Why cheaper jet fuel won't mean lower airfares anytime soon
Airlines will save billions this year thanks to cheaper jet fuel, but they aren't likely to share the bounty with passengers, not while so many flights are already full.
Instead, the airlines will use their windfall to pay down debt and reward shareholders.
Airline CEOs worry that oil prices could just as easily go higher. They hope consumers benefiting from cheaper gasoline will splurge on airline tickets. But the biggest reason airfares aren't falling: Planes are plenty full at current prices.
Fuel is the biggest single expense at most airlines, and spot prices for jet fuel have tumbled by half since mid-September. If prices stay around these levels, US airlines could save US$20 billion this year by some estimates.
The road to fuel savings at an airline isn't always as simple as it is for a driver at a gas station.
Airlines often buy contracts known as hedges to protect themselves against sudden upward swings in fuel prices. However, when the price of oil crashes, those contracts can lose a great deal of value. Analysts say the accounting losses will be more than offset by lower fuel prices.
For example, Delta Air Lines Inc, the nation's third-biggest airline company, reported Tuesday that it spent US$342 million less on fuel in the fourth quarter than it did a year earlier. But it reported a US$712 million loss because it had to write down the value of future fuel-hedging contracts by US$1.2 billion.
Airlines won't benefit equally from cheaper fuel because some, like Delta, will suffer losses on their hedging strategy. The biggest winner could be American Airlines Group Inc, which generally does not hedge.
Airline executives also cite the volatility of oil prices - they spiked to records in 2008, collapsed, then surged again until the recent drop - as a reason not to cut fares now.
Delta CEO Richard Anderson said Tuesday that his airline expects to save US$2 billion this year on fuel, even with hedging losses. He said Delta will pay down debt and reward shareholders by buying back company shares, which raises the value of the remaining stock. As for passengers, he suggested that they can shop around.
"The marketplace is incredibly competitive, and there are always differences in fares," Anderson said.
The prospect of cheaper fuel led Moody's Investors Service to raise its outlook for airlines this week from "stable" to "positive." Moody's analysts say that if crude oil is US$55 per barrel all year long - it was trading at US$44 last week - fuel costs at seven of the biggest US airlines will fall about US$20 billion in 2015 compared with last year.
Even with hedging give-backs, they will come out ahead by US$15 billion, Moody's says.
Travellers who expect airfares to drop when fuel becomes cheaper assume that airlines calculate ticket prices based on their costs.
That used to be true, says Robert Mann, a former airline executive who now consults to the industry. A decade or more ago, a financially weak airline would cut fares to sell tickets and raise desperately needed cash by filling seats that would otherwise fly empty. Not anymore.
"The industry is full at these prices," Mann says. "You couldn't stimulate additional revenue by cutting prices."
Mergers have left four airline companies controlling more than 80 per cent of the US market. And they have been very slow to add new flights. That makes planes more crowded. US airlines are filling more than 85 per cent of their seats in some months - close to record levels, according to the government.
"Right now the airlines have a great balance of supply and demand, and they are using it to ratchet up fares," says Jim Corridore, an airlines analyst for S&P Capital IQ.
By last summer, US airfares had increased five per cent in a year and 31 per cent in five years, according to government figures.
There is an increasingly popular view within the industry that cheaper oil might even lead to higher airfares.
The theory goes that consumers who are saving money on gasoline and heating bills now have extra cash to spend on travel. Moody's says that is one reason travel demand will grow at least 5 per cent this year.