Airlines and Fluctuations in the International Oil Markets - Research Paper Example

Airlines and Fluctuations in the International Oil Markets Tourism is a dynamic industry and in a constant of change. Airlines are an important sub-sector of this industry and play an essential role in the global tourist market. Airlines allow people to travel from one end of the planet to the author and the commercialization of flight and the expansion of the airline industry has been a boom for the international tourist trade. Could you imagine what the travel and high end tourism industry would be like without direct flights from any major center to Los Cabos, Mexico, Honolulu, Hawaii or Varadero, Cuba? How would people get to these destinations? Since most people cannot walk to any of these destinations and both Cuba and Hawaii are islands so driving is an impossibility, without airports, airlines and planes visiting any of destinations would be next to impossible. Airlines have rejuvenated the tourism industry and contributed to the globalization of the tourist trade. Without airlines this industry were be remarkably different and would not be the lucrative global industry that it has now become. Airlines give us unparalleled choice in the vacations we choose and commercial flight operators are the backbone of the dynamic tourist trade. Seeking to understand structure of the airline industry through a holistic analysis, this research paper identify three innovations brought by the major carriers in the 1980s and discuss how these innovations have changed the structure of the airline industry. This early section will be descriptive and will describe the major changes put forth by the most important airline players in the 1980s and will explore how these changes in fact contributed to the dramatic alteration of an industry which has always been in a state of flux and evolution. Following this analysis, the second component of this research paper will be prescriptive in nature and will discuss how the structure of the airline industry will change in the next 10 years. The bulk of this assignment will explore the future if the airline industry; by looking at the major issues facing the global airline industry in the future we will help provide solutions to the major challenges facing this dynamic industry. Airline Industry Innovations In the context of the United States, the deregulation of the airline industry set the stage for the complete transformation of the American airline industry. Accordingly in 1978, US President Jimmy Carter signed the Airline Deregulation Act, a United States federal law which paved the way for major changes to the airline industry in the United States in the following decade. Accordingly, this law aimed o remove governmental control over the price of fares, the routes available and the entry of new airlines into the market of commercial aviation. The deregulation of the American airline industry was at the time perhaps the most important, yet undervalued, change ever to impact airlines in America. The deregulation of the industry loosed governmental controls over a variety of aspects associated with domestic as well as international travel and set the stage for three important changes within the industry. Accordingly, “the competition within the established industry was intensified by three innovations pioneered by the major carriers in the early 1980s that collectively represent a change from the regulated era” (Wensveen, 2007). These changes were dramatic and began with the establishment of what was called a “hub-and-spoke” route structure. This route structure represented an innovation in the ways in which airlines operate and was designed to funnel traffic from outlying regions to major “hub” destinations. Accordingly, major “hubs” such as New York, Los Angeles, Miami, and Philadelphia for US Airways sprung up and developed an importance presence in the global airline industry. Accordingly, the establishment of these “hub-and-spoke” route structures proved to be costly but they were an important change brought about following the deregulation of the airline industry. The second major innovation brought about in the airline industry was the establishment of frequent-flier programs, created to enhance brand loyalty. These programs proved to be expensive to maintain but deemed essential in an era of unregulated market competition. The third and final major innovation brought about in the wake of deregulation was the establishment of sophisticated reservation systems which sought systematize the way that travel, fare and information was made available. By computerizing the reservation process and systematizing an intricate system to hold reservations, the airlines integrated the travel agent subset of the industry and embarked upon a major overhaul of the reservation process. Thus, as competition increased as a result of governmental deregulation in the early 1980s, a variety of changes and innovations were underway in the American airline industry. This industry is constantly in a state of evolution and development; now that we have explored the three major innovations of the 1980s, we now turn to a strong overview of the future of the