High oil prices are here to stay. So can airlines boost revenues to compensate? asks Chris Tarry of CTAIRA, with analyses from Fabrice Tacoun
Even the most cursory glance at the latest economic news might result in a mild sense of confusion. On one hand, the oil price, which at the time of writing is on an upward trend at $72 a barrel, is clearly not good news. On the other hand, the latest economic data suggests an acceleration of growth in some countries and a restoration of growth in others. For the airline industry it is rather a mixed bag. In the USA the ATA (Air Transport Association) airlines continue to report yield improvements, whereas Moody’s has downgraded JetBlue Airways. On the eastern side of the Atlantic there has been the perhaps inevitable sharp decline in easyJet’s share price following the sale by FL Group of its stake.
IATA’s latest forecast for jet fuel in 2006 is now just under $78 a barrel, with an expectation that the fuel bill for the industry will be some $17 billion higher than in 2005. Setting this in context, the additional spend on fuel is equivalent to a profit margin of 3.8%. To offset this there is a need to generate an additional $17 billion of revenue or reduce non-fuel costs by this amount.
In theory at least, given what appears – for the time being – an improving economic environment, there should be no difficulty in recovering the higher fuel costs through a mixture of explicit or more general fare increases. However, there is often a breakdown between theory and practice. So far, in the wake of the most recent fuel price rises, we have seen KLM and British Airways announce higher long-haul fuel surcharges; where they lead others will surely follow. On the basis of the market’s current traffic expectations this will add £62 million ($108 million) in revenue to BA – equivalent to a margin on its passenger revenues of 0.9%.
In the USA the latest ATA yield figures for February show an increase of 12.4% in the domestic market and almost 10% on the Atlantic. In Asia the latest raft of results shows that while revenues are often well up, the increase in the cost of fuel has been greater.
There is no doubt that without the sharp rise in the fuel price the financial performance of the industry would reflect the benefit of the savings elsewhere; the reality is that oil costs more than $70 a barrel and is likely to stay there.
In the December edition of Airline Business we reviewed the relationships between economic activity and airline traffic and revenue. The current expectations for 2005 suggest passenger traffic grew at a rate some 2.2 times that of economic activity; above the long-term trend. Revenue grew 1.5-1.6 times that of GDP compared with the long-term trend value of 1.0 times.
Perhaps a key question is whether this raises the prospect of a structural shift/improvement in the relationship. This in itself raises another and perhaps even more fundamental question: are legacy carriers capable of structural revenue growth or is the peak of the economic cycle always going to reflect the best that it will ever be? As the new model airlines have demonstrated, structural growth is possible even in markets which have generally been regarded as mature.
In these cases the ingredients for success have been market access, fares that are low in relative if not absolute terms and an appropriate cost base. However, as we have seen, these carriers are not immune from competition and the consequences are the same as for any other business in terms of the operating result.
For airlines in Europe and the USA the prospect of transatlantic Open Skies appears ever closer. While the actual outcome might not satisfy all wants, it may bring what airlines on both sides of the Atlantic need to gain: greater market access.
Such an agreement would clearly reflect a structural shift in the dynamics of the market place and the opportunity that the market offers. However, it is clearly that not everybody will be a winner. The transition to the new market environment will neither be instant nor cost less. For some airlines the combination of increased market access, low absolute or relative fares, and an appropriate cost base will ensure that the change in the market enables structural growth.
However in the nearer term, the more pressing issue for all airlines is how to recover the costs of a yet higher fuel bill. And against this background, despite the improving economic conditions, particularly in the USA, the timing of the industry’s return to profit overall may begin to move again. Clearly something to add to the watch list. ■
Source: Airline Business
