Summer vacation may cost more this year than you expected: Rising jet-fuel prices are pinching airline profit margins, prompting carriers to consider raising fares.
The months from July through August, when most U.S. students are out of school, are historically the busiest for the airline industry, and accommodating the additional fliers requires more fuel — among the industry’s largest expenses and one with a price tag that has been rising since the beginning of the year. In the 12 months through April, the average price per barrel increased roughly 46.5 percent to $89.30, according to the International Air Transport Association.
[Also read: US exit from Iran nuclear deal may jeopardize billions in jet sales]
Low-cost carriers such as Spirit Airlines, whose profit margins have a smaller buffer from the higher fuel costs, have already raised fares and signaled that reductions in seating capacity could follow. Even larger companies like American Airlines reduced earnings goals for the year and warned that price increases are pending.
“This is feeling somewhat more like the new normal, so we need to adjust our business plans accordingly,” American Airlines Chief Executive Officer Doug Parker recently told investors. “As the cost of production goes up, the cost of the product generally follows. I would expect you would see higher fares to consumers over time.”
How quickly the increases take effect will likely depend on how high fuel costs rise. Jonathan Kletzel, the transportation and logistics leader at professional services firm Pricewaterhouse Coopers, says the breaking point for the industry is a sustained price of $80 per barrel.
“Below $80, you probably won’t notice; the carriers will be doing something in the background,” he said in a recent interview. “Once you cross that $80 threshold, you will begin to see more noticeable changes and more dramatic, and those could be in pricing or in cost cutting.”
Daily fuel prices already have spiked beyond that level intermittently, touching $89 a barrel on April 30, according to data from S&P Global Platts.
In the first three months of the year alone, a 25 percent increase in fuel prices boosted American’s expenses by $412 million, according to Parker. At Atlanta-based Delta Air Lines, fuel expenses grew $317 million in the same period.
That’s not bad news for everyone, however: Energy companies are touting major profit increases. ExxonMobil, for example, reported 16 percent growth in quarterly earnings, which touched $4.7 billion at the beginning of the year.
“There’s a huge correlation between airline revenues and fuel price, but it does take a little bit of time [in] both directions, up and down, before it’s absorbed into the marketplace,” Delta president Glen Hauenstein told investors. “Under normal circumstances with the growing economy, we would see that roll into fares probably in the 90-to-120-day range, but it has to stay there. And I think, as it’s fluctuating around, it’s premature for us to start speculating.”
Budget airlines, whose business model is built around lower ticket prices in lieu of amenities such as free carry-on luggage or in-flight meals, are likely to be hit particularly hard.
Allegiant Air reported a 25% year-over-year increase in aircraft fuel costs for the first three months of 2018. A spokesperson did not respond to an email inquiring whether the airline was considering raising ticket costs in the coming months, but senior vice president Lukas Johnson alluded to increases on a recent investor call.
“Typically, you’ll have a pass-through a little bit on the fuel side,” he said. “If fuel is to go up X amount, you’re going to recapture Y percentage, and the industry will see that in general, not just us.”
Industry experts say budget airlines may be squeezed from both ends, as rising fuel costs combine with heightened competition from larger airlines.
“As fuel prices have fallen over the last couple of years, what the major carriers have done is they’ve looked at their route network and identified routes that used to be unprofitable,” and reopened them, Kletzel said. That has “created some pressure on the low-cost carriers in those markets,” he said.
In addition to increasing fares, carriers might also trim flights or routes.
“To the extent [there are] going to be any, we’ll look to do those as we start to build our fall schedule,” American’s Parker told investors. “It doesn’t mean that we should expect that if fuel prices stay here, we won’t make changes, but also there’s nothing for us to tell you right now.”
If fuel prices remain elevated, airlines may also pull back on projects such as revamping airport lounges and upgrading older aircraft.
Carriers of all sizes suffered losses in prior years when the average price of fuel topped $130 a barrel. But since 2015, fuel prices have been relatively constant and airlines have grown more profitable.
“Airlines have become much more adept at adjusting for changes in fuel price,” says Candice Cook Irvin, managing director at Deloitte Consulting. “When fuel prices go up, they are able to pull up capacity and have the balance sheet and cash to withstand that, whereas before, you would see people do things because they needed the cash to fund operations.”
The direction of the overall economy could also influence ticket prices. Consumers might abandon or postpone travel plans, for example, if growth slows substantially.
In April, consumer sentiment worsened 2.6 percent, according to a survey from the University of Michigan, and the Bureau of Economic Analysis said that spending — which accounts for more than two-thirds of the U.S. economy — slowed at the start of the year.
While GOP-led tax cuts in late 2017 put more money in Americans’ pockets, some of the Trump administration’s recent moves have sparked worries that put the brakes on stock-market growth. A potential trade war with China, for example, may pinch corporate profits, particularly in the Midwest agriculture industry, and reduce travel demand.
