The cruise line industry grew globally at a CAGR of 8% during 2009-15 and raked over USD 39.0 bn of revenue in 2015 (Source: Statistica).
The industry derives over 75% of the revenue from the sale of tickets to passengers, while other sources of revenue include onboard services like a casino, equipment rental, and retail concessions. Onboarding expenses (food, concessions, etc.) are a significant portion of the cost for the cruise line operators. But, apart from this, fuel expenses are a major part of the remaining cost structure.
Televisory’s analysis of the top three global cruise line operators (Carnival PLC, Norwegian Cruise Line Holdings and Royal Caribbean Cruise Line) reveals that the crude oil consumption by the cruise line operators varied marginally in response to the movement in oil prices. The crude oil prices remained range-bound at a significantly high level during 2011-14, this was followed by a notable decline commencing from 2014.
Thus, generally, a decline in the crude prices will have a positive impact on the cost structure while an increase in the crude oil prices will affect the cost structure negatively. However, this was not the case for the cruise line operators.
Televisory’s analysis on the fuel expenses pattern of the aforementioned companies reveals that the decline in the fuel expenses was not proportionate to the decline in the crude oil prices. Moreover, even the impact was opposite in certain cases, for instance, despite a fall in the crude oil prices there was an increase in the fuel expenses.
The above-stated charts if analysed in conjunction with the crude oil price movement in the same period depicts that, although the crude oil prices declined in 2012, the fuel expenses as a percentage of the gross revenue increased for all the three operators. It is worthy to note that the overall revenue for the operators either declined or remained stagnant in 2012 on a Y0Y basis. However, fuel expenses as a percentage of the gross revenue for all the operators exhibited a declining trend since 2013, the magnitude though was not similar. Moreover, an identical trend was observed in the average fuel expenses per PCD (Passenger Cruise Days) over the same period.
The above anomalies can be explained through the business operating model of the cruise line operators. In order to limit the losses due to the volatility in the crude oil prices and in order to have more predictable cash flows, the cruise line operators typically tend to hedge their fuel requirements by using different kinds of financial derivative instruments. Normally, cruise line operators hedge their fuel requirement for three to four years in advance to safeguard from an upward price movement. However, any downward movement in the crude prices results in a premium loss which is accounted for in the fuel expenses. On an average, the operators hedge 60-65% (1-Year onward), 55-60% (2-Year onward), 40-50% (3-Year onward) and 15-40% (4-year onward) of the fuel requirements based on the current prices. Although, the percentage vary from operator to operator as per their specific hedging policies.
* For Carnival PLC % saving/(loss) is 0.0% for all years as the company does not report hedging gains/(losses) as part of fuel expenses
In 2015, all the operators incurred huge hedging losses on account of significant reduction in the crude oil prices. Further, due to this, the full benefits of a significant decline in the crude oil prices was not realized by the cruise line operators. This is validated by an analysis of the hedging (loss) gain adjusted fuel expenses in the chart below. In the period, where cruise line operators recorded gains from hedging activity (like 2011, 2012 and 2013), unadjusted fuel expenses as a percentage of revenue was lower than the adjusted fuel expenses as a percentage of revenue. On the contrary, at a time, when cruise line operators recorded losses from hedging activity (such as in 2014 and 2015), unadjusted fuel expenses as a percentage of revenue was higher than the adjusted fuel expense as a percentage of revenue. Hence, even though the fuel expenses were declining in tandem with the crude oil prices the full benefit of the decline in the oil prices was not realized by the cruise line operators.
* The graphs have been adjusted to remove the impact of hedging
However, cruise line operators witnessed a cost saving on account of declining crude oil prices, the average ticket revenue per PCD remained largely at a similar level over the past 5 years (only Norwegian Cruise Line Holdings registered a growth owing to an increase in the ticket prices).
Therefore, supported by largely stable revenue/PCD and fuel cost savings all the operators fared well and profited in 2014 and 2015 despite a high hedging loss as hedging losses were more than offset by the savings on fuel expenses on account of sharp decline in the prices of crude oil.
Norwegian Cruise Line showed improvement in EBITDA margins throughout because of continuous increase in passenger ticket prices
On the basis of the hedge adjusted fuel expense, the average EBITDA/PCD was even better for the cruise line operators.
Hence, the conclusion is that, since fuel expenses form a significant portion of the cruise line operator’s operating expenses, crude oil price movements does have a strong bearing on their profitability. However, due to the industry-wide crude oil hedging the impact of crude oil price movement is not fully recognised in their operating profitability.