Airfares Could Rise Next Year as Carriers Face Rising Costs

Major airlines reported third quarter profits for 2017, but while virtually all carriers were in the black, the financial outlook for the industry is more challenging than it was earlier this year, analysts say.

In short: get ready for a round of fare hikes, as airlines seek to pass along rising operating costs to customers.

In recent weeks, American, Delta, Southwest and United all reported strong earnings for the most recent quarters, but also raised some red flags. While carriers weathered the effects of Hurricanes Irma and Maria without serious damage to their bottom lines, they are facing higher costs following a round of labor contracts that yielded pay hikes for pilots and other employee groups.

American, for example, told analysts that it expected costs in the last quarter of 2017 to rise significantly, although that should ease somewhat next year. Meanwhile, Southwest, for its part, was bullish on the outlook, with CEO Gary Kelly telling analysts that despite numerous challenges, “it was a very strong quarter, and fourth quarter looks better.”

Both of the Texas-based carriers narrowly beat Wall Street’s profit forecast for the quarter.

The price of jet fuel, the airlines’ biggest expense after labor, is also going up, but more efficient aircraft in carriers’ fleets should lessen the impact. And airlines are making significant investments to upgrade their product; purchasing new planes and refurbishing airport terminals, such as Delta Air Lines’ $4 billion upgrade of its digs at New York’s aging LaGuardia Airport.

The industry is still highly competitive
According to Rajeev Lalwani, an analyst at Morgan Stanley, the combined impact of these factors will raise airlines’ costs by up to 2 percent in 2018, excluding fuel. Airline fares could rise by more than that, especially in markets with less competition. But in general, air fares on average are about $10 lower this year than a year ago, suggesting that the industry is still highly competitive, says Airlines for America economist John Heimlich.

Major network carriers like United, of course, traditionally have had higher costs than their smaller rivals like JetBlue. But in recent years they have bucked conventional wisdom and have slashed expenses and raised revenue through ancillary services like bag fees and ticket changes. Recent data from the IdeaWorks consulting firm shows that the Big Three legacy lines – American, Delta and United – raked in more than $16 billion collectively in ancillary fees in 2016.

Still, industry officials say that while the mega-carriers that emerged from a round of mergers in the past decade may benefit from their large size, that is not enough to ensure profits in what has always been a tough industry. “The reality is that legacy carriers still have very high costs, and consolidation didn’t really improve the cost structure,” Spirit Chief Executive Bob Fornaro said in a quarterly earnings call. “It improved the networks, but the costs are going higher.” 

Of course, budget airlines like Spirit and Frontier are champions of the a la carte approach to pricing, but even with their low costs, they are facing similar challenges. Pilots at Spirit are demanding higher pay in contract negotiations that have already dragged on for two years.  

Individual carriers are also facing additional expenses stemming from their mergers. United, for example, expects technology costs to rise next year as it finally integrates its IT systems with Continental’s. And Alaska is on track to absorb Virgin America into its system, ultimately retiring the latter’s brand.