How A Rise in Fuel Prices Affect the Airline Industry
Rise in Fuel costs
This paper reviews how oil prices affect the macro-economy and assesses quantitatively the extent to which the economies of OECD and developing countries remain vulnerable to a sustained period of higher oil prices. I have chosen this topic because airline industry in the economy of any country plays very important role and every economy in the World dependent on the Fuel largely and the rise in the fuel prices impacting the decisions of the countries and this topic I think need to be addressed. It summarizes the findings of a quantitative exercise carried out by the IEA in collaboration with the OECD Economics Department and with the assistance of the International Monetary Fund (IMF) Research Department. That work constitutes the most up-to-date analysis of the impact of higher oil prices on the global economy.
Oil prices still matter to the health of the world economy. Higher oil prices since 1999 partly the result of OPEC supply management policies contributed to the global economic downturn in 2000-2001 and are dampening the current cyclical upturn: world GDP growth may have been at least half a percentage point higher in the last two or three years had prices remained at mid-2001 levels. Fears of OPEC supply cuts, political tensions in Venezuela and tight stocks have driven up international crude oil and product prices even further in recent weeks. By March 2004, crude prices were well over $10 per barrel higher than three years before. Current market conditions are more unstable than normal, in part because of geopolitical uncertainties and because tight product markets – notably for gasoline in the United States are reinforcing upward pressures on crude prices. Higher prices are contributing to stubbornly high levels of unemployment and exacerbating budget-deficit problems in many OECD and other oil-importing countries.
The vulnerability of oil-importing countries to higher oil prices varies markedly depending on the degree to which they are net importers and the oil intensity of their economies. According to the results of a quantitative exercise carried out by the IEA in collaboration with the OECD Economics Department and with the assistance of the International Monetary Fund Research Department, a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second years of higher prices. Inflation would rise by half a percentage point and unemployment would also increase. The OECD imported more than half its oil needs in 2004 at a cost of over $260 billion – 20% more than in 2002. Euro-zone countries, which are highly dependent on oil imports, would suffer most in the short term, their GDP dropping by 0.5% and inflation rising by 0.5% in 2005. The United States would suffer the least, with GDP falling by 0.3%, largely because indigenous production meets a bigger share of its oil needs. Japan’s GDP would fall 0.4%, with its relatively low oil intensity compensating to some extent for its almost total dependence on imported oil. In all OECD regions, these losses start to diminish in the following three years as global trade in non-oil goods and services recovers. This analysis assumes constant exchange rates.
Today’s airlines face many new problems. The historical trends show the true story of what is happening in the airline industry. There are many factors that contribute to these problems and Increase in fuel rates/cost is one of them. The value of a barrel of oil has a direct impact on airliners within the European aviation industry, at the present moment the price of a barrel of Oil has held at about “$60 a barrel”, this figure however, is very unstable. To emphasize further, in mid July 2006 a barrel of oil had broken the “$78 mark” and has since stabilized, the long term issues however, suggest the value of oil could escalate again which can of course have cost implications for airliners. With the current political disputes in Eastern Europe and the unrest in the Middle East, the cost of oil is likely to rise as is the unstable nature of this resource and industry in general.
According to the latest statistics from the General Aviation Bureau, due to the fuel price surge, the cost of fuel has accounted to 31% of the cost of major business of airline companies in the first half of this year from 22%. The whole airline industry has afforded additional cost expenditure of 1.27 billion RMB.
Why does the airline industry which is always sensitive to price change take no action this time? The South-west Airline Company disclosed that now it was the peak period for tourism, and the number of airline passengers had just revived a little. If we raised the ticket price at this time the passengers would scare away. Several transportation companies also mention that the domestic transportation is stagnant recently, and it would be further overwhelmed if the airline raised price now. Therefore under the present condition of fuel price surge, the airline should minify the loss through management strengthening, cost lowering and efficiency improving, but not simply raise the price.
The airlines are in perilous financial condition. Two major airlines, representing more than twenty percent of the industry, are in bankruptcy. Passenger carriers have reported over $10 billion in 2002 net losses. Industry debt now exceeds $100 billion, while the industry’s $15 billion total market capitalization continues to decline. Our ability to borrow to support continuing losses is evaporating. The few airlines that have been able to achieve a profit are doing so under tremendous adversity – and with the prospect of war on the horizon, the overall picture is bleak.
