Soaring fuel prices and challenges to air travel

Dr. Ruwantissa ABEYRATNE

Two thousand eight (2008) can only go down in the annals of the world economy as a year in which a plethora of negative factors such as rapidly rising fuel prices, liquidity tightening policies due to the sub prime crisis and inflation control policies of many emerging economies impacted economies adversely.

When all is over and done, this slackening in growth will in all probability have resulted in a slowing of the pace of traffic growth throughout 2008. Yet, it is encouraging that the continuing steps initiated by the airlines in earlier years to keep controllable costs in check have paid rich dividends for the airlines.

Cost management and forward fuel contracts entered into by major profitable international air carriers over the past years

 helped them to manage rising fuel costs, and one can only hope that a similar approach might well help mitigate the fuel price rise to a great extent in 2008.

By June 2008, it was clear that the impact on un-hedged carriers and the domestic airline industry which had to contend with duties and other levies on imports was more severe than that experienced by the major profitable international carriers.

However, there was no doubt that if the uptrend in fuel prices held, hedging would no longer have proved to be a mitigating factor and the industry would have to operate under a substantially high operating cost and breakeven scenario in the days to come.

In this equation, the most disturbing factor is that aviation fuel is generally 15-30 per cent more expensive than the crude oil prices. This make the issue even more serious for air carriers.

Soaring oil price

At the time of writing the price of a barrel of crude oil was soaring past US$140 Airlines in the United States were staggering just to keep operations going, and the 10 largest carriers of the country had posted a cumulative net loss of $11.76 billion.

Although the price may decline in the short term, the prognosis among economists was that in the long term, prices would continue to climb. In response to the surge in fuel prices, airlines were cutting costs, reducing fleets and domestic capacity and retrenching staff.

CNN has reported that US Airways will be charging passengers $15 to stow just one bag in the cargo hold for tickets booked on or after July 9, 2008 and that the airline will be the third major carrier to add such a charge. This is not all: the free beverages in coach are on their way out, too. Passengers in the back will be charged $2 per non-alcoholic drink, starting August 1, 2008.

In addition, US Airways was reportedly planning to cut domestic mainline capacity by 6% to 8% in the fourth quarter. In mid 2008, it had also planned to return 10 planes, cancel leases on two more and was discussing plans to park more through 2010. Earlier, it was reported that United Airlines had commenced charging $15 for the first checked bag. American Airlines was to follow immediately thereafter.

Houston based Continental Airlines announced in early June 2008 that it would cut 3,000 jobs and reduce capacity by 11 per cent in view of the record fuel costs. The pull back of operations was to take place in September 2008.

The soaring fuel prices was serious enough for aviation industry leaders to convene a summit in New Orleans July 2008 to brainstorm how best to respond to the fuel costs, which were expected to rise to $150 per barrel in the United States in Summer 2008.

Increase in prices

Elsewhere in Europe, the same effect was being observed. British Airways Chief Executive Willie Walsh was reported to have said that with the increase in prices, thee will be some decrease in discretionary travel.

There were similar statements by the Chief Executive Officer of Air France and the Managing Partner of the Oneworld Alliance.

Virgin Atlantic responded to the rising fuel costs in a similar way, by adjusting fares, although the carrier adopted the novel approach of imposing lower fuel surcharges on economy class passengers as compared to its higher premium classes, on the ground that the higher classes took up more space in the cabin and that their baggage allowance was higher, which made the aircraft burn more fuel.

This practice is a deviation from standard airline protocol which applies the same surcharge to all passenger tickets.

In the Asia-Pacific region, Thai Airways International grounded an entire fleet of four engine aircraft and stopped operating its Bangkok-New York flights in early June 2008, while announcing that it would be selling its four long haul Airbus A 340-500 aircraft which were bought in 2005 to operate air Services from Bangkok to New York.

In addition, it has been reported that the airline was adjusting its fuel surcharge on international and domestic flights, effective June 25, 2008, due to the massive increases in the price of jet fuel.

