The implications of the downward trend in oil prices

When oil prices shot up a few years ago, many transportation and delivery businesses started adding fuel surcharges to their prices. This year, the Airlines’ spend on fuel will drop to $192 billion, from around $204 billion last year. Indisputably, the drop in the cost of oil is a huge factor in the airline industry, where 30 percent of all expenses are for fuel. But airlines, along with other industries with large fuel expenses, have been slow to respond with lower prices: since June the spot prices for jet fuel fell from $2.84/gallon to $1.51/gallon those days. This is the magic about airline pricing in general where each carrier determines what fees to tack on, and they can use those additional revenues to cover any expenses – not just fuel – and we might have a split view of this. Just because fuel prices decline doesn’t mean fares should. But if you as an airline are going to specifically tie a piece of your pricing to fuel under YQ surcharges, then under transparency principle it better go down as well as up.

The general argument that airfare should be pegged to fuel costs (or any cost) makes no sense to me. Airlines should price based on demand for the product and demand is strong right now worldwide and not only for the growing Middle Eastern carriers. During the next downturn, fares will fall regardless of what fuel prices are doing. It’s all based on demand. The response to this is usually, ‘yeah, but airlines blamed fuel prices when they jacked up fares before.’ That is true. But that’s because a business needs to make money. Back in 2007/2008 ($145 a barrel in 2008), that wasn’t possible since spiking fuel prices and depressed economy made things ugly. But fares had to go up quickly so airlines could try to lose as little money as possible. Airlines didn’t increase fares with impunity, however. They had to slash capacity in order to be able to have a level of supply that could support higher fare levels. As the economy improved, capacity slowly increased with fares going higher as well. As you can imagine, when I hear people saying that fares should go down just because fuel prices have gone down, I disagree. But I do draw the line when it comes to fuel surcharges. Airlines have used surcharges in a variety of ways over the years. For the most part, they’re just an easy way to change pricing on a mass scale. But in many cases, we’ve seen airlines call them fuel surcharges. Then we’ve seen some quote along the lines of ‘we didn’t want to increase prices but we had to add a surcharge because the price of fuel is so high.’ If you’re going to specifically tie a surcharge to the price of fuel, then you better damn have it fluctuate as fuel fluctuates. Some airlines agree. Air Asia or Virgin Australia Airlines just eliminated their fuel surcharges. For other like Qatar Airways or Qantas they ditched also their fuel surcharge but it’s going to raise its base fare to offset the cut, basically without any reduction in the ticket fare but much more transparent. For other carriers, in particular Europeans or Americans, the drop in oil prices is too recent to justify removing surcharges or cutting ticket prices, but if the price of a barrel of oil stays around $50 for 12 months, that might be enough… Really? A year? Here we just miss to consider a small detail: as airlines hedge most of their fuel costs, it will take some time for the reduced cost of fuel and many players are not ready to be transparent with their fuel-hedging positions, a strategy close to gambling, especially for those who lose heavily! Anyway, the law of gravity – what goes up, must come down – applies to jetliners. It just doesn’t seem to cover airline surcharges and as we know also other costs have been increasing — costs of labor, cost of aircraft rent, cost of buying new planes. Whether the recent fall in price of oil represents something more significant than just short-term imbalance of global supply and demand remains to be seen, but if it continues, airlines would be motivated to keep their older, fuel-guzzling jets flying for a few more years and delay new orders in hopes of saving money. We can’t yet predict if it will last or how the air carriers will react, but I think now would be an excellent time for caution as something has changed despite very low interest rates… Definitely what is good news for the airlines raises questions for the jet makers which have been riding a wave of demand for the latest fuel-efficient jets, driven in large part by the stubbornly high price of oil… We may be about to enter one of those ‘interesting’ periods in the business again.  But as we’ve previously warned, all bubbles eventually burst.  Will lower fuel prices burst the narrow-body order bubble?  We’ll find out soon.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s