While the recent relenting in oil prices has provided airlines with an unexpected but welcome easing of their costs, the pain that has been caused by fuel volatility makes it unlikely that carriers will too drastically alter their current course.
Continued falls since July have brought the Brent Crude oil price down at $66 – its lowest level for five years, and close to half the peak of around $125 in the spring of 2011.
This, however, does not necessarily translate into lower cost for most airlines, at least not in the near term.
"The big guys are all hedged, so the benefit doesn't really kick in yet," says Oliver Sleath, European airlines analyst at Barclays. He notes the example of Ryanair, which had mixed fortunes with its hedges against the fuel volatility of 2007/8 but is now 90% hedged for the next 12 months. Europe's other major carriers are also significantly hedged.
He also points to the impact of the US dollar's strength, which – for airlines based in the eurozone – partly mitigates the lower costs.
"Hedging is something of an illusion as it postpones the day of reckoning and, as some people are learning, it also postpones the day of cheaper fuel to some extent – so it can work that way depending on the hedge you've got,” says Peter Morris, chief economist at Flightglobal consultancy Ascend.
"In the long run, the belief must be that oil prices are going to rise in real terms, because you've got a finite natural resource," he says. "What we are seeing [at the moment] is on the one hand an impact of weak demand and on the other the US fracking, which gets you some cheaper oil for a while.
"I think there is going to be a period of instability but, certainly if you start to see world growth return, then the demand – particularly in places like China and emerging markets – is going to start going up again. And when it does, you are going to get shortages of supply," adds Morris. "So I look on it as temporary phenomenon, but it could be one people find quite useful."
Where the oil price goes next is a guessing game. Few would have predicted the drastic fall over the last few months. There is a multitude of factors behind the current fall, including the impacts of shale gas supply in the USA and the political restrictions around Russia. There's an even greater multitude of theories on what might make oil go even lower or jump back. But few are ready yet to believe that low oil prices will be a "new norm" for the industry.
"We’ve seen big falls in the past followed by big rises," notes Brian Pearce, chief economist at IATA. "When you look at the oil market, there is clearly oversupply. But the oversupply is relatively small compared to the oversupply of 2008 and '09.
"I would have thought there would be some wait-and-see [on strategy], because it's very difficult to predict oil prices and airlines will want to take a longer-term view," he says.
Historically, oil prices have often moved in line wit the economy. This has meant that the benefits of lower costs have been offset by weaker travel demand amid a bleaker economic picture. But the sharp fall in oil prices comes as economic growth – at least at a global level – is on the rise.
"A lower oil price has to be good for the airlines as their costs will come down, though there will be some time lags there," says IATA chief executive Tony Tyler. "But if it's a sign of weaker global economy, it's a bad thing. The improvement in airline results has happened when the fuel price is quite high, so it's not obvious there is necessarily a connection."
Pearce adds: "In terms of financial performance of airlines, it is not clear whether high or low oil prices are the best thing. We have seen over the last few years an improvement in performance for airline investors during a period of high oil prices. But I think what we can say is it is unambigiously good for consumers. There will be some delay because with volatile energy, airlines have been hedging for some time. That will come through [in] fares and cargo rates."
In releasing an improved financial outlook for the industry under which this year's record net profit, in cash terms, of $19.9 billion would be surpassed again next year with a profit of $25 billion, IATA anticipates airline fuel costs falling nearly 6% next year. That is based on an average crude oil price of $85 per barrel – the lowest level since 2010. The airline body expects this to translate to ticket prices and the average return airfare (excluding taxes and surcharges) falling 5% to $458.
"You'll get all sorts of decisions off the back of that [lower costs] and people who aren't tied in to hedges will be looking at using some planes for a bit longer," says Ascend's Morris. He adds that airlines might be tempted to use written-down aircraft – despite their higher operating costs in terms of fuel – for longer while the oil price is down.
"If we were talking about it going down to $60 from what was $120, you are talking about halving the fuel price, which on written-off aircraft will make it quite attractive to put that capacity into the market," he says.
Barclays' Sleath also believes that lower fuel costs could have an impact on airline capacity and, in turn, the competitive landscape, as some airlines may look to take advantage of lower costs to secure market share.
"On the North Atlantic and US domestic, the markets are consolidated, and airlines are very generally disciplined and want to maximise pricing," he says. "In Europe, it's a different question. There are still 150-odd airlines in Europe, and many are focused on market share.
"I can quite easily see some of the weaker players – who couldn't afford to hedge – either cutting prices to match LCCs or not withdrawing capacity as fast as they had planned to, because suddenly their cost base has improved and they are losing less money."
Tyler, though, believes drastic change is unlikely as airlines have seen a benefit from a disciplined approach in the market. "High oil prices have put quite a discipline on the industry, and one of the reasons why airline profitability has improved despite the higher fuel price is because of that discipline," he says. "We'll have to see what impact the lower fuel prices will have on airline plans."
Source: Cirium Dashboard
