Fuel prices have been steeply climbing since the early part of this decade and the trend is showing no sign of reversing. April saw a number of airline casualties in the USA and one in Hong Kong. How many more victims will be claimed by fuel?
Airlines in the USA have been dying in droves recently, struck down by the seemingly relentless increase in the price of their most basic lifeline - fuel. As the fuel price axe continues to swing, how many more carriers will fall victim to its massacre? And will the airline deaths in the USA have a domino effect on carriers in other parts of the world?
The first week of April could be said to have been the week in which the airline industry really started to show concrete signs of a downturn. The first few days of the month saw Aloha, ATA and Skybus Airlines shut down their operations, citing rising fuel prices and competitive pressures, and US charter carrier Champion Air announce that it would cease operations in May. Days later Frontier Airlines filed for Chapter 11, although the Denver-based carrier insisted that it "filed for very different reasons than those of other recent carriers", instead blaming its predicament on its main credit card processor.
Perhaps following the "safety in numbers" philosophy, Delta Air Lines and Northwest Airlines on 14 April announced the long-awaited news that they are to merge in an all-stock deal valued at $17.7 billion. IATA chief economist Brian Pearce says the planned merger is a symptom of what will be a "critically difficult year for airlines exposed to US markets" - a year in which there will be a strong emphasis on efficiency measures. "One of the best ways of achieving these efficiency measures is through consolidation," adds Pearce. "This year is the most difficult year the industry is facing since 2001.
The difference with the latest rise in fuel prices to the previous three years is that the US economy appears to be in recession. Previously there was some offset driven by strong revenues, but that has disappeared."
IATA in April again downgraded its industry profit forecast for 2008, citing a slowing economy and high oil prices. It is now predicting industry profits of $4.5 billion for the full-year. In September 2007 the prediction had been $7.8 billion, which was downgraded to $5 billion in December of that year.
Outside the USA, Oasis Hong Kong Airlines became the second Asia-Pacific casualty after Indonesia's Adam Air. While oil prices were not the primary problem at Adam, Oasis singled them out in announcing on 9 April that it had entered liquidation and halted all operations. "As oil prices sharply increased, the fuel costs took up the majority of our budget," says Oasis chairman Raymond Lee.
And sharply increase they certainly did. In the 10-year period from 1997 to 2007, average jet fuel prices almost quadrupled from 58.4¢ per gallon to 213.5¢ per gallon. By March 2008 this figure had shot up to 316.8¢ per gallon, and it is showing no signs of abating. John Strickland, director of aviation consultancy JLS Consulting, points out that when "major carriers with money in the bank like easyJet and Ryanair are talking about profit warnings, it shows the magnitude of seriousness".
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"We will sit 20 of our aircraft on the ground this winter because it's cheaper than flying them" Michael Cawley |
Ryanair warned earlier this year that its profits for the fiscal year ending March 2009 could fall by as much as 50% due to high oil prices and fears of recession. The carrier has embarked on a cost-cutting programme that will see staff salaries frozen and aircraft grounded this winter to help it cope with its rising fuel bill. "We will sit 20 of our aircraft on the ground this winter because it's cheaper than flying them," says Ryanair deputy chief executive Michael Cawley. "That's wrong and it's a huge issue for us. We've made a virtue in the past of having year-round servicesbut I want to point out the difficulty we'll have this year."
Cawley adds that Ryanair's average passenger cost increased by €6 ($9.50) "just on fuel" this year: "We made an €11 profit per passenger last year, so we predict profits will decrease by 50% this year. This coming winter is going to be extremely difficult and there is enormous pressure on airlines to reduce costs elsewhere."
Cawley does not see a positive future for carriers in a less fortunate financial position than Ryanair. "It's chastening to remember that airlines in Europe were losing money when fuel was $20 a barrel," he says. "In the long-term, not even airlines can survive. What will happen, and I don't know when, is that many airlines will no longer be flying. This could be the last straw, perhaps, for some of them."
IATA's Pearce expects the battle for survival to be much tougher for carriers with exposure to the US market, and says that "two elements mean it's not going to be the same story across the world". The first is that "unlike the 1991 recession, the US economy looks very weak but Asia is very strong - even in Europe economies are still holding up". Secondly, there is "some offset" for carriers outside the USA because of the fall of the US dollar. For instance, Pearce points out that in the last year the price of a barrel of jet fuel in euros has risen by about 50% while the price in US dollars has risen by 100%. "So the situation is half as bad for airlines getting euro revenues," he says.
Tough Competition
On the flip side, the falling value of the dollar means that US carriers can offer more competitive ticket prices than their European counterparts. "Although the euro offsets fuel costs against the dollar, it makes competing with US carriers more difficult. So it's going to be tough for European carriers as well," says Pearce.
In Asia, although the region is somewhat cushioned by its strong economy, Chris Tarry of consultancy CTAIRA says carriers will feel the pressure of high fuel costs because of the longer sector lengths they operate. "In Asia the average sector length is 4,000km [2,485mi], while it's 2,000km in North America and 800km in Europe," he explains. Despite this, Qantas chief executive Geoff Dixon says he doesn't expect the downturn seen in some parts of the world to have a domino effect on other regions. "We don't see it as much in our part of the world," he says, adding that carriers had strengthened their businesses over the last several years to ensure that they were in "a better position to meet a downturn".
There are also signs the downturn is starting to have an impact on aircraft lease rates. Nok Air chief executive Patee Sarasin says the Thai carrier is now receiving proposals from leasing companies offering new 737-800s at 20% lower rates than a few months ago and he expects lease rates will drop further as distressed carriers offload aircraft or cancel new aircraft deliveries. "Leasing companies are more flexible now because they see the downturn coming," he says. "Four months ago we were looking at next-generation [Boeing 737s] and people were saying 'you have to wait a long time'. Now we're getting a lot of offers."
Cawley agrees that changes are afoot. "The aircraft market is going to change, although the timing is unclear," he says. "Leasing companies are repossessing aircraft from companies that have gone bust. It's a question of supply and demand and we're heading into a period of excess supply." Ryanair famously took advantage of lower aircraft purchase prices in the period following 11 September 2001 to snap up a large order for 737-800s. So will it follow a similar strategy if this downturn leads to significantly lower aircraft prices? "It will be post-2014 when our order book runs out, but there are opportunities between now and then to speak with manufacturers in a meaningful way," says Cawley.
No Fair Hikes
Raising fares to compensate for high oil prices is not really an option for carriers in markets where consumers are facing a possible recession. "You can't keep putting up the cost of travel because passengers will not travel," says Cawley. Ryanair has steadfastly refused to add a fuel surcharge to its fares, and there are signs that airlines that do levy such a charge are under pressure not to increase it too much on short-haul routes.
AirAsia adds a fuel surcharge but its chief executive, Tony Fernandes, says at the end of the day passengers look at the final price. "We are in a price sensitive market so we can't transfer the price of oil to other carriers," he says. "The challenge is to keep our fares low." He adds that carriers will have to focus on shaving costs from other parts of the business.
But while oil prices appear to be on a relentless uphill march, there could be a ray of hope later this year, according to Pearce. "Commodity prices don't go in one direction for ever," he says. "What will turn this around is either widespread recession to slow down demand [for oil], or the fact that new oil refineries will come on stream in 2010. We're likely to see prices declining at some point later this year." Pearce adds that there has been significant investment in oil production in the Middle East but "OPEC [the Organisation of the Petroleum Exporting Countries] has turned the taps off. They've got the ability to increase oil production, but they're not doing so".
Source: Airline Business
