What has been the effect of the current low price of fuel on airlines, airline passengers and the air transport industry and how long is this state of affairs likely to continue? BILL READ FRAeS reports.
The price of oil is currently at record low (Money AM.com)
The price of oil has fallen from $115 per barrel in 2014 to between $30 and $45 per barrel over the past six months. This, in turn, has reduced the cost of jet fuel which has gone down by as much as 70% from previous highs.
In theory, this ought to be good news for the air transport industry with reduced costs for airlines, lower ticket prices for passengers and a general expansion in the airline industry. However, in practice, low fuel prices have resulted in some unexpected repercussions in certain sectors of the aerospace industry where it has had a negative rather than a positive effect.
Good news for airlines?
Ryanair has been unable to benefit significantly from low fuel prices due to over reliance on hedges. (Ryanair)
Low fuel prices should benefit airlines which have been complaining bitterly about how their finances were hit when prices were high. According to figures from the US Department of Transportation, US airlines spent around $30bn on fuel each year in 2013 and 2014, when prices were at their highest. In its World Airline Profit Outlook 2016 report, the CAPA Centre for Aviation calculated that airlines’ fuel costs fell from 30% of total revenue in 2014 to 25% in 2015 and could continue to fall to as low as 19% this year. In January, the International Aviation Transport Association (IATA) reported that, provided crude oil prices remain low, the airline industry’s annual fuel bill could fall by around $12bn in 2016.
However, whether or not an airline benefits from the fall in fuel prices depends on how much it is actually paying for it. Many airlines opt to offset potential fuel price rises through hedging contracts. If the price then goes up, then the carrier benefits but, if it goes down, it ends up paying more than if it had bought it on the open market. To give some examples: US carrier low-cost Southwest reported that it had spent $852m on fuel in the first quarter of this year. However, the airline suffered from $275m in hedging losses which meant that it paid $1.78 a gallon for its fuel instead of the current rate of $1.22. In 2015 US carrier Delta Air Lines had hedging losses of $2.3bn while United Continental lost $960m. Both Delta and United have since reduced their reliance of hedging and had said they have no hedges in place for next year. American Airlines, which abandoned hedging in 2014, benefitted from cheaper fuel costs than many of its rivals.
While US airlines are starting to benefit more from low fuel costs, some European and Asian airlines rely more heavily on hedging because they have to buy fuel with US dollars but collect most of their revenue in other currencies, are still locked in to higher prices. The International Airlines Group (IAG) – which owns British Airways, Iberia and AerLingus -reported that its fuel costs for 2015 had fallen by 6.3% but Irish low-cost carrier Ryanair - which is reported to have relied on hedges for 95% of its fuel needs - is paying an average of 165% above current spot prices.
In the current low price market, it is tempting for airlines to abandon fuel hedges and just pay the going rate. However, while this policy might pay dividends if fuel prices remain low in the future, it could equally well backfire on the carrier if prices start to rise again.
More money for airlines
Low fuel prices have enabled airlines to introduce new long-haul routes. (Emirates)
The reduction in fuel prices had helped airlines improve their finances. According to IATA at the end of last year, US carriers were collectively set to post $33bin in net profits in 2015, nearly 90% up from $17.4bn in 2014. IATA claimed that profits could rise again this year to $36bn.
So what are airlines using their extra money for? According to a report by Credit Suisse, US carriers retained between 50 and 75% of their fuel cost savings which they used to upgrade fleets, reduce debts and reward shareholders. In 2015, over $10bn was returned to shareholders in the form of stock buybacks and dividends - twice as much as in 2014.
Airlines are also able to introduce new routes which were not previous viable, such as ultra-long routes. In March Emirates inaugurate the longest non-stop flight in the world from Dubai to Panama City of 17 hours and 35 minutes using a Boeing 777-200 LR. Singapore Airlines has announced plans to for a 19-hour non-stop flight from Singapore to New York in 2018. “Not only is the industry as a whole more profitable but it can now also afford to fly to new locations which were previously uneconomic,” comments Norbert Kamp, Chief Commercial Officer of Air BP. However, he warns that: “the additional capacity driven by lower fuel prices may, in the long term, erode margins and expose airlines to a loss if prices go up again.”
What about ticket prices?
A question being asked by passengers is why have airline ticket prices not fallen in line with lower fuel costs. Charlie Leocha, chairman of the consumer-advocacy group Travelers United, claims that airlines have done a poor job of passing along fuel savings to consumers, saying: ‘consolidation in the airline markets and the way that airlines follow each other’s airfares and fees in lockstep have eliminated competition in the aviation market.’
The airlines have a variety of answers to this, the main one of which being that they are still committed to higher fuel costs due to price hedging - although IATA says that the higher price hedging agreements should begin to drop during 2016.
Other reasons given by carriers for tickets remaining at roughly the same level as before is that other costs are still high - particularly that of labour. To return to the example of Southwest, while the airline paid a quarterly fuel bill of $852m, it also paid $1.54bn to staff.
