Alaska Airlines and Horizon Air 2007 Annual Report Download - page 107

travel early in 2007, and unit revenues declined
on a year-over-year basis during the first half of
the year. Unit revenues rebounded later in the
year, principally in response to higher passenger
load factors and actions taken to help offset
increases in jet fuel prices.
Several traditional or “legacy” carriers have
reorganized through bankruptcy proceedings over
the past several years. These carriers have
gained a competitive advantage by significantly
reducing their costs almost immediately. In
addition, so called “low-cost carriers” (LCCs)
have grown significantly since 2001 and currently
carry more than 30% of total U.S. domestic
passenger traffic. However, the line between the
LCCs and legacy carriers is becoming more
blurred as the legacy carriers make further
reductions in unit costs and the LCCs face cost
pressures, and as the legacy carriers reduce
service offerings. Because of their unit cost
advantage, the LCCs and recently reorganized
airlines have and continue to exert downward
pressure on ticket prices compared to historical
levels. Because of the relatively low barriers to
entry and financial success of LCCs, we expect
the expansion of low-cost and low-fare carriers to
continue. We compete with many of these
carriers directly now, and expect to compete with
new entrants in the future. For example, Virgin
America, a new LCC, has announced plans to
offer non-stop service between Seattle and Los
Angeles and between Seattle and San Francisco
in the spring of 2008.
FUEL
Our business and financial results are highly
affected by the price and, potentially, the
availability of jet fuel. Fuel prices have increased
dramatically over the past few years and these
increases have hurt our financial results. We
refer to the price we pay at the airport or “into-
plane” price, including applicable taxes, as our
“raw” fuel price. Raw fuel prices are impacted by
world oil prices and refining costs, which can
vary by region in the U.S. Generally, West Coast
jet fuel prices are somewhat higher and
substantially more volatile than prices in the Gulf
Coast or on the East Coast, putting both Alaska
and Horizon at a competitive disadvantage.
Historically, fuel costs have generally
represented 10% to 15% of an airline’s operating
costs. However, in recent years, fuel costs have
risen sharply to represent 20% to 30% of total
operating costs for airlines. Both the crude oil
and refining cost components of jet fuel are
volatile and outside of our control, and they can
have a significant and immediate impact on our
operating results. Our average raw fuel cost per
gallon increased 8%, 17%, and 34%, in 2007,
2006, and 2005, respectively.
Raw Fuel Price per Gallon
$0.50
$1.00
$1.50
$2.00
$2.50
2002 2003 2004 2005 2006 2007
We almost exclusively use crude oil call options
as hedges to decrease our exposure to the
volatility of jet fuel prices. Call options effectively
cap our pricing on the crude oil component of
fuel prices, limiting our exposure to increasing
fuel prices on a percentage of our planned fuel
consumption. With these call option contracts,
we still benefit from the decline in crude oil
prices, as there is no downward exposure other
than the premiums we pay to enter into the
contracts. We also use collar structures in
limited instances for fuel hedging purposes.
Additionally, we enter into fuel purchase
contracts that fix the refining margin we pay on a
certain percentage of our fuel consumption.
Fuel costs, including gains and losses stemming
from changes in the value of our hedge portfolio,
were approximately 27% of our total operating
expenses in 2007, 26% in 2006, and 20% in
2005. Currently, a one-cent change in our
hedged fuel price per gallon affects annual fuel
costs by approximately $4.0 million. In addition
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ŠForm 10-K