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Will Air Fares Fall As Oil Drops?

Posted on: Monday, 15 September 2008, 12:00 CDT

As crude oil prices jumped over the past two years, airlines and other fuel-dependent companies turned to surcharges as a way to cushion their balance sheets from higher costs. Now, however, crude oil is in the midst of a retreat, dropping briefly below $100 per barrel on Sept. 12. In the past two months, crude has declined by nearly one-third since topping $147 per barrel. In a Sept. 12 client note, Credit Suisse (CS) analyst Daniel McKenzie cited crude's "collapse" as one reason he's bullish on the airline industry's deeply discounted stocks.

Lower crude oil prices mean airlines will also drop fuel surcharges, right? Not quite. Jet fuel is still running 40% to 50% higher than a year ago -- and it's not clear if the price relief will last. "At the moment, airlines are in balance-sheet repair mode, and it is not likely we will see any fuel or base-airfare rollbacks until they recoup some of the major losses of the past year," air fare watcher Rick Seaney of travel site Farecompare.com said in an e-mail. He predicts crude would need to drop by another $20 a barrel or so before airlines begin rolling back fuel fees.

As much as carriers strain under jet fuel costs, price volatility has been equally burdensome, since fluctuations creates havoc in financial planning. That's why no U.S. airline has yet eased surcharges and why most industry observers don't expect any domestic carriers to reduce or eliminate the fees anytime soon. "I think there is a fear in the marketplace that as oil went up so quickly and then dropped, it could just as easily go back again," says Bob McAdoo, an analyst with Avondale Partners and a former airline executive. "I think management teams are concerned that they generated substantial losses and the economics of their business changed."

Charging for Water, Too Airfare fuel surcharges, which have been around for several years, have risen as part of a broader and more aggressive effort by the industry to boost revenues in the face of soaring energy costs. In 2008, U.S. airlines so far have introduced new fees for travelers to check bags, obtain specific window or aisle seats, redeem frequent-flier miles, and even for getting a cup of water or coffee onboard. Nearly all the new fees have stuck, as airlines and passengers adjust to what many expect will be permanently high prices for fossil fuels and a push to pass along more costs to the public. Burned by billions in losses, the carriers are reluctant to pare back. "Fuel and oil prices remain very volatile, despite short-term trends," says Tim Wagner, a spokesman for the largest U.S. carrier, American Airlines (AMR).

That's little solace to travelers, who wonder why an airline's fuel surcharge should not operate more in tandem with actual fuel prices. "Guess it would be crazy to think we could get a break commensurate with the dropping fuel prices?" asked a blogger for AirportGyms.com. "Oh yeah, sorry, we are dealing with the airline industry."

Charges Can Dwarf Fares Jennifer Urbaniak, a spokeswoman for Lufthansa (LHAG.F), concedes that falling jet fuel could increase pressure on the carrier to cut its surcharge. Lufthansa's charge on long-haul flights has jumped from $15 in August 2004 to $105 now, including six increases in the past 12 months. The surcharge "significantly increases the cost of the trip so of course we have pressure from our customers to respond," Urbaniak says. Still, higher costs -- crude oil finished last week at $101.18 -- mean that "right now we are not decreasing our fuel surcharge."

The surcharges can be quite hefty and often dwarf actual fares. British Airways (BAY.L), for example, assesses a surcharge of $147 to $257 depending on flight length and class of service. UAL's (UAUA) United Airlines charges up to $250 for each leg of a trip. On a $908 round-trip British Airways fare in late September between Los Angeles and London, more than half the cost -- $586 -- is for taxes, fees, and the fuel surcharge. Rival Virgin Atlantic charges $151 to $261, "depending on where customers sit on the plane," says spokeswoman Emily Andariese. Neither British airline -- nor the major domestic U.S. carriers -- have cut surcharges in recent weeks. "There needs to be a sustained drop in the oil price and an end to the volatility we have been seeing," Andariese says.

So far, reduced surcharges have been initiated by international players. On Sept. 4, Air France-KLM (AIRF.PA) said it would cut its surcharge by $3 to $20 depending on flight length, and on Sept. 9, Singapore Airlines reduced surcharges on short and medium-haul routes by $4 to $10 per segment, citing lower fuel costs. In July, Air France had pledged to remove its latest surcharge hike when oil stabilized below $125 per barrel, the Associated Press reported.

Northwest Airlines' (NWA) cargo division has also announced a slight rate cut based on fuel, and cargo giant FedEx (FDX) said its quarterly results would exceed earlier estimates because of lower fuel spending. Northwest has not lowered its surcharge for passenger flights. "The decision to reduce the fuel surcharge for cargo was based on competition in the marketplace," Northwest spokeswoman Michelle Aguayo-Shannon noted in an e-mail. "Northwest Airlines continues to monitor the price of oil; however, the run-up in our costs related to fuel prices continues to exceed the surcharge levels currently in place." In other words, don't expect a break in air fares just yet.

Source: Business Week

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