Reduced Fuel Costs Could Boost Airline Capacity and Lower Fares

Reduced fuel costs are helping airlines rack up record profits without dramatic fare hikes.

While lower oil prices are making it harder for carriers to boost fares, lower-than-expected spending on fuel gives them more flexibility to drop prices in highly competitive markets.

As fuel costs remain low, carriers will feel growing pressure to add capacity.

Fuel accounts for 30% to 35% of airline operating costs, according to Bob Brindley, vice president and principal for Advito, BCD Travel’s consulting arm.

Any decline in fuel costs falls straight to carriers’ bottom lines. Those surging profits give them more opportunity to lower ticket prices or cut better corporate deals in highly competitive markets while maintaining healthy profit margins.

“Those higher profits also make it more attractive for new entrants to come into the market with lower fare,” Brindley told Travel Market Report.

Stymied projections
Advito is projecting a modest 1% decline in North American economy fares, due to fare and capacity adjustments.

But that slight decline in the company’s latest 2015 forecast replaces the projection of a 4% increase made at the end of 2014.

‘This is a very good time to be an airline,” said Brindley. “The mainline carriers in the U.S. are acting very much like a successful oligarchy, very closely tying capacity to demand to keep load factors and margins high.”

The benefit of an ‘oligarchy’
The domestic effects of lower oil prices will be market specific. Consolidation has effectively reduced mainline competition to three carriers: American Airlines, Delta Air Lines and United Airlines.

“The three joint venture partners have significant market power nationally, but they are highly competitive in certain domestic markets and on the global scene,” said Brindley. “They know they can’t overplay their hand or they will invite the kind of competition that will upset their carefully crafted capacity controls and high profits.”

Expect price increases on routes with little or no competition. Routes with more competition will see more capacity, lower fares, or both.

“There are plenty of aircraft sitting in the desert for new carriers to enter the marketplace,” said Brindley. “The only way the mainline carriers can prevent that is to add new capacity themselves.”

Corporate take
Expect stronger discounts on more highly competitive routes, and smaller discounts on routes with less competition, on the corporate side.

JetBlue and Virgin America are pushing hard to build business between New York and both San Francisco and Los Angeles, creating increased competition and lower fares.

American and United are both hubbing in Chicago and competing for market share– and that’s good news for local companies.

Cleveland, by comparison, is seeing lower capacity and higher prices after United closed its hub operations. Denver could be the next United hub to shrink and the combined American/US Airways will likely reduce hub operations.

The importance of load factors
Load factors make a difference, too.

With higher load factors, carriers are quicker to drop companies that fail to deliver on contracted volume. Carriers are also slower to accept increased discounts, unless they are faced with credible competition for a significant piece of business.

The same math works internationally. Corporate discounts are improving between the U.S. and London as Delta/Virgin Atlantic offers a significant alternative to what used to be a near monopoly by American/British Airways.

Companies flying between Philadelphia and Europe, however, are seeing the reverse.

Global perspective
Look for similar constraints on global pricing. In Europe, growing capacity and falling costs will limit carriers’ ability to raise fares. Economy fares will be the most constrained.

The continuing rapid expansion of low cost carriers combined with an overall economic slowdown will lead to lower fares in most segments.

In the Middle East, though, capacity expansion will affect all segments. The continuing global expansion by Emirates Airline and Etihad Airways, in particular, could even push U.S. carriers to reinstate service to business destinations in India and Asia that they abandoned during the recession.