If forecasts are correct, rising fuel prices are likely to add further gloom over the next year to an industry already struggling to reduce costs, says Chris Tarry.
It is a fact of airline life that swings in the fuel price can have a disproportionate impact on industry profits, even at the best of times. And in these bleak times too a rising oil price is due to cause further pain in the near term. Even discounting the possibility of war in the Gulf, and allowing for some gains through more fuel-efficient flying and a degree of hedging, rising oil prices could penalise carriers with another couple of percentage points added to costs over the next year.
The relationship between fuel costs and airline profits is hardly a new theme. As previous analysis has shown, the price falls of 1999 did much to hide an otherwise dramatic decline in the operating performance of the industry (see Market outlook, April 2000).
More recently, during the first six months of 2002, although the absolute fuel price was perhaps 50% higher than in the first half of 1999, the fuel price in relative terms was 15-30% below the levels in the first half of 2001.
The consequence of this is dramatic and immediate. For the major US airlines alone, the benefit can be estimated at just over $1billion. Looked at another way, without the fuel price gain, first half losses would have been 25% higher for the US majors. As prices again climb, so the gain becomes a penalty.
There are factors which could soften the full impact of any future rise. The retirement of old, inefficient aircraft and changed operating procedures should have a positive benefit on the "fuel productivity" of the fleet. That will be further enhanced by reduced delays. In 2001, for example, British Airways estimated that delays at its London and Manchester hubs resulted in the consumption of some 66,000 tonnes of fuel, equivalent to the requirements of 2.5 Boeing 777s for a full year. At the same time, the reduction in delays in 2002 saved enough fuel for one 777 to fly for half a year.
There is also clear evidence that older aircraft types are indeed being removed from active flying and now represent a relatively smaller proportion of the fleet than they did a decade ago in the crisis that followed the Gulf War.
According to the latest statistics, 10% of the fleet of the US majors is now reported to be in storage. This, in large part, accounts for the reduction in the industry's overall fuel bill, although there is also evidence of active aircraft flying less. As around 60% of these stored aircraft are earlier generation narrow- bodies, some degree of a structural shift in fuel efficiency is not unexpected. A trend of improving fuel productivity appears to have begun in the US domestic market in early 2001, corresponding with the start of the increase in the number of old aircraft making their way to desert storage.
The rate of improvement in fuel consumption per seat mile, however, began to slow from November 2001.
The calculations are, of course, a little more complex than simply taking account of how many old aircraft are being stood downand replaced with newer, more efficient models. The analysis also needs to take account of changes in aircraft size and any related improvement in fuel consumption.
The rate of change in the price of fuel itself can also have an influence on fuel productivity. When the oil price rises rapidly, it tends to result in shifts in airline operating procedures. For example, that could include shutting down an engine to taxi in. Indeed, even over the last decade, fuel management has become more sophisticated and this too is reflected in the figures.
However, the more immediate issue is the impact that the forecast upward trend in fuel price will have on the bottom line today. Forecasts from the US Department of Energy suggest fuel prices are due to rise steadily over the next year or so. More specifically, the expectation is that the price of jet fuel in 2003 will be 15-20% above the levels of 2001 and therefore 20-25% above the levels seen this year.
The latest third quarter reports from the major US airlines show the emerging trend. It is true that, for some individual carriers, the impact of higher oil prices will be offset in the short term through hedging, but not entirely. While Delta Air Lines had hedged 50% of its requirements for the third quarter at an average price of ¢66 a gallon, the overall fuel price was ¢71. That compares with ¢60 over the first half and ¢69.6 in the third quarter of 2001.
Given continuing weakness in the passenger market, airlines have, at best, only limited ability to pass higher fuel costs through to the ticket price. At worst they will recover none of the cost from customers. So if the oil price forecasts hold true, and all other things being equal, then only one conclusion seems possible - that airlines will need to cut their underlying costs by a further 2-3% simply to stay where they are today.
Admittedly, divining the future cost of oil is hardly an exact science. Events could quickly change the picture for better, or for worse, especially if war breaks out in the Gulf. Meanwhile, it would seem wise to hold on tight for a bumpy ride ahead.
Source: Airline Business
