How Increase in Fuel Prices are Effecting the Airline Industry - Essay Example

Discuss how increase in fuel prices is affecting the airline industry? The fuel prices have been continuously increasing for the last few years. The world airline industry appears to be at major risk as a result of this increase because fuel expense is one of the major expenses of airlines. The fuel prices have not only affected the operating profits of the airlines but they have also influenced the business environment, strategies, labour and future plans of the airlines. The aim of this essay is to discover how increase in fuel prices affects the airline industry. Since the fuel cost is one of the major costs incurred by the airlines therefore, the continuous increase in the fuel prices for the last years has been very threatening for all airlines. The major impact of increase in fuel prices is reflected in the increasing operating expenses and operating losses of airlines. Even the airlines which have been able to survive during this turmoil through their aggressive hedging options could not make targeted revenues. The rise in fuel prices has not only influenced the airlines individually but it has also influenced the entire world airline industry. According to International Air Transport Association, the profits of airlines will reduce with the rise in oil prices. The net profit of airline industry will be $8.6 billion in 2011 as compared to $16 billion in 2010. Moreover, if the unrest situation in Libya and Middle East persists then oil prices will further increase which will negatively influence the airline industry (BBC News 2011). At individual level, all airlines have been incurring huge losses for the last few years. The United States Passenger Airlines Industry faced a total operating loss of $4.3 billion in first three quarters of year 2008. According to the report of Government Accountability Office, the price of jet fuel was the major operating expense in 2008 and the major contributor of loss in 2008. The fuel costs were 25 percent of the total expense of the airlines in the first three quarters of 2007 however, in the first three quarters of 2008, the fuel costs became 32 percent of the total expense. In the third quarter of 2008, when fuel prices increased by 60 percent as compared to 2007, seven smaller airlines stopped their operations and many entered into bankruptcy (Government Accountability Office 2009, p. 14). Today, the rise in fuel prices is continuously harming the operations of airlines around the world. Air India, the national carrier of India is facing a loss of Rs. 600 crore a month. The monthly income of the airline is Rs. 1,100 crore whereas; the expense of airline was Rs. 1,700 crore and the increase in fuel prices was the major factor for this loss (Hindu 2011). According to Bob Herbst of AirlineFinancial, if the fuel prices remain at $105 per barrel in 2011 then the major eight airlines of the United States will have to pay more than $9 billion on fuel costs as compared to 2010. Moreover, these airlines will have to improve their revenues to breakeven to avoid any operating loss (Centre for Asia Pacific Aviation 2011). On the other hand, a few airlines are also reporting the profits despite the high fuel costs. Korean Air reported a net profit of $29 million in second quarter of 2011 as compared to a huge loss during the same period in 2010 (AFP 2011). The airline claims that despite the high fuel prices, the airline has been able to make profits in the second quarter of 2011. Interestingly, the increase in fuel prices has also provided significant benefits to few airlines like Southwest Airlines. Southwest Airlines had the advantage over its competitors because of its hedged fuel prices. The company had hedged 70 percent of its fuel consumption at $51 per barrel when other airlines were paying $135 per barrel. However, the airline will ultimately go under the impact of high fuel prices because in 2012, the airline will be having only 15 percent of its total fuel purchases at $63 per barrel (Baysden 2008). The success stories of these two airlines and many others cannot negate the huge losses which the airlines industry has faced in the past few years. These airlines have been fortunate because of their aggressive hedging options and if the current rise in fuel prices persists then soon these airlines will be suffered. The rise in fuel prices has also influenced the air travel demand in the world. The decline in the growth of UK domestic airline traffic and UK resident international holiday is mainly because of rising fuel prices which increased the overall cost of travel thereby, influencing the relationship between passenger travel demand and consumer expenditure (Civil Aviation Authority 2009). Passenger traffic growth has remained positive on some routes however, the growth has declined as compared to previous years. According to IATA Director General Giovanni Bisignani, the passenger traffic in International Airline Industry is growing at 3 percent to 4 percent however; two factors are constantly hindering this growth including the demand shocks and high jet fuel prices (Raghuvanshi 2011). The increase in fuel prices has increased the cost of air travel. According to Merrill Lynch Equity Research (2008 cited in Heimlich 2008), the fuel costs has become 40 percent of the total airline industry costs and the prices of jet fuel has increased by 100 percent since 2007. The research suggests that a three percent daily increase in oil prices can eradicate the total profit of the years of airlines therefore; if the current situation persists then airlines will be continuously reporting losses. It has been mentioned in the research that the airline industry has been trying to pass on the higher fuel costs to the passengers by increasing fare prices however; the elasticity of demand reduces the domestic capacity. Yu (2011) highlights that airlines deal with the rise in fuel costs by adding fuel surcharges or increasing base fares for example, United Continental has added a surcharge of $6 for roundtrips tickets and American Airlines has enhanced the base fares by $4-$10. Mouawad (2011) argues that in an attempt to cope with fuel prices by increasing fare prices, the airlines have increased their fare prices four times since the beginning of year 2011 whereas, throughout 2010 the fares were only increased thrice. In this way the airlines are coping with the skyrocketed fuel prices by reducing other costs such as reducing labour costs. Airlines are also looking for fuel-efficient planes however; it requires an investment of billions of dollars therefore, the easiest way is to pass on the higher costs to travellers. As mentioned above, the rise in fuel prices has also influenced the business strategies of the airlines. In addition, the airlines are also facing complexities in business planning. John Heimlich, the Chief Economist and Vice President of Air Transport Association argues that as the major cost of the airlines remain volatile, business planning has become really difficult for airlines. He mentions that the price of jet fuel has increased by 67 cents per gallon between 2010 and 2011 as compared to 44 cents per gallon between 2009 and 2010. As a result of this increase, the airlines are reducing their capacities and reporting negative growth plans (Dooley 2011). According to Joe Brancatelli, the rise in fuel prices is influencing the business strategies of the airlines. Since the airlines know that a continuous increase in base fares can reduce the demand of air travel therefore, by looking for business travel can help them to generate more revenues. However, business travelers also cancel their trips when the fares increase. Brancatelli explains that the economy is really hurt when the demand of air travel reduces (The Economists 2011). Despite the increase in fare prices airlines could not avoided the huge financial losses. Another strategy which the airlines had adopted was the reduction of non-fuel costs such as downsizing. For example, Qantas airline has recently announced to cut management jobs, reduce capacity on the domestic and international routes and increase retirements of aircraft staff as a result of increase in fuel prices (Hannan 2011). The organisation has been struggling to cope with high fuel prices by increasing fares and managing capacity however, in spite of this, the organisation could not resist the impact of high jet fuel prices. Similarly Delta Air Lines has offered its employees “voluntary early retirements and buyouts”. According to a press release, the Chief Executive Officer, Richard Anderson said that organisation has to cut costs to cope with high fuel prices because the world’s second largest airline has to cut flying by four percent in September 2011 (Michigan Radio Newsroom 2011). Herbst (2011) highlights that most of the employees in airline industry are currently working at pay rates and work rules which were define 20 years ago. Therefore, it can be concluded that increase in fuel prices has influenced the world airline industry severely. 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