Rising prices

Niko Herrmann, aviation expert for Oliver Wyman discusses the impact of escalating fuel costs on the global aviation industry and on Middle Eastern airlines.
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Niko Herrmann, aviation expert for Oliver Wyman discusses the impact of escalating fuel costs on the global aviation industry and on Middle Eastern airlines.

How have recently escalating oil prices impacted carriers around the globe?

For many airlines, fuel now accounts for 40-50% of operating costs - a level that is hardly sustainable, especially for airlines with less than rock-solid balance sheets and limited cash.

Even fare increases and surcharges passed along to passengers are not enough to help carriers. And other efforts to increase ancillary revenues, such as on-board sales or fees for checked baggage, while helpful and necessary, still cannot fully offset the tremendous impact of oil on the aviation industry's cost structure.

 

Oil-rich Gulf countries still provide for passenger growth; but there is no immunity from the impact of rising fuel cost.

The impact of rising fuel prices has been felt most acutely in the US. As many US legacy carriers have gone through a recent wave of bankruptcies and out of court restructurings, they have postponed aircraft purchases for several years due to lack of funding for fleet renewals.

As a result, they now have much older fleets on average (ranging from Continental at 10 years to Northwest at 18) compared to Middle Eastern and Asian airlines. These older aircraft are less fuel efficient, so higher fuel prices are especially painful.

Several US carriers have announced plans to ground large parts of their fleets. For example, United has announced the grounding of more than 70 aircraft, retiring the oldest and most fuel inefficient aircraft in its fleet. Continental plans to ground 11-12% of domestic capacity, and American has announced cuts of similar magnitude.

Additionally, while European and Asian airlines have been able to recover part of the fuel cost impact through strong foreign exchange gains, US airlines have been hit by both fuel costs and the continued weakness of the US dollar.

Is the ME in better standing to survive this crisis than other regions?

The Middle East is at the crossroads of global traffic flows and therefore has seen less impact on demand than, for example, the US market. The booming economies of the oil-rich Gulf countries still provide for passenger growth both in local markets and in transfer markets via the growing Middle Eastern hubs.

For example, Emirates announced record profits in 2007, largely driven through successful growth of consumer demand in its ever-expanding network. Especially in the highly profitable premium segment, carriers like Qatar and Emirates experienced strong growth in load factors and were able to increase unit yields, or revenue per seat offered.

Middle Eastern airlines also have enough liquidity available to engage in expanded fuel hedging programs. But there is no immunity from the impact of rising fuel cost.

Emirates attributed savings of more than US$200 million to its fuel risk management program - but it nevertheless stated that profits had been dented substantially because of soaring fuel cost.

Business class carrier Silverjet went bust, with oil costs cited as one of the reasons. While there's less risk of this for commercial carriers, what can they do to cope with the increases?

Silverjet and two other all-business start-up airlines, EOS and maxjet, went out of business because their business plans were written with fuel prices of $60-80 per barrel in mind.

No start-up can weather cost variance of up to 100% on one of the largest cost items - they do not have the deep pockets required.

Any airline has to look at both cost reduction and revenue maximisation initiatives. Cost reduction alone without structural changes to improve the revenue profitability of the airline's assets will not be sufficient.

Additionally, many cost reduction measures have a long lead time; for instance, maintenance cost reductions or supplier contract renegotiations can take 3-6 months before those savings materialise in cash flow.

Are oil prices expected to continue rising and if so, what impact will this have on Middle East carriers?

Most experts believe that the high oil prices are here to stay - giving the airlines no hope of immediate relief from drastically higher than anticipated cost.

Of course, higher oil prices are not only a concern for airlines, but for economies as a whole. The slowdown of the US economy and the expected reduction in growth in Europe and Asia will eventually impact passenger demands in the Middle East, too. None of the Middle Eastern airlines have enough local demand in their home markets to not be impacted by waning transfer demand.

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