How Cheap Oil Could Become a Real Problem for Airlines

How Cheap Oil Could Become a Real Problem for Airlines
If crude oil is priced under $100 per barrel, many airlines will find reasons to add routes and flights???and this makes investors nervous (Photograph by Mark Elias/Bloomberg)
Photograph by Mark Elias/Bloomberg

Oil futures have been on a torrid plunge in recent weeks, touching lows below $80 per barrel. Great news for airlines, right? Maybe not.

For roughly the past 35 years, inexpensive jet fuel has routinely served as a siren call to airline executives. Cheap fuel spurs more flights and wild grabs for whatever business looks attainable in the travel market. Marginal routes become profitable with lower fuel prices, which, in turn, bolsters the argument that new flights can boost revenues with little cost. Cheap fuel also lets an airline experiment more radically with flight schedules in the bid to swipe market share from rivals.

“If it keeps trending lower, it totally changes the economics of the industry again,” says Seth Kaplan, managing partner of Airline Weekly, an industry journal. With oil cheaper, Kaplan predicts that many airlines will probably fly their planes in off-peak periods because of the low costs associated with those extra flights. A few additional flights on the weak travel days of Tuesday and Saturday could return to some schedules.

This possibility has some Wall Street analysts in a tizzy, concerned that if oil stays cheap enough for long enough, lower prices will cause airlines to backslide on their new-found religion against deploying too much capacity. “We feel like this industry needs an oil spike now more than ever,” Wolfe Research analyst Hunter Keay wrote last week in a client note. “[C]apacity discipline of late (from some) seems theoretical at best.”

Brent crude, the energy index most airline executives monitor for its correlation to jet fuel, has declined 22 percent this year; settling Friday at $86; a day earlier, the Brent Index scored a four-year-low, under $83. This constitutes a sharp reversal from recent years: After oil spiked to nearly $150 per barrel in July 2008, U.S. airlines radically restructured to try to cope with oil at whatever price it may be. That effort has left high or low oil prices much less important—quick swings either way are now the enemy—while turning expensive oil into somewhat of a barrier for new flying.

A bear market in oil futures is far from the worst economic problem airlines might confront: Oil at $80 per barrel is enormously beneficial, compared to $100. It’s a swing worth billions of dollars across the industry. All else being equal, when a carrier’s so-called “input cost” declines—and fares don’t—a healthy expansion of profit margins will follow. “The fuel price reductions we’ve seen in the marketplace are a huge opportunity going forward,” Delta Air Lines Chief Executive Officer Richard Anderson said last week during a quarterly earnings call, referring to the profit potential. That’s likely to play out in abundance in the fourth quarter, a time of robust fares for holiday travel.

At a time of high demand among U.S. consumers, low fuel costs practically beg the airlines to add flights. Greater capacity might reduce fares, but additional flying reduces an airline’s unit costs: Expensive items such as airplanes, ground equipment, and employees become more productive as they are put to more use. Then there’s the greater revenue that comes from selling more tickets. American, for example, said earlier this month that it will add flights in March at its Miami hub and Los Angeles, including redeye flights from Salt Lake City to Miami and from Los Angeles to Atlanta. Last month, Delta said it would inaugurate flights from Los Angeles to Austin, Dallas, and San Antonio in Texas in the spring.

“I don’t know if they would have announced that with oil at $100,” Kaplan says of American’s new routes from Miami. “There are things that work at $90 [per barrel] that don’t work at $100 and things that work at $80 that don’t work at $90.”

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