Fuel Costs Affect on Airline Industry - Essay Example

How Fuel Costs Have Affected the Airline Industry: A Critical Review How Fuel Costs Have Affected the Airline Industry: A Critical Review Continuingly increasing fuel prices have caused incredible turbulence in the airline industry. The impact on the airlines themselves, as well as business performance and the impact on travelers, are all of great significance. The airline industry that was already in stress due to the decline of the tourism industry is still greatly affected by increasing fuel price - a factor which has been incredibly negative on the airline industry. In order to come to a clearer and more knowledgeable understanding on this subject matter, the key elements as well as those related to the subject at hand must be thoroughly discussed; by doing this we can gain a more intellectual viewpoint on this issue. The aim of this paper is to discuss all of this, as well as all characteristics and factors involved in the matter of how fuel costs have affected the airline industry. This is what will be dissertated in the following. The six most primary airlines in the United States have been ailing since 2001; four out of these six were in fact forced to file for bankruptcy in 2005. According to some analysts, the entire airline industry is on the brink of collapse altogether; the primary cause being that of ever-increasing fuel prices. "It's very bad right now, it's unsustainable," said Kevin Mitchell, Chairman of the Business Travel Coalition based in Pennsylvania. "It's as bad as it gets. If (oil) goes up another couple of dollars it's going to be more of a pain but it's going to be hardly distinguishable from the pain that the airlines are feeling right now." (Delaney, 2006). In fact, according to Mitchell, the American airline industry basically refused entirely even to recognize the shift in the marketplace five years ago. "They failed to understand that consumers were demanding everyday, low, affordable airfares. The carriers in Europe recognized that and began to take action in 2001 and 2002 to become competitive with low-cost carriers. The US carriers were stubborn throughout the whole time, thinking that as soon as the economy would rebound, so would business travelers willing to pay $2500 for coast to coast fares, and of course that never happened." (Delaney, 2006). In fact Northwest Airlines, the nation's fourth-largest airline which is based in Eagan, Minnesota, has made many headlines since the year unfolded. "It reported $450 million in losses the first quarter of 2005, it's stock prices are declining, it's fuel costs are rising, it asked its labor unions to freeze their current pension programs in lieu of new contribution plans, it is attempting to cut annual labor costs by $1.1 billion, and on July 1 the union representing its mechanics authorized a strike vote." (Oo, 2005). The current spike in oil prices is especially taking its toll; taking the airline industry into uncharted territory and raising many questions about the economic viability of many players in the industry. Increasing fuel prices have also had effects on global trade, which is one of the United States' most profitable resources. "No doubt increasing oil prices are likely to dampen global trade. Air cargo traffic is a leading indicator of any economic slowdown. The air cargo industry itself, in which fuel accounts for 20-30% of the operational cost, is poised to be the prime casualty of the new era of expensive oil," says a report entitled 'The Oil Crisis and its Impact on the Air Cargo Industry.' "Jet fuel prices have almost tripled in the past four years. As a result, the world's airlines spent over $100 billion on fuel in 2005, a 50% increase over 2004. At reasonable oil prices of $30-$40 a barrel, world air cargo traffic was projected triple over current traffic levels." (IAGS, 2006). Fuel expenses rank in as the number-one or number-two cost category in regards to the airline industry, and because of this, airlines have an enormous built-in financial incentive to reduce consumption; this incentive of which during the last two years has increased dramatically, and the carriers have responded by leaving no stone unturned in identifying operational or other means of fuel consumption. Over the last four years, the United States' airline industry has lost roughly over $32 billion, with an additional $9-$10 billion loss which had been projected for the year of 2005. Airlines have developed numerous different operational and planning techniques aimed at saving fuel and optimizing fuel purchases. Statistics show that "Since 2000, airline fuel efficiency has risen an impressive 18.1 percent, on average, from 38.2 revenue passenger-miles (RPMs) per gallon to 45.1." (Heimlich, 2006). Unbeknownst to some, the recent hurricanes have had a dramatic effect on fuel prices. In fact, in the days and weeks immediately following hurricanes Katrina and Rita, when oil production in the Gulf of Mexico and refining capacity along the Gulf Coast was shut down, air carriers were forced to take extraordinary measures to avert fuel supply-related service curtailments. "For several weeks air carriers, fuel suppliers and airport fuel-system operators worked closely to identify airports where fuel supplies were tight and make operational changes such as 'tankering', to slow supply draw-downs. Tankering, the process of flying additional fuel into an airport on an aircraft so as to minimize fuel uplift at that destination, can be extremely expensive and inefficient." (Heimlich, 2006). It was in the period after the hurricanes that carriers operating into airports with tight fuel supplies not only suffered from record-high fuel prices but were forced to burn extra fuel when tankering, in order to maintain these routes. Damage to refineries and pipelines in the Gulf Coast following Hurricanes Katrina and Rita eliminated about 25% of daily domestic fuel production; and although the U.S. was left with plenty of crude oil in the Strategic Petroleum Reserve, damage to Gulf Coast refineries left little spare capacity to refine crude oil into jet fuel. Due to this, United States airlines have become more dependent on imports in order to meet their jet fuel requirements in the weeks following the hurricanes. The Air Transport Association (ATA) actually recently proposed a one-year 'jet fuel tax holiday' as a way to provide relief to the suffering airline industry. According to the ATA, during the 10-year period from 1992-2001, the median price per barrel of crude oil was just under $20. This median price subsequently increased to $41.44 per