Delta's $1.6 Billion Fuel Shock Didn't Break Its Profits

By Daniel Okafor

Delta Air Lines absorbed a $1.6 billion jump in jet fuel costs last quarter and still kept profits intact. CEO Ed Bastian calls that result unprecedented for the industry.

"To not dent those profits, to me is incredible," Bastian said in an interview with CNBC on Friday. "In past cycles, past shocks, if we saw a 60% increase in fuel prices, we'd be flat on our back."

The 60% fuel spike, tied to the war in Iran, did not stop travelers from buying tickets. And that, in Bastian's view, changes the economics of airfare. Higher prices could stay even if oil falls.

How Delta passed the cost to passengers

The mechanism is simple. Airlines raised fares, and customers paid them. In July, after second-quarter results, Bastian told CNBC that Delta was passing along 60% of its higher fuel costs to consumers. He expected that figure to reach close to 100% in the third quarter.

Delta reported $17.6 billion in adjusted revenue for the third quarter last week. That is a 16% rise year over year, though just short of the $17.67 billion analysts expected. Fuel spending rose an adjusted 62% from a year earlier. Revenue per seat mile — what an airline earns for each seat flown one mile — climbed 15%, reflecting higher fares and steady demand.

"Fuel has been the impetus for the industry to move quickly to adjust the pricing environment. But given the fact that the market has accepted these price points," Bastian said on the earnings call, Delta's position is very sustainable.

What is driving fuel costs?

Oil prices explain most of the pressure. The war in Iran has crippled transit through the Strait of Hormuz, which carried 20% of the world's oil before the conflict. Brent crude stood at $108 on Monday, up more than 70% from a year ago.

For airlines, fuel is the second-largest expense after labor. It made up about 21% of operating costs earlier this year, according to Airlines for America, the industry's trade group. Jet fuel tracks oil prices, and it has already risen more than 100% year over year, according to the International Air Transport Association. U.S. Gulf Coast jet fuel cost $4.34 a gallon on Thursday — almost double the $2.19 of a year earlier, CNBC reported.

U.S. carriers do not hedge against oil prices, unlike their European rivals. That means increases flow straight to the customer. Delta has one structural buffer: it bought an oil refinery more than 10 years ago through a subsidiary, which helps offset fuel costs.

Are travelers still buying?

Yes, across the industry. The average domestic airfare hit $445.26 in the second quarter, according to the Bureau of Transportation Statistics. Ticket prices rose about 23% year over year, the U.S. Travel Association reported.

Other chief executives see the same resilience. "Despite high fuel and high prices, we're seeing really strong demand," Southwest Airlines CEO Bob Jordan told CNBC in July. On American Airlines' second-quarter call, CEO Robert Isom said: "Consumer spending remains resilient, underpinned by a healthy labor market and a sustained preference for travel relative to other discretionary categories."

What did the higher fares fail to cover?

The fare increases did not fully shield Delta. Last week the airline cut its full-year profit outlook to between $5.10 and $5.60 per share, down from its previous forecast of $6.50 to $7.50. It also missed Wall Street's earnings estimate for the first time in two years.

Bastian still expects fuel to ease. "I think we're going to be fine as you look forward. Hopefully, we will see fuel recede into the next year at some point, and that's when I think you'll see the real earnings power of this franchise be amplified," he said on the call.

That is the bet: fares reset higher now, fuel costs fall later, and the gap becomes profit. Delta reports first among major U.S. carriers, so its rivals' results will test whether the pricing power holds industry-wide.