airline industry with an emphasis on the challenges it faces in the next 10 years and the means through which it can overcome these challenges. The Future of the Airline Industry The important role played by airlines in the worldwide promotion of global tourism has come under threat recently by global events and circumstances beyond the control of the airline industry. Plane hijackings on the morning of September 11th 2001 dealt a severe blow to airline industry as a whole, but particular airlines, including American and United, two airlines which had their planes hijacked that fateful morning, suffered substantially following the horrendous attacks. In fact, following 9/11 there was talk that both airlines would go under and fold because people simply refused to fly on American or United planes. The events which took place that fateful morning were obviously beyond the control of those two airlines but the repercussions were industry-wide and some argue that more than seven years later, the industry has never really fully recovered. In addition to terrorism and its unintended effects, the almost daily fluctuation in the price of oil has been irritating to some, infuriating to others and downright deadly to some segments of the global economy. Some industries, including the airline industry, are particularly susceptible to global fluctuations in the price of oil and have faced numerous challenges in the age of high oil prices. Transportation relies on oil and oil remains the literal fuel of the airline industry. As a sub-sector of the global tourist market, how has the airline industry responded to the trend of unpredictable oil prices? In addition to asking what has been done to date, we ask how can the airline industry look to the future and deal with the future unpredictability of the oil price of oil? there steps that the industry can take to ensure that it can cope with the erratic price of oil? Seeking to be descriptive and by offering solutions in a prescriptive manner, the following seeks to address the questions surrounding rising oil prices and the airline industry. Data will be compiled from the past two years and analyzed with an eye to how the airline industry can respond to this important threat to its very existence (Douganis 2002; Hill 1998; Jenkins 1998). How has oil production and the price of oil fluctuated over the past few decades? The following graph explores this question with an eye to pricing and production by the world’s largest and most important cartel, OPEC. WTRG Economics 2007 The graph above charts oil production and the crude oil production of the OPEC countries over a seventeen year period from 1990 to 2007. OPEC, the Organization of Petroleum Exporting Countries, is an international trade cartel composed of 12 oil producing countries. These 12 countries account for two-thirds of the world’s total reserves and close to 40% of the world’s total oil production. Due their significant share of the world oil market, OPEC plays a huge role in global oil production and the determination of oil prices (Mouad 2006; BBC 2008). As the graph shows, between 1990 and 2007 OPEC oil production has fluctuated from a low of approximately 23,800 thousand barrels of oil per day in 1990 to a high of almost 32,000 thousand barrels of oil per day sixteen years later in 2006. Despite a fairly steady trajectory of upward growth in oil production for the countries of OPEC over the past decade and a half, the price of oil has fluctuated dramatically. Accordingly, the price of oil reached a high of nearly $69 dollars a barrel in 2006 and remained high at almost $65 a barrel in 2007, a more than 300% increase from approximately $20 a barrel in 1990. In the middle of this past year, oil prices hovered around the $100 mark: the highest ever recorded. As the world becomes smaller and globalization becomes a feature of our daily lives, demand for oil increases and has been steadily increasing over the past twenty years. In line with the increases in demand, the price of oil has also increased over this period, sometimes sharply and almost always in an unpredictable fashion. The ramifications of these sharp increases in the average cost of oil hurt commuters at the pump, consumers who rely on international trade for their goods and service providers such as airlines who basically sell transportation and the ability to get people from point A to point B. Rising oil prices have challenged the viability of the airline industry as the price of oil has gone up and up and up. Although not as high as it has been in recent memory, Bloomberg Media reports that the price of a barrel of crude oil today (November 29th 2008) sells for approximately $55 a barrel (Bloomberg 2008). At the height of the crisis speculation ran rife that the price of oil would one day reach $200 a barrel. Fuel costs now account for 40% of all airline expenses and “according to an industry analyst, a 3 percent daily rise in oil prices is enough to wipeout an entire years profit” (Seany 2008). How has the industry responded to the challenges posed by unrelenting hikes in the price of oil? Airlines have employed a multiplicity of tactics to deal with the rising and unpredictable costs of