barrel in 2004 and $54.03 per barrel in 2005 (year-to-date through August 2005). "The higher cost of crude oil, the widening crack spread, and greater consumption are all driving higher fuel costs for airlines." (Keifer, n.d.). In order to protect itself, the airline industry absolutely must support initiatives to reduce oil consumption in the ground transportation sector, where most of the oil is consumed. "While the airline industry is doing all it can to minimize costs by reducing its fuel consumption, it has little influence on overall demand and global air prices. Air transportation accounts for only 6% of the world's demand for refined petroleum products," says Dr. Gal Luft, IAGS' executive director who presented a report's findings before the Annual Executive Meeting of the International Air Cargo Association. "Being a marginal consumer with limited capacity to affect global oil prices the air transport industry should look beyond minimizing its own fuel bill. The industry should seek ways to affect the market at large and help reduce oil prices. The sector where substantial oil savings can be achieved, in sufficient quantity to drive down oil prices, is ground transportation. This sector alone consumes over half of the world's refined petroleum products. Therefore, in addition to all the internal measures the airline industry has taken it should also support from the outside policies aimed to increase supply and reduce demand for oil in the ground transportation sector." (IAGS, 2006). According to new research into airline risk management trends, airlines are spending at least $8.36 billion per year on risk management - especially so in regards to the dilemma of increasing fuel prices - with around 70% (or $5.86 billion) going on insurance premiums. Facts show that "Insurance premiums fell significantly in 2005, but despite the expectation within the risk management community that this downward trend will continue in 2006, albeit less markedly, there is considerable anxiety about the cost of premiums." (Jenner, 2006). These risk strategies are of incredible importance and relevance, especially in regards to an issue such as the dilemma of fuel prices and their impact on the airline industry. In fact, risk management, on average, actually accounts for 2.1% of airlines' total revenue - and if that is applied to the revenues of the world's top 200 airlines, that equals a budget of at least $8.36 billion per annum, with a roughly estimated average of 70.1% channeled into insurance. "Since jet fuel is the second largest operating expense for airlines, the slightest decrease in fuel costs or consumption can turn into big savings. If airlines can control the cost of fuel, they can more accurately estimate budgets and forecast earnings. As a result, all the major airlines have 'hedged' fuel prices in recent years." (Keifer, n.d.). Although certain steps can and are already being taken to fight against the high fuel cost situation in regards to the airline industry, there are those who believe that it will take much more than these solutions in order to even attempt at pulling the airline industry out of the present dilemma. "The environment for airlines is quite tough. We are all fighting bad financials and even if they get better, it is still a little bit fragile," says Eva Dahlberg, director of SAS Group Insurance. "The premium cost is substantial these days, some insurances are mandatory and if you have fragile finances, it is important that you can insure against risks." (Jenner, 2006). There are numerous challenges ahead which must be faced by the airline industry; such things as spiralling fuel costs continue to greatly affect the airline industry's ongoing cost containment initiatives, and must be dealt with appropriately. The challenges ahead, which includes such things as discussing and finding prospects for industry profitability and the operating cost and revenue obstacles; as well as working towards a recovery, dealing with such things as airline security issues, the impacts on airline operations, labor/management relations, and an overall overview of the airline industry's financial status are all of great significance. Soaring petrol prices have certainly put a damper on the economy; airlines have been suffering relentlessly due to the slow in travel rates due to the increasing price of fuel. In fact, for the first time ever in aviation history, the financially troubled United States airline industry is actually shrinking domestic flying capacity in the face of strongly growing public demand for its service. From this review we can see that the issue of fuel costs is incredibly significant to the damage which has, and which continues to fault the airline industry. With some of the United States' most known airlines falling to bankruptcy, and those left struggling, the situation must be assessed and dealt with vigorously and promptly. Although it is considered by some that "the consumer is the winnertraveling at fares at historic low points", the fact still remains that the significantly increased fuel prices issue must be conceptualized and followed out with a viable and positive solution. After all, airlines with these tight operating margins are still trying to shake the effects of the 2001 terrorist attacks and economic recession - both things which greatly affected the revenue of the airline industry. References Delaney, J. (2006). Rising Fuel Costs to Cause Airline Crisis. Retrieved May 8, 2006, from http://www.theepochtimes.com/news/6-4-22/40707.html Heimlich, J. P. (2006). Commercial Jet Fuel Supply: Impact on U.S. Airlines. Retrieved May 8, 2006, from http://72.14.207.104/searchq=cache:cyR_rcimOQQJ:www.house.gov/transportation/aviation/02-15-06/heimlich.pdf+fuel+costs+affecting+airline+industry+in+America&hl=en&gl=ca&ct=clnk&cd=5 IAGS. (2006). High Oil Prices Endanger Future of Airline Industry. Retrieved May 8, 2006, from http://www.evworld.com/view.cfmsection=communique&newsid=11775 Jenner, G. (2006). Risk Profile. Retrieved May 8, 2006, from http://www.flightglobal.com/Articles/2006/04/26/Navigation/177/206198/Risk+profile.html Keifer, M. (n.d.). Current Situation and Future Outlook of U.S. Commercial Airline Industry. Retrieved May 8, 2006, from http://www.house.gov/transportation/aviation/09-28-05/09-28-05memo.html Oo, P. (2005). Keeping the Birds of Steel Flying. Retrieved May 8, 2006, from http://www1.umn.edu/umnnews/Feature_Stories/Keeping_the_birds_of_steel_flying.html Pratt, D. (2006). Executive Overview: Jane's World Airlines. Retrieved May 8, 2006, from http://www.janes.com/transport/news/jwa/jwa060308_1_n.shtml Read More