The prospects of further steep rises in the price of oil have already seen several carriers add fuel surcharges to ease the pain, writes Chris Tarry of CTAIRA

The airline industry's tentative recovery over the past year has taken place against the bleak backdrop of a seemingly inexorable rise in the price of fuel. And now that steady rise looks like turning into an even more aggressive hike. In May, as crude oil prices climbed to a decade high at over $40 a barrel, that sparked an immediate airline reaction in the form of a series of fuel surcharges.

In reality, the link between oil price and airline well-being is a little more complex than the reaction to the price of crude suggests. Not least, there is the question of currency. The dollar oil price is clearly at its most painful for those carriers exposed to a strong dollar exchange rate. To date, the dollar has been relatively weak against the major currencies but it is now moving and in the wrong direction.

Equally significant is the extent to which a carrier is protected from the immediate pain by past hedges fixed at lower prices. The most recent quarterly results from both sides of the Atlantic illustrate the point. In the March quarter, the US majors reported fuel price rises that ranged from 18% at Northwest Airlines to only 1.9% at Continental Airlines. The absolute dollar price paid for oil also showed a wide range: from United Airlines at just over 107¢ a gallon, through to Southwest Airlines at just under 80¢.

The latest figures from Europe show that the average dollar price for British Airways before hedging stood at 105¢, compared with just over 100¢ a year ago. In local currency terms there should have been a fall of some 8% given that the exchange rate moved from $1.60 to the UK pound in the first quarter of 2003 down to $1.83 this time.

But hedging has its limits. In the end, it is most useful in helping to minimise the risk in an input price that accounts for some 10-15%of airline costs. However, hedging comes at a price and neither is it always certain to have a positive outcome. Clearly, it also depends on how you view the prospects for the future path of the oil price. New hedging at current levels would appear unlikely.

There are a number of ways in which the effects of the fuel price rise can be offset, including the introduction of fuel price surcharges on cargo and passengers. In the case of a charge on passenger tickets, it is clearly a case of leaders and followers. Indeed where some airlines might have led not all others will necessarily follow. In Europe, BA provided the lead with the announcement that it was to introduce a £2.50 ($1.40) per leg surcharge for tickets sold in the UK and $4 elsewhere. Given that BA expects fuel to be £150 million higher in the current year, the surcharge at the current levels mathematically will recover in the order of £90 million.

BA's no-frills competitors have chosen not to follow suit and quickly sought to exploit any marketing advantage that they can. The reality, as low-cost carriers themselves realise, is that their segment of the market is so price sensitive that any increase in fares is to risk a decline in traffic. What is not certain, however, is whether by not following they will gain a traffic and revenue advantage.

Other international carriers have now followed BA's lead, including KLM, Virgin Atlantic, Air New Zealand and Singapore Airlines. In the USA, American Airlines has announced a $2 surcharge for domestic passengers. Had this been in place in the first quarter, this would have produced revenue of $58 million compared with a $66 million increase in the published fuel bill.

While there have been the inevitable consumer reaction to the surcharges, it would appear that the airlines that are introducing them are attempting to ensure that they are seen as reasonable and cost-related rather than an excuse for a blanket fare increase.

While airlines need to seek to recover the increased fuel cost from higher fares, the imbalance that exists between supply and demand poses a significant challenge. The last time passenger fuel surcharges were introduced, the relationship between supply and demand was very different and they were absorbed by the market. This time there is clearly a need to go the extra mile to demonstrate their transparency.

There are a wide range of views on what might happen to fuel over the next year or so - the view we have selected is that of the US Energy Information Administration, which suggests that it may remain over a dollar a gallon until almost this time next year - but anything could happen between now and then.

Source: Airline Business