Airlines – but not passengers – see benefits as crude oil prices drop

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If you think airfares will be falling because of cheaper fuel prices, think again.

Airlines are reaping the benefits of a sharp drop in jet-fuel prices because of the tumble in crude-oil values, but industry experts said carriers are likely put the cost savings to work elsewhere.

“In the short-term, the answer is: there really is no benefit for the consumer,” said Jeff Klee, chief executive officer of, an online travel agency. “The reality is airlines don’t price their flights based on their cost. In the short term, they price it based on demand. Unless demand changes, just because they’re paying less [for fuel], they’re not going to pass that savings on unless they have to. And they don’t right now. People are traveling and the flights are full.”

Crude-oil prices fell more than 50% from their June 2014 highs to the low of around $44 a barrel set in January based on New York Mercantile Exchange values, and prices remain low, trading around $48 as of 11 March.

Frank Werner, associate professor of finance and business economics at Fordham University’s Schools of Business and an airline finance expert, estimated US domestic airlines will increase their profits by $6bn in 2015 because of fuel costs. “We’re looking at some big, big numbers and the airlines are thrilled about this,” he said. Werner said jet fuel can represent about 30% of airline costs, and for some smaller airlines it could be higher.

Jet fuel is the top operational expense for airlines. In 2013 and 2014, US airlines spent around $30bn on fuel each year, according to Department of Transportation data.

Falling energy prices are good for airlines, but some airlines are benefiting more than others. That’s because some airlines choose to try to mitigate the mercurial nature of crude-oil prices by using derivatives contracts. In a process called “hedging”, airlines can use futures, options and swap contracts to either offset fuel purchases made in the short term or to try to lock in prices in the future. Considering that crude-oil prices rose annually for several years, it made sense for airlines to try to avoid being at the mercy of ever-higher prices, these sources said.

One popular hedge is called a “costless collar”, whereby airlines tried to put a cap and a floor on prices, Werner said. If prices rose above a certain level, the firm on the other side of the trade would pay the airlines. If prices fell below a certain level, then airlines would pay the firm on the other side of the trade. If the prices are set correctly, the net cost is zero, he said.

“The thing works if there are no [big price swings]. When you get a real break in the pattern, then you’re stuck. That’s what happened here. No one was planning for this drop [in energy prices]. Anyone who constructed a hedge where they were willing to pay a minimum price – [but did not expect prices to] drop below there – was stuck with the higher fuel prices. These became very expensive hedges,” he said.

It was the magnitude of the crude-oil price fall that destroyed many of these hedges, since values probably fell through these price floors, said Vik Krishnan, partner at consulting firm Oliver Wyman. One solace for these US airlines is that they usually only hedge a fraction of their needs, about 10% to 20%, he said, so they’re still receiving a big benefit of the drop in oil.

With crude-oil prices still down 50% from their peak, airline executives are probably thinking about how they can take advantage of the lower prices. Some Asian airlines, which hedge much more of their fuel costs than US carriers do, have publicly stated that they have locked in several months’ worth of energy prices.

Since storing 12 months’ supply of actual fuel is difficult, a simpler strategy is for an airline to buy a New York Mercantile Exchange futures contract. These contracts estimate where prices might be in the future and are dated from one month to two years forward, said Steven Schork, editor of energy newsletter the Schork Report, who has consulted for airlines.

There is a bit of risk locking prices here as values could still go lower. But odds are prices will be higher a year from now. “We know oil can rise more than $50,” said Schork.

After many lean years, US airlines are doing well financially. The recent mergers of airlines – for instance, American Airlines with US Air and United with Continental – have helped, as has filling planes to near-capacity and flying fewer planes on existing routes.

Airfares might come down a smidge in 2015. The International Air Transport Association (Iata) forecasts global airfares may fall 5%, but the price falls don’t reflect the cost savings airlines are seeing, the experts said.

“They don’t need lower prices to sell more seats,” Werner said.

Krishnan said one of the few places where fares may come down is where there is more seat capacity than demand. In those cases, “there’s a tendency to race to the bottom,” he said.

So what might carriers do with their extra scratch?

Richard Wysong, director of PricewaterhouseCoopers’s US transportation and logistics practice, said in the short term, carriers could focus on paying down debts and strengthening their financial positions. Fleet upgrades could occur, too. Werner said the Iata forecast that in 2015 alone there will be 1,700 new aircraft worldwide. These newer planes will be more fuel-efficient than the older planes.

“Lower fuel prices may encourage airlines to increase capacity, either by deferring retirements of older aircraft or increasing the hours of flying of older aircraft, which have been reduced with high fuel prices,” he said. Increased capacity might create more options for consumers and possibly lead to some reductions in price, he said. But don’t expect deep cuts any time soon.


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