Airlines check the oil gauge

March 11, 2011

It was all going so well. In mid-February, pundits were bullishly suggesting that despite a year of rising airline prices business travel was inexorably on the up. And though Friday’s earthquake in Japan provoked an oil slide by more than $3, with U.S. crude falling below $100, events across the Arab world have scuppered last month’s optimism and thrown energy costs into disarray.

Business travel is all revved up – a poll of corporate travellers released today by Ascend, an aerospace consultancy, says 49 percent expect to fly more for business this year – but airlines are reacting to the rise of energy costs with a slew of new surcharges (jet fuel makes up 35-40 percent of costs — higher for low-cost carriers). IATA said last week that global airlines’ net profits will halve this year as rising costs, especially oil prices, offset increasing demand.

Finance departments at firms all over the world will start thinking twice about their executives’ travel plans: our pleas that basic fare hikes won’t be affected will be met by benevolent sneers. Surcharges sit on top of negotiated corporate discounts.

So how has it panned out thus far? We reported this week that India’s airlines are staring at probable losses in the Jan-March quarter thanks to the spike in crude prices. So far, they haven’t passed on these costs to customers.

We also related how Qantas and Singapore Airlines will raise fuel surcharges to offset higher oil prices, while Cathay Pacific warned that growing energy costs could hurt its profits. The article quoted Andrew Herdman, director general of Association of Asia Pacific Airlines as saying, “Ticket prices have to go up by about 5-6 percent just to accommodate the extra cost on their oil.” Emirates also increased fares, while Lufthansa and Air Berlin told Reuters that they were considering higher surcharges.

US airlines have also been in the spotlight. Tom Parsons, chief executive of travel site Bestfares.com, perhaps puts it best: “The airlines are jacking up rates wherever they think they can get away with it… From the airfares to the fuel surcharges to the peak travel day surcharges, there’s not much you can get from an airline these days other than a seat assignment.”

Cutting price targets on major U.S. carriers, Deutsche Bank pointed out every penny per gallon rise in jet fuel costs the industry $170 million a year.

Chinese airlines seem to be weathering the storm more effectively so far. Read Air China’s chairman Kong Dong on the subject: “Oil prices were not cheap in 2009 and 2010, and our earnings have surged. That says a lot about our effort to cut costs and prioritise our network and improve our service.”

If the chaos continues – and much will rest on whether the so-far subdued situation in major-oil-producer Saudi Arabia escalates – surcharges will swiftly be buttressed by hikes to airline’s basic fares (particularly pronounced at the premium end of the scale) and a downward-travelling spiral could ensue.

Everyone will feel the pinch. Margins at travel companies, already battling fierce competition, severe weather and political risk, will be ever more tightly squeezed. Hotel groups have yet to be affected, but rising oil prices, said Starwood Hotels’ Chief Executive Frits van Paasschen, “could slow the economy, and hotel demand is a function of the economy.”

Carlson CEO Hubert Joly went further, saying: “For leisure travellers, there’s a psychological effect, and they might change their destination.”

I was keen to end on a happy note, but not a lot of respite can be felt looking ahead to 2012. Though marginal compared to rising jet fuel prices, airlines’ entry to the EU’s carbon market will add at least 1 billion euros to their costs, some of which will be passed on to customers. The cost of a return economy flight from Europe to New York, we figure, could rise by between 5 and 40 euros.

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