It was also reported that China Airlines and Eva Airways of Taiwan were also planning stringent cuts, with the former reducing its US operations by 10 per cent and Eva planning an overall 5 per cent cutback commencing September 2008.

Summit

Speaking for the airlines of the world, Giovanni Bisignani, Director General of the International Air Transport Association (IATA) said at the 2008 IATA World Air Transport Summit held in Istanbul from 1-3 June 2008 that IATA predicts the global industry faces losses as high as $US6.1 billion if crude prices stay at their current level of $US135 a barrel, and $US2.3 billion if they fall to a predicted price of $US106.50.

The new estimate is a reduction of $US6.8 billion on IATA’s previous forecast in March of a profit of $US4.5 billion. Much of that comes from the troubled US industry. Airlines in other parts of the world, while preparing for difficult times, say they are better placed to ride out the storm.

Bisignani also stated that by the time the industry switched to the northern winter schedule later in 2008 the full impact of rocketing fuel prices was expected to prompt airlines around the world to follow Australian carrier Qantas in cutting routes, grounding planes and laying off staff.

Already in the region, Air New Zealand had raised its fares by 4% and planned to cut its Hamilton to Sydney route in September 2008 from three to two frequencies a week as well as its Dunedin to Sydney route.

As for the manufacturers, at the IATA Summit, Boeing stated that although the fuel crisis could not be underrated, it was manageable.

Scott Carson, President and Chief Executive of Boeing Commercial Airplanes was of the view that the industry has seen patterns such as the current crisis and that Boeing had taken adequate measures to respond to such situations in the past.

Current crisis

However, what was of concern to Carson was the plight of the airlines. Although in their preliminary estimates, both major manufacturers of aircraft- Boeing and Airbus Industries - had agreed that the fuel crisis will not adversely affect the market for new aircraft as airlines will need replacements to their ageing fleets, more recent reports indicate that the fuel crisis is proving to be worrisome to the manufacturers.

A corollary to the crisis is that air-traffic growth is starting to cool in some of the world’s hottest markets: the Middle East; India and China.

In the overall scheme of things therefore, by mid 2008 it seemed that a combination of reduction in traffic and rising fuel costs was adversely affecting the profitability of air carriers.

Some were forced to further hike fuel surcharges and this negatively impacted traffic growth further. Slowing growth in traffic as well as real yields and the limited scope available to achieve further reductions in costs proved a major challenge for most air carriers.

The only way to mitigate these negative trends seemed to be to achieve consolidation of major air carriers within the United States and intra US-Europe and to replicate this approach in other regions, especially in the emerging economies burdened with overcapacity.

In this regard, it is submitted that consolidation would certainly help airlines manage the expected excess capacity more effectively and give them tighter control over pricing decisions.

This and the expected positive impact of the open skies agreement between the US and Europe, India and China and other open skies and liberalization agreements should see the industry ride the difficult times expected in 2008.

Consumption and traffic levels

The first issue concerns rising consumption levels of fuel and the corresponding demand on producers. It is claimed that the world now consumes 85 million barrels of oil per day, or 40,000 gallons per second, and demand is growing exponentially.

It is also claimed that the problem of soaring fuel prices is not predicated by depletion of the world’s oil reserves but rather by the fact that the ability of the oil producing nations to produce high-quality, cheap and economically extractable oil on demand is slowing down, mostly because of highly increasing demand.

After more than fifty years of research and analysis on the subject by the most widely respected and rational scientists, it is now clear that the rate at which world oil producers can extract oil is reaching the maximum level possible, or peak oil levels.

The picture is somewhat ominous, since although with great effort and expenditure, the current level of oil production can possibly be maintained for a few more years, beyond that oil production must begin a permanent and irreversible decline.

Fuel surcharges imposed by the airlines would make travel more expensive and may impact demand. A recessionary environment in the United States and the adverse liquidity impact of the sub prime crisis could spread to other regions, especially to the emerging economies of Asia, thereby adversely impacting growth.