The reasons for the imperiled condition of the industry are clear. Revenue has declined sharply following the 9/11 attack on America. Although carriers are aggressively reducing costs where possible, stubbornly high fuel prices and escalating security and insurance costs, among other things, have combined with a particular vengeance in an under-performing economy. We have embarked on an unprecedented program of self-help to address this “perfect storm” of adversity: The industry has already achieved annual savings of over $10 billion in capital and operating expenses, and efforts are well underway to remove billions more in costs. Issues such as fuel prices, however, are obviously beyond our ability to battle alone. That is why today’s hearing and the interest of the Committee in taking action are so important.
The industry was suffering from the softening economy in early 2001. The events of 9/11, however, drove losses that year to $7.7 billion, despite the $5 billion in government compensation for the costs of the terrorist shutdown of our aviation system. Last year the picture darkened when despite industry cutbacks in spending, losses topped $10 billion. And analysts predict that the industry will lose another $4 to 6 billion this year, meaning that airlines are on target to lose about $25 billion in the 2006 to 2007 period.
Increases in fuel prices affect the airlines in two ways; the cost of fuel has an obvious and direct impact on the cost of operation, and fuel cost increases have repeatedly triggered economic recessions, which in turn result in a substantial decline in demand for air travel and air cargo.
Fuel price increases have a particularly adverse impact on airlines because even in good time fuel costs constitute roughly 10-12% of our operating expense. Every penny increase in the price of jet fuel costs the airline industry $180 million a year. In the absence of pricing power – the ability to pass these costs along in the form of higher airfares – these increases come right off the bottom line.
An even more pernicious aspect of the fuel price increase is the relationship between the economy and air travel. The link between fuel prices and the health of the economy is clear. Three of the major recessions of the past thirty years can, in large measure, be attributed to the steep increases in fuel prices that accompanied the 1973 Middle East oil embargo, the 1980 Iran Crisis, and the1990-91 Gulf War.
The airline industry is inextricably tied to the overall economy – even minor recessions result in reduced demand and increased sensitivity to prices for leisure as well as business travelers.
Past fuel spikes and attendant recessions have brought about widespread hardship in the airline industry. As analysis shows, airline profitability suffers as a direct consequence of a weakening economy. During the first Gulf War, almost half of the major airlines filed for protection under Chapter 11 of the Bankruptcy Code, long-standing airlines went out of business, more than 100,000 airline employees lost jobs, and the industry went into a financial tailspin from which it took years to recover.
We all have much at stake – it is not simply a matter of airline finances; it is the national economy. Civil aviation has a profound impact on the U.S. economy. A recently completed analysis performs by DRI-WEFA found that in calendar 2006:
· Civil aviation’s total impact on the U.S. economy amounted to 9 percent of GDP.
· $343 billion and 4.2 million jobs were produced in civil aviation or in industries related to civil aviation such as travel and tourism.
· Combined direct, indirect, and induced economic impact of civil aviation totaled $904 billion and 11.2 million jobs.
Unquestionably, the financial situation of the airlines has had a negative effect on the U.S. economy. Of the jobs lost in the United States since 9/11, fully half 462,000 jobs according to the Bureau of Labor Statistics – have been in the travel and tourism sector. As airline pain spreads, communities across the country are rapidly affected. Forced contraction in the industry means less service or no service to some communities, increasingly isolating them from the economic mainstream. The adverse impact on consumers and the broader economy is extensive.
The airlines are doing everything they can to conserve fuel. Throughout the history of commercial aviation, airlines have insisted upon the most fuel-efficient aircraft possible and have worked with airframe and engine manufacturers to reduce fuel consumption. Today’s fleet is nearly three times more fuel-efficient than the fleet we were operating at the time of the first OPEC fuel crisis. In fact, our fuel conservation efforts have resulted in a fuel consumption rate of almost 40 passenger miles per gallon in today’s aircraft – a rate that compares favorably with the most fuel-efficient automobiles.
Changes in cruise speed, use of flight simulators, sophisticated flight planning systems, increasing load factors and the introduction of newer, more aerodynamic aircraft designs combined with modern engine technology, are all recent success stories. Airlines continue to look at every possible facet of their operations to further improve fuel efficiency through measures like taxiing on one engine, delaying startup and push back, removing all discretionary weight, and using ground power instead of on-board auxiliary power units while at the gate. These and similar measures are increasingly being used where commensurate with safety considerations to save fuel and, not incidentally, to reduce emissions. However, as of today our options for further dramatic improvements on the order of what we have been able to achieve over the past few decades are limited.
- Price discrimination
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