As the world’s air transport industry shakes off travel restrictions ahead of the summer season, rising fuel prices may be another hurdle on the path to recovery for airlines.
Having grappled with restrictions imposed to reduce the spread of the Omicron variant, airlines are now facing a new challenge to contain their costs, which have been affected by the surge in oil prices due to the Ukraine conflict.
In October 2021, the International Air Transport Association estimated that fuel costs would account for 20% of an airline’s expenses at $78 per barrel. However, in early March prices skyrocketed to as high as $140 per barrel, levels comparable to the oil crisis in 1973.
With fuel costs now estimated to account for up to 40% of airlines’ expenses, carriers are having to hold off on capacity expansion and instead explore measures to curb expenses and bolster their balance sheets.
AeroTime explores the effect this has on carriers in North America.
Helane Becker, managing director at Cowen and a senior research analyst who covers airlines, air freight, and aircraft leasing tells AeroTime that the recent hike in fuel prices came as a shock to the market and airlines.
“We don’t think airlines, or the market were prepared for such a steep increase [in prices],” she says.
Although they forecast healthy travel demand in the US, airlines such as Delta, JetBlue (JBLU), United Airlines and Southwest have also announced slight revisions to their expected capacity in mid-March 2022, due to the high oil price environment.
Becker points out that airlines were somewhat prepared for jet fuel costs to increase due to rising demand for oil as world economies reopen, although the scale of the increase was unexpected. Airlines do have other tools at their disposal to mitigate higher fuel costs.
She says: “They [airlines] are reducing capacity growth plans and raising ticket prices. Also, the airlines still have significantly more liquidity than they had pre-pandemic, and although their intent was to use some of that capital to pay down debt, they’ll pay down debt as it comes due and patiently wait with their substantial cash balances to repay that debt. The high cash balances should give them protection this year from catastrophic events.”
For example, Southwest Airlines (LUV) said in an SEC filing on March 15, 2022 that it was confident in its balance sheet strength, with a cash and short-term investment balance of approximately $15.7 billion, well in excess of the outstanding debt.
To hedge or not to hedge?
Historically, fuel hedging was widely used as a way for airlines to protect themselves against fluctuating jet fuel prices. The practice involves airlines and suppliers entering into a contract with a predetermined buying or selling price of jet fuel.
In the event of a spike in fuel prices, airlines can manage future fuel costs through hedging. But it can also affect airlines if fuel prices fall below the predetermined prices.
While a number of US airlines have stepped away from fuel hedging after a turbulent history with the practice, low-cost carriers Southwest Airlines (LUV) and Alaska Airlines have hedge positions of up to 50% of their forecast needs, according to Becker.
Southwest Airlines (LUV) told AeroTime that, despite the current situation in the market, their multi-year fuel hedging program places the airline in a favorable position.
“The current energy price environment is exactly why we have a systematic hedging program —to provide insurance in the near-term, particularly over the timeframe of our published schedule,” the airline says.
The airline has approximately 65% of its fuel costs hedged for 2022, with 37% hedged for 2023 and 17% hedged for 2024.
In addition to high fuel costs, the increased maintenance and labor costs as a result of staffing shortages may lead certain airlines to rethink their fleet financing decisions.
“We are seeing inflationary pressure in maintenance and labor costs,” says Becker. “Airlines that have seen their balance sheets stressed by the pandemic will increasingly turn to the lessors to be able to replace older aircraft with newer aircraft.”
Furthermore, as momentum builds toward net-zero carbon initiatives and wider sustainability across the industry, airlines are keen to modernize their fleets with younger, more fuel-efficient models despite delays from original equipment manufacturers (OEMs) to deliver aircraft.
“[Airlines] have been taking delivery of new aircraft for the past few years,” says Becker. “The pandemic had them restructuring their order books, but they are still planning on taking new aircraft.”
Southwest Airlines (LUV) told AeroTime that its fleet modernization plan includes 418 firm orders for the 737 MAX, with deliveries expected between 2022 and 2031.
High airfares over the summer?
While carriers around the world are introducing surcharges to ease the pain of rising fuel prices, US carriers seem to be divided on the decision.
With strong revenue projections, American Airlines (A1G) (AAL) said in an SEC filing that it believes the current booking demand will help to offset high fuel prices. Meanwhile, Delta Airlines CEO Ed Bastian expects domestic airfares to increase between 5% to 10%, according to an interview with the BBC.
Across the Atlantic, Ryanair is not looking to introduce surcharges over the summer, with 80% of its fuel hedged until March 2023. Similarly, Lufthansa (LHAB) (LHA) is 63% hedged across 2022 and is monitoring the situation. However, Air France-KLM will look to raise prices on its long-haul routes.
Ethiopian Airlines told Aerotime that, while the carrier is cautious of the recent hike and fluctuations in oil prices, it expects fuel surcharges to have an insignificant and non-inflationary effect on its airfare rates across its cargo and passenger operations.
“Our pricing strategy has always been competition based but we’re cautiously monitoring the cost of our operation through a companywide cost saving and cost management programs,” said Samson Arega, Ethiopian Airlines Regional Director Sales, Marketing and Services, USA.
“That allows us to ride through the up and down swings of fuel prices without having to translate that volatility directly into pricing,” added Arega.
Further east, carriers such as AirAsia, Cathay Pacific, Emirates, Japan Airlines and ANA Holdings (ALNPY) have also introduced surcharges on both domestic and international routes.
While we may be emerging from the COVID-19 pandemic, it seems like travelers could be in for a bumpy ride.
With oil prices, staff shortages and even aircraft delivery delays, travelers in the United States – and elsewhere – may find they are subject to more flight cancellations this summer.