Alaska Air Playing Long-Game with Biofuel Investment

Alaska Air Group (NYSE:ALK) is showing off its green credentials this month by launching a large-scale trial of biofuels. The airline will operate 75 commercial flights with a blend of regular jet fuel and 20% biofuel, hoping to spur on development of the experimental technology and eventually reduce its dependence on CO2-emitting fossil fuels.The initiative is about much more than environmental responsibility. Jet fuel expenses currently account for about 27% of the airline’s revenue –this actually compares favorably to competitors such as United Continental (NYSE:UAL), but we expect the figure to rise as oil prices head north. Alaska Air is therefore eager to get its foot in the door for an alternative energy source, but as our analysis shows any benefit will be a very long way off.

See Full Trefis Analysis for Alaska Air Here

Curbing Fuel Costs Top Priority for Industry

Throughout 2011, airline bosses have been hamstrung by the rising cost of crude oil. The industry’s total fuel bill is forecast to reach $176 billion this year, putting in jeopardy its meager profit margin of just $4.9 billion. ^[1] While fuel hedging contracts give some breathing space, sustained protection can only come from drastic improvements to energy efficiency.

Alaska Air leads the pack among US airlines when it comes to low fuel consumption, having invested in a modern, fuel-efficient fleet and streamlined air routes with satellite-based navigation systems. As a consequence, its fuel bill is much lower than competitors like United Continental (NYSE:UAL), which we expect to spend 35% of revenue on fuel from 2012 onwards.

Though Alaska Air’s fuel costs will steadily climb over the coming years, we believe its commitment to energy efficiency will see it beat the industry average through 2018. This justifies our current price estimate of $68. If the airline cuts costs faster and manages to flat-line its fuel bill by 2015, there could be upside of 25% to our estimate. However, the fledgling state of the biofuel industry makes this an unlikely scenario.

Biofuels will Take Decades to Grow Profit

Alaska Air freely admits that its biofuel-powered flights are a long way off being commercially viable. The airline paid $476,000 for the 28,000 gallons of biofuel required for the test flights – six times more than it shells out for an equal amount of conventional jet fuel.

High costs are symptomatic of an under-developed supply side, with the lack of feedstock farms and refineries on the West Coast forcing the airline to import biofuel from Texas before refining it in New Orleans. For now, this makes the fuel prohibitively expensive, which is unsurprising given that airlines only gained regulatory approval for commercial biofuel flights this year.

Once the infrastructure matures to the point where it becomes cost-effective, Alaska Air will have both the logistical framework and commercial relationships in place to capitalize on biofuels. Most analysts say this will be at least 15 years away, with Boeing setting a modest target of 1% of aviation fuel containing biofuel content by 2015. ^[2] Alaska Air cannot therefore expect to benefit from these test flights in the near future, but it is playing a pragmatic long-game.

Understand How a Company’s Products Impact its Stock Price at Trefis

This article was submitted as part of our Trefis Contributors program. Email us at contributors@trefis.com if you’re interested in participating.

1. Weak Economy Weak Profits – 2012 Looking Even Tougher, IATA, Sept 20 2011 [↩]
2. Commercial Airlines May Get 1% of Fuel From Biofuels By 2015, Bloomberg, July 22 2010 [↩]