Fuel prices have been on the rise again this year and carriers are unlikely to be able to pass on the burden, cautions Chris Tarry of CTAIRA
While there may be a hint of traffic recovery in the air, already scented by labour unions, airline management knows only too well that the pressure to cut costs is far from over. Yet there is at least one major input price over which even the most talented management team can have little control and that is the cost of jet fuel.
The vagaries of oil prices are a familiar shadow looming over the industry, influencing the bottom line for both good and bad. The significant impact comes less from the short-term fluctuations, especially for those carriers which are hedged, but from sustained highs and lows. At present, the risk is of the former.
Over the decade through to the end of 2002 jet kerosene prices had averaged around 60¢ per gallon, based on spot prices from Europe, Singapore and the USA provided by ICIS-LOR, a sister online pricing service to Airline Business. Within that range the most notable low came in 1998 when the average annual price dropped below 40¢, having fallen fairly consistently from the highs which followed the first Gulf War in 1991. The high came two years later in 2000 as the economy boomed and kerosene prices climbed above 85¢ per gallon.
Last year it still looked as though the price was broadly in decline from that high, benefiting the airline bottom line. In the first half of 2002 the falling price actually improved the cash position of the US airline industry by some $1billion. Since then the price has again been on the rise, spiking as the Iraq war came into view at the start of the year. Spot prices over the half have been close to a third higher. The US majors report an even steeper rise of 40% in their actual purchase price.
That, however, is history. The real value would be to predict the future trend, although that can be a thankless task in the roller-coaster world of oil.
Not withstanding this caution, expectations from the US Energy Information Administration (EIA) help give a guide to the future. They suggest that the price of jet fuel in the USA this year will be some 19% higher overall than in 2002, and some 11% up on 2001. For 2004, the current expectation is that the fuel price will be some 6% lower than this year but still 12% higher than 2002.
The problem is not the extent of the expected rise, so much as the timing. Unlike the last time there was a rapid swing in the fuel price, the opportunity to pass on fuel price increases through higher fares is absent. In the early 1990s and even in 2000, the control over capacity in the market allowed at least a partial recovery. Today the airline market remains exceedingly price-sensitive. Furthermore, there is also another factor to be taken into account as ticket promotions act to pull forward bookings. Whilst up-front cash may be welcome, if not essential, it does mean that an increasing share of future travel may be locked in at today's prices too.
Consequently, attention inevitably focuses on the cost side of the equation. In addition to reducing the cost of fuel by flying less, there are at least two other factors that come into play and will help alleviate, albeit marginally, the high fuel cost. First, there are changes in operating procedures - in particular not using all the engines to taxi in or out. Second, is the grounding of older less fuel-efficient aircraft which will also have, and is already having, an effect, boosted by the entry into service of new aircraft with reduced fuel burn. The production policies of the aircraft makers have clearly added to this with some opportunities to buy new aircraft cheaper than old.
Recent data suggests that the fleet is indeed getting younger, albeit with marked differences between regions. As suggested in this column a few months ago a large proportion of the currently surplus aircraft are, in fact, structurally unemployed on account of age and type. Certainly the changes in the jet fleets of the IATA member airlines give some indication of the extent of a substitution effect. Between the end of 2000 and 2002, there was a net reduction of just 29 aircraft, yet within this the number of Boeing 727s, DC9s and MD80s declined by almost 550 - a trend that will continue as the rate of new aircraft delivery continues at or close to current levels.
What then of the overall picture? Of late, a common theme among a number of airlines has been a target operating margin of 10%. Given that even at the peak of the cycle the industry has struggled to reach 6%, to say that there is a challenge ahead is understatement. In round terms, the industry, given a realistic view on revenue, has to cut its cost base by some $35 billion to get close to this target. Looked at against the backdrop of such a task, current swings in the fuel price are a relatively minor sideshow.
Source: Airline Business