doing business. During a recent frenzied period in which analysts predicted the price of a barrel of oil to rise to $200 within the next twenty years, Southwest Airlines CEO Gary Kelly took an abstract figure and stated, "No airline can make money at $123 a barrel." (Seany 2008). The rising cost of oil has meant fare increases, fewer airlines as some have and will cease to be commercially viable and will be forced to close their doors, fewer available seats and fewer discounts. Yes, the $49 return flight to Miami Beach in February may very well become a thing of the past. Canadian airlines like Air Canada and low-cost carrier Westjet have begun tacking on an unpopular fuel surcharge to their flights, passing on the rising cost of fuel directly to the consumer. In Canada, the fuel surcharge was implemented in 2005, after a period in which the price of oil jumped an incredible 50% in a one year period in the Canadian market (CTV 2005). The rising cost of oil is a global concern with international ramifications for sub-sectors of the tourist industry. The following section offers prescriptions for how the airline community can tackle these challenges in the short to medium term. In the long term, the airline industry can take a variety of measures to help itself weather the storm caused by unpredictable oil markets. First and foremost, a long-term goal for the airline industry should be one which is research-focused and labour intensive. Seeking to lessen their dependence on oil and subsequent vulnerability to fluctuations in the global oil trade, airlines should make a conscious effort to work towards decreasing their dependence on crude oil. Although this is an important research initiative which will take years to achieve, the results could bring new life into the industry and save airlines from near death if the price of oil ever obtains the anticipated $200 a barrel. Further long-term steps would be cutting unprofitable destinations, corporate down-sizing and cutting special discounts which serve to undercut the competition. In addition to these steps, the airline industry should also consider entrenching the already implemented steps mentioned above in the short-term 12 month plan, including fuel surcharges and small, incremental extra fees to passengers. Concluding Remarks The airline industry represents a dynamic sub-sector of the global tourist trade. Airlines make international travel possible and today it is easy, painless and relatively cheap to fly from one end of the earth to the other, often on a whim. We have begun with an overview of the three major innovations of the 1980s, following deregulation, which effectively transformed the industry. These changes includes a “hub-and-spoke” route structure, the establishment of frequent-flier programs, created to enhance brand loyalty, and sophisticated reservation systems which sought systematize the way that travel, fare and information was made available. These changes could not have been made without the deregulation of the American airline industry. Looking to the future, the unpredictable cost of oil is the most pressing challenge facing the industry over the next 10 years. Accordingly, due to its dependence on oil and the inherent instability of global oil markets over the past few years, the airline industry must devise certain concrete steps to deal with fluctuating oil prices and unstable markets in order to remain a viable business option. This research paper has been both descriptive and prescriptive in nature, offering concrete solutions in both the short-term and the long-term to help the airline industry stay afloat. Seeking to understand the important implications of oil dependency on airlines today, solutions have been aimed at ensuring the viability and sustainability of the global airline industry. REFERENCES Doganis, R. 2002. Flying Off Course: The Economics of International Airlines. Routledge, London. Energy Prices. Bloomberg.com, Accessed August 20, 2009 http://www.bloomberg.com/energy/ Hill, C. W. L. 1998. International Business: Competing in the Global Marketplace. Irwin, London. Jenkins, G. 1998. Derivatives Trading by Oil Companies and Airlines: A Survey of the 1997 and 1998 Annual Reports with Critical Commentary. Sunningdale Publications, New York. Mouawad, J. September 12, 2006. OPEC confirms plan to retain production. International Herald Tribune, Accessed November 29, 2008, http://www.iht.com/articles/2006/09/11/business/opec.php “Oil scales new record above $115”. April 16 2008. British Broadcasting Corporation (BBC.com). Accessed August 20, 2009 http://news.bbc.co.uk/2/hi/business/7349852.stm Seaney, R. May 14, 2008. “Disaster for Airlines: Oil Prices”. ABC News.com, May 14, 2008, Accessed August 20, 2009 http://abcnews.go.com/Business/BusinessTravel/Story?id=4847008&page=1 Wensveen, J. G. 2007. Air Transportation: A management perspective. New York: Ashgate. “WestJet follows Air Canada with fuel surcharge”. May 05 2005. CTV News.com. Accessed August 20, 2009 http://www.ctv.ca/servlet/ArticleNews/story/CTVNews/20050815/westjet_fuelpricelevy_20050815?s_name=&no_ads= “World Oil Prices” WTRG Economics, Accessed August 20, 2009 http://www.wtrg.com/prices.htm Read More