Another reason given by economists is that there is no incentive for airlines to compete against each other with lower prices while demand for air travel remains high. IATA has commented that airlines also have to take into account variation in the trading value of the dollar, the currency in which fuel is traded.
Carrier imposed charges
Carriers have been accused of retaining fuel surcharges despite the fall in the price of fuel (United).
Another bone of contention from airline passengers has been on the subject of fuel surcharges. In September the United Federation of Travel Agents’ Associations (UFTAA) sent an open letter to airlines, accusing them of being ‘shameless’ in continuing to include fuel surcharges in their prices despite the decrease in the price of fuel. The surcharge was originally introduced to cover sudden unexpected increases in oil prices, However, according to UFTAA, many airlines were still charging a fuel surcharge ranging from €25 to €450 per ticket.
In recent months, many airlines have dropped their fuel surcharges, although market experts have commented that the charges have reappeared until the title of ‘carrier imposed charge’.
Other commentators not fond of the airlines have suggested that the recent consolidation of the airline industry in a smaller number of larger groups have enabled the carriers to work with each other to fix prices. US Senators Markey and Blumenthal have proposed a ‘FAIR Fees’ amendment to the Senate’s FAA Reauthorization Act which says that: ‘Ancillary fees are out of control and the lack of effective competition means that market forces alone are unlikely to stop their growth. In 2015, US airlines collected $10.8bn in ancillary fees, an increase of 24% since 2014.’
In January British Chancellor George Osborne was been quoted as saying that he will be watching the airlines ‘like a hawk’ to ensure that passengers benefit from lower prices, although what action he could actually take to enforce this is uncertain.
Even where fares have dropped, they have not been in line with fuel prices. Data from the US government reports that international fares have fallen by 15%.
Where ticket prices have come down has resulted in an increase in passengers. Data from the Indian Ministry of Civil Aviation showed that passengers carried by domestic airlines between January and November 2015 grew by 20.41% to 73.38m. Even if airfares do not fall, air transport may benefit as passengers have more money to spend from other oil-related price reductions - such as lower petrol costs.
Bad news for helicopter operators
Offshore helicopter company CHC Group has filed for Chapter 11 bankruptcy due to low oil prices. (Airbus Helicopters)
However, low oil prices are not good news for everyone. The fall in prices has hit both oil firms and their supporting businesses who have less money to spend on services such as air travel. “Some airlines have lost business travellers, especially in business class due to the fact that the low oil prices are partially due to the slowdown of the global economy,” observes Norbert Kamp of Air BP.
Another economic casualty has been the helicopter sector, whose oil and gas transport business have been hit by the current downturn in the fossil fuel market. As energy companies cut back on the total of working oil rigs in operation, there is a knock-on effect on specialist transport companies, such as CHC or Bristow, which use helicopters to ferry workers and supplies to and from the rigs. These companies, in turn, ground their unused helicopters and reduce orders for new units. One report claims that, of the 1,900 helicopters around the world which could be used in the oil and gas industry, only one fifth are currently in full-time use. In early May offshore helicopter company CHC Group filed for Chapter 11 bankruptcy due to low oil prices.
Meanwhile, rotary wing manufacturers, such as Lockheed Martin, Airbus Helicopters and Bell, have all faced a fall in sales. This decline has not just come from customers directly involved in the oil industry but also from companies or countries which have been indirectly affected by the fall in prices.
The fall in the price of oil is also having an effect at a macro economic and political level as it weakens the influence of countries which rely heavily on oil revenues. Nigeria’s government is reported to rely on oil revenues for 75% of its revenues, with Venezuela and Russia’s dependence is estimated at 40% and 50%, respectively. The economic effect has already been noticed in the Middle East where national governments have cut back on spending - making last year’s Dubai Airshow one of the quietest for new orders on record.
Reduced oil revenues are also changing the geopolitical fortunes of major energy-producing countries. Nigeria is currently fighting an insurgency by Boko Haram while Venezuela is in a state of economic collapse with inflation running at 700%. Russia’s economy is expected to contract in 2016, accelerated by economic sanctions due to its intervention in Ukraine. Angola has cut back on government spending and is in negotiations with the International Monetary Fund while other oil producing countries, such as Iraq and Libya, are in a state of political turmoil.
Boeing’s re-engined fuel-efficient 737 MAX was launched during a time of high fuel prices. (Boeing)
It was no coincidence that oil prices were high when Airbus launched its re-engined fuel efficient A320neo in 2010, followed by Boeing in 2011 with its 737MAXs in 2011. Now the prices have come down again, is there a risk that airlines might decide to defer deliveries of new fuel-efficient aircraft and to extend the service life of existing aircraft, at least as long as their maintenance costs do not exceed fuel price gains? Because investment in new fleets is a decision which looks to the long term, this trend does to seem to be happening, although there was one example in June 2015 when American Airlines postponed delivery of 35 A320 neos from 2017 to 2019. Another airline which has also deferred its new orders but also switched from conventional to more fuel-efficient aircraft is US carrier JetBlue which, in November 2014, announced the cancellation of 18 A320 family ceos due for delivery between 2016-2018 in favour of 18 A320 neos to be delivered in 2022-2023. “Fleet plans are based upon long term trends and most airline executives would bet fuel prices won’t stay at these low levels,” comments market analyst Jay Sorensen from Ideaworks.
