezuelans responded by ousting members of Hugo Chavez’s United Socialist Party of Venezuela (PSUV),

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