With regard to non scheduled operations, it is estimated that, in 2007, the total international non-scheduled passenger-kilometres decreased by about 3% compared with 2006, with the non-scheduled share of overall international air passenger traffic decreasing some 1 percentage point to about 9%.

Domestic non-scheduled passenger traffic represents about 8% of total non-scheduled passenger traffic and around 1% of total domestic passenger traffic worldwide.

Economic contribution of aviation

The second issue is whether carriers can cut back on air services to reduce costs despite the exponential and fast growing demand for more capacity. The demand for more capacity is inevitably linked to the importance of aviation to the global economy and the contribution of air transport to the world.

The Air Transport Action Group (ATAG) of the International Air transport Association (IATA) has reported that aviation transports globally 2 billion passengers every year and 40% of the inter-regional goods by value. 40% of tourists now travel by air and the air transport industry generates a total of 29 million jobs annually through direct, indirect and catalytic impacts.

Aviation’s global economic impact is valued at US$ 2.960 billion which is equivalent to 8% of the world’s gross domestic product.

In addition to its total output and employment impacts, civil aviation has a broader influence on overall economic growth, deriving from non-quantifiable benefits for the users of air transport, businesses and individuals alike. Air transport acts as a facilitator for the development of markets and trading of goods as well as service.

ICAO has estimated that in the year 1998 (a year taken as a benchmark that reflects current trends), the direct contribution of civil aviation, in terms of the consolidated output of air carriers, other commercial operators and their affiliates, was 370 billion US dollars.

Direct employment on site at airports and by air navigation services providers generated 1.9 million jobs while production by aerospace and other manufacturing industries employed another 1.8 million people. Overall, the aviation industry directly employed no less than 6 million persons in 1998.

Legal Issues

The legal issues concerning measures taken by airlines to counter the rising fuel prices broadly hinge on the imposition of a surcharge on the passenger ticket as well as the baggage allowance. Do airlines have the right to impose such surcharges? The answer is a clear yes, inasmuch as a restaurateur has the right to increase prices on his menu in response to rising prices of ingredients.

However, such actions should, at common law, accord with the principles of contract law, particularly with regard to the fundamental notion of offer and acceptance.

Admittedly, where there is a passenger rights charter in any jurisdiction, courts would be inclined to determine whether the airline acted with prudence and in conformity of such a charter, although this would be only in terms of trade practices and not in terms of contract law.

The most fundamental legal premise that would impose liability on the carrier for imposing a surcharge on the ticket or baggage carried is that there is a compelling need for clear and adequate notice be given to the customer of the price and the pricing policy of the carrier.

This is particularly so in the case of electronic ticketing where the originator of the communication usually clearly indicates the price of the ticket offered and a mere quotation of a ticket that will be sold would not amount to an offer but a mere invitation for the buyer to make an offer.

It is quite evident that, irrespective of a carrier’s right to impose surcharges on a passenger ticket and the baggage allowance, in the ultimate analysis, it is the carrier’s dedication to efficiency that would largely assist the carrier in cutting fuel costs which are at least 40% of operating costs of most carriers. There are certain measures, if efficiently adopted would greatly assist in this regard.

Efficient method

One such measure is to maximise load factors and optimise the position of the centre of gravity of the aircraft when loading.

Another is to reduce taxi time wherever possible. This could be done by using fewer engines while taxing or minimising the distance between the gate and the runway. The replacement of on board power generators with electrically operated ground support equipment would be another efficient method of minimizing fuel consumption.

An enhanced and more fuel efficient aircraft maintenance programme would also be beneficial. Reduction, to the extent possible, of such consumables as water and ice and obviating the carriage of heavy trays and ovens in flights that do not serve hot food would also assist in this endeavour.

The use, wherever possible of small jet aircraft instead of higher fuel consuming turboprops is yet another example of fuel conservation. Additionally, the reduction of non-revenue generating flights and use of flight simulators in place of test flights would also add to lessening the operational costs of an airline in the context of fuel consumption.

The writer is Coordinator, Air Transport Programmes, International Civil Aviation Organisation Montreal, Canada.