Looking beyond new aircraft orders, the availability of cheap oil may have a damping effect on the incentive to invest in alternative, sustainable energy sources. Although the international meetings of the UN Framework Convention on Climate Change have committed the international community to tackling the problem of global warming by cutting carbon emissions, most of the pledges made by individual countries are voluntary. Because oil costs are low at the moment, it is tempting for companies and counties to continue to rely on fossil fuels and cut back on investment in green technology. But this is a false economy, as this technology will be needed in the future when the price of oil will eventually rise again. In fact, it can be shown that the best way to keep oil prices low in the future is to continue to invest in green technology. A recent report from economic consultants Cambridge Econometrics (Oil Market Futures, April 2016) suggests that, without active climate policies to reduce carbon emissions, the global oil price could rise to $90 per barrel by 2030 and as high as $130 per barrel by 2050. However, if there was government investment in low-carbon technologies for air, sea and road transport, the demand for oil from the transport sector could be reduced by 11m barrels per day in 2030 and 60m barrels per day in 2050. This reduced oil demand could enable oil prices to stabilise at around $83-$87 per barrel in industries and consumers would benefit from reduced spending on oil, leading to net macroeconomic benefits.
CO2 targets and biofuels
The now scrapped British Airways and Solena Fuels Corporation biofuel plant was planned to produce 50.000 tonnes of aviation biofuel. (BA/Solena)
Meanwhile, the air transport industry has committed itself to tight environmental targets, including reducing CO2 emissions by 50% over their 2005 levels by 2050. “IATA’s CO2 reduction targets are not linked to the price of crude oil or jet fuel and hence the industry’s desire to achieve those targets should not be significantly impacted,” comments Norbert Kamp from Air BP. However, the introduction of more fuel-efficient aircraft and more efficient ATC operations will play an important role in meeting these targets.
Turning to alternative fuels for aircraft, the incentive to look for alternatives to fossil fuels is greatest when the cost of such fuels is high. “Low crude prices make green technologies, including biojet, less competitive,” admits Norbert Kamp. “In essence, higher jet fuel prices better support the business case of green technologies and biojet.”
Investment in green projects has been cut back. In 2015 the GreenSky project by Solena and British Airways to create 16m gallons of fuel from London rubbish was terminated due to lack of funding. However, early 2016 saw the opening of an Avinor/Air BP biofuel facility at Oslo airport to offer airlines an alternative to conventional fuels.
The lesson to be learned from all this would appear to be not to get complacent. Although there is no short term financial incentive to do so, the time to invest in new and renewable energy is now - before it is needed. Also, less oil being used in one sector means more is available elsewhere - and keeps prices down.
The cost of fuel to come
While the price of oil has now remained low for around two years, there is no guarantee that it will remain so. Looking back at the previous changes in the oil market, economic analysts attribute the previous peak in oil prices to a surge in demand from China, together with other developing countries such as Brazil and India. The rapid decline in oil prices from 2014 was due to a subsequent increase in the supply of oil, as production increased from newly tapped ‘unconventional’ shale fields in the US, combined with increased output from deep offshore fields and from Iraq. This was combined with a decline in demand from China, together with low economic growth from the US and Europe.
Currently, the price of oil is currently expected to remain at between $20 and $40 a barrel - although there may be fluctuations above and below this price. Even rumours can affect prices - in April a prediction from the International Energy Agency (IEA) of a major fall in production from non-Opec (Organization of Petroleum Exporting Countries) nations was enough to cause the price of oil rise to $46 a barrel.
What happens next will depends on supply and demand. If demand grows more than supply, then prices will start to rise again. There have already been attempts to reduce supply. A meeting was held in April between some of the major oil producing nations with the aim of reducing production to increase prices but no agreement was reached. Russia, Saudi Arabia, Venezuela and Qatar (which collectively account for around 23.75m barrels a day, equivalent to 25% of total global output) all agreed to freeze production but Iran - which has recently resumed exporting oil after emerging from economic trade sanctions - refused to send a delegate to the meeting.
Another scenario that might reduce supply is the possibility of more political meltdowns in cash-starved oil-producing countries. Alternatively, oil prices might rise if demand increases from the emerging economies of China and Asia.
When the wells run dry
Sustainable biojet is currently more expensive than fossil fuel but will become more competitive in the future (Air BP)
In the longer term, the supply of fossil fuels is not infinite and supplies will eventually start to run down - pushing up prices ever further. “This point in time is not exactly around the corner and we foresee that fossil fuels will continue to play a big role going forward,” comments Norbert Kamp of Air BP. “One critical factor is to manufacture biojet at prices competitive to fossil jet so that biojet can become more and more part of the aviation industry’s supply chain. This will, however, take some time and in the meantime it’s important that the industry works together to pave the way for biojet. Since initially the demand for biojet outstrips supply, it’s important that airlines are willing to pay a premium for biojet until supply and demand are balanced and eventually fossil jet parity is a reality.”