American Airlines had their quarterly earnings call with the Wall Street types and it was more eventful than their typical announcement. But one thing stood out: fuel prices.
The $2 Billion Problem
You probably don’t pay much attention to the daily fluctuations in the price of oil, but the airlines do. It’s their second-largest cost, and even a penny move in the price of a gallon can affect their earnings by tens of millions of dollars. Yesterday, due to a recent spike in the price of oil, American announced that it would not meet its previous estimates for full-year profit. The stock declined 6%.
Rising oil prices generate a two-fold problem for ticket prices. First, airlines raise prices to offset