When will air fares fall on the back of cheap oil?
Everyone is talking about the plunge in oil prices but, while consumers can reap the benefits in many sectors, air passengers are yet to see cheaper fares.
Some optimists expect airlines to pass on fuel savings to passengers, while others say airfares will remain as high as when oil was above US$100 a barrel because demand for air travel is still strong.
The International Air Transport Association (Iata) says consumers will benefit substantially from lower oil prices and will see ticket prices slashed in 2015. The airlines’ association expects airfares to fall by an average of 5.1 per cent in 2015 compared with 2014.
But the relief for passengers may be delayed, according to Iata, as airlines are still using oil they purchased months ago – what is known as “hedging” – and for which they paid substantially more than today’s prices.
Fuel hedging has been a common practice among airlines in recent years in light of rising energy prices. Typically, airlines sign contracts to buy fuel at a specific price range to protect themselves from excessive rises in oil prices. But now, as oil has shed more than 40 per cent of its value since June, airlines that hedged are missing out on the cheaper jet fuel.
“Airlines have a history of passing cost savings to passengers rather than having sustainable returns,” says Will Horton, a senior analyst at the Centre for Aviation (Capa).
“But in the short-term, some airlines that will incur losses from fuel hedging will need to make up for that.”
This month, Etihad Airways said it had ended its hedging programme with lenders to mitigate risks on jet fuel after oil prices dropped at the fastest pace in two years.
Since June, oil has fallen from about $115 per barrel to nearer $60 per barrel now – on the back of an increase in production in countries such as the US and Opec’s decision not to cut output below its current levels.
Oil constitutes an average of 30 per cent of an airline’s costs.
But despite the possibly good news for passengers, some are less sanguine.
“Many airlines are locked in on fuel hedges, months ahead and so cannot simply reduce prices as soon as oil falls,” says John Strickland, the director of the London-based JLS Consulting.
George Hobica, the founder of Airfarewatchdog.com, says as long as demand for air travel is there, airlines have no enticement to bring their fares down.
“Why would they lower their fares, if they don’t have to? They will just take the money and run,” says Mr Hobica.
“The airlines’ attitude is, ‘We have lost billions of dollars. Profit margin is around 1 per cent, which is ridiculous compared to other industries.’”
In its industry predictions for 2015, Iata expects airlines to make a total of $25bn next year but this only represents a net profit of 3.2 per cent.
Mr Strickland, however, sees market forces of supply and demand working more in favour of the consumer.
“Market competition means that prices are already pretty competitive and this dynamic is a bigger favourable influence for passengers than unpredictable oil price changes,” he says.
Airlines have restated this point of view. Emirates Airlines says it offers a variety of fares depending on “market forces”. This year it incurred some extra fuel charges, as it had to change some of its routes to avoid flying over conflict zones.
“As a precautionary measure we do not overfly Iraq, Syria or Ukraine, but fuel consumption increases as a result of the longer flights paths,” Emirates says.
“Emirates has already incurred significant costs by absorbing the previous price increases and the fuel surcharge … rather than incorporating them into fares.”
Etihad Airways also says the market is the main determiner of its ticket prices.
“Total ticket prices are made up of a combination of elements, including fuel surcharges,” it says, adding that it “continuously monitors and adjusts total ticket prices” to ensure it is competitively positioned in the markets it sells in.
Analysts seem particularly optimistic for Etihad, saying its equity partners can also benefit from the drop in jet fuel prices.
Over the past three years, Etihad has been acquiring equity stakes in struggling carriers to boost its geographic footprint and connectivity.
This year, Etihad has grown its equity partnership to eight, comprising Air Seychelles, airberlin, Virgin Australia, Air Serbia, Ireland’s Aer Lingus, India’s Jet Airways, Italy’s Alitalia and Etihad Regional (formerly known as Darwin Airline), which is awaiting final regulatory approval.
Saj Ahmad, the chief analyst at StrategicAero Research, says it would be a sensible move for Alitalia, a financially struggling carrier, to consider hedging.
“With oil prices falling, now is a good time as any for Alitalia to think about hedging its fuel needs. Oil prices going down now means that soon they will start to rise again,” says Mr Ahmad.
In the meantime, Mr Hobica says if any airlines can afford to lower their prices, it would be the Arabian Gulf carriers, given their strong financial positions.
“Airlines don’t feel like they need to give back but if anyone can do it [cut fares], it is probably the Gulf carriers.”
“We may see some promo-code sales [from Gulf carriers]. They may test the water in some of their new routes, as they have to fill the planes,” he adds.
Competition between American, European and Gulf carriers, in particular Emirates, Etihad and Qatar Airways, has heated up in recent years. Legacy carriers view Gulf airlines as the new kids on the block.
Germany’s Lufthansa, for instance, has previously alleged Gulf carriers receive state subsidies and government support. In response, Emirates refuted claims it benefits from unfair subsidies and said the European country benefited from its activities.
In a 139-page report published in 2012 it claimed more than 18,000 jobs in Germany were dependent on the economic activities of the carrier, while the value of money spent by incoming tourists carried by Emirates exceeded €1.6bn (Dh7.94bn) each year.
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Updated: December 29, 2014 04:00 AM