Fuel Prices – the Airlines’ Achilles’ Heel?

Amid the news of soaring earnings from a plethora of airlines following the drastic drop in fuel prices, it is evident that not all airlines have cut passenger fares as a result of such industry developments, but, in most cases, continue to reap the benefits in the form of improved bottom lines. As it is not a regulation for carriers to align fuel surcharges with oil prices, these fees still remain predominantly consistent for many market players, although pressure from regulators is intensifying.

Breaking the pattern are several airlines in Asia Pacific, which announced the removal of these charges. It remains to be seen if such changes will be reflected in an actual fall in passengers’ fares or whether it will simply be added into the base flight rates, which ultimately will make no difference for the end consumer.

Among the major reasons behind this discrepancy in the response of market players to the fluctuating fuel prices are bad hedging strategies and the aim of some airlines to compensate for the poor performance of revenue-weak routes as well as boost meagre corporate financial results.

The domino effect

It comes as no surprise that in the wake of the falling oil prices the International Air Transport Association (IATA) expects solid profitability in 2016 for the whole airline industry in the form of US$36 billion net profits for the year. Among players in North America, American Airlines has already registered a net profit (excluding net special credits) of US$6.3 billion for 2015, while Delta recorded adjusted pre-tax income of US$5.9 billion – a 29% rise over 2014. In Europe, the financial results for Q3 2015 appear encouraging for such labour strike-burdened carriers as Lufthansa and Air France-KLM, which for the Lufthansa Group reached €24.3 billion (US$26 billion) and for the latter player €7.4 billion (US$8.2 billion) revenues, excluding strike impact.

Airlines: Top 10 Global Companies by Value Share 2014 and Ranking 2010-2014

Company name 2010 2011 2012 2013 2014 % share of airlines 2014
American Airlines Group Inc 5 5 3 1 1 7.8
Delta Air Lines, Inc 2 2 2 3 2 4.3
United Continental Holdings Inc 1 1 1 2 3 4.1
Deutsche Lufthansa AG 6 6 6 6 4 3.1
International Airlines Group 7 7 4 5 2.9
Air France-KLM Group SA 5 5 3 3 6 2.7
Southwest Airlines Co 8 9 9 8 7 2.4
Emirates Group Plc 11 11 10 7 8 2.3
Qantas Airways Ltd 9 10 11 9 9 1.9
Air China Co Ltd 14 12 12 10 10 1.8

Hedging – the double-edged sword

Fuel prices have been fluctuating since 2014, with sharp variations, to reach some of the lowest levels of crude oil prices per barrel of US$38 in December 2015. Fuel is among the biggest expenditures for many airlines, varying between 20% and 50% of their costs. As such, the fall in fuel prices has forced many airlines to monitor their hedging strategies in an effort to prevent any losses in the medium term.

As most airlines use hedging to lock in a fixed amount of fuel for a fixed price, many of them are not fully benefiting from cheaper oil. For example, according to trade sources, Singapore Airlines has hedged 65% of its fuel needs from October 2014 to March 2015, ensuring the stability of up to 40% of its operational costs.

In line with these specifics of the market, airlines also insure themselves by introducing a fuel surcharge to the fare, thus preventing rocketing flight ticket prices, which can, in turn, hurt consumer demand – key for the pricing strategies of airlines. Fuel surcharges vary depending on the specific airline, destination and flight type (ie long haul or short haul), and can range from US$100 to over US$600.

When fuel prices go down drastically, it is expected that airlines will be able to lower or eliminate fully the fuel surcharge – a move that is ignored by most players, however.

World-Oil-Prices

Note: Euromonitor International forecast for Feb-Dec 2016

Not all is doom and gloom

Following the oil price fluctuations, Asia Pacific is taking a lead, with the Civil Aviation Department (CAD) in Hong Kong announcing that, as of 1 February 2016, the fuel levy for outbound travel will be abolished. This is expected to drive more demand for travel, reinforce price wars and boost competitive environment in the market, potentially benefitting the passenger. Dominant airlines in the region, such as AirAsia, Virgin Australia, Cebu Pacific, Cathay Pacific, Malaysia Airlines and Thai Airways, are among the players that have already removed the fuel duty. Plans are in place for Japan Airlines and ANA to follow suit. Other operators, such as Qantas, Air India and Air France-KLM, have opted to either add this levy to the total ticket price or reduce this tax.

What next

The contentious problem of fuel tax and how it is passed on to consumers will remain a shady area in the industry – and one which demands review. What is clear is that airlines that want to remain competitive will need to be responsive to the market fluctuations. Building stronger brand loyalty with passengers will require more transparent ways of building ticket prices, which also excludes a simple renaming of the levy to “carrier-imposed surcharge” – a move implemented by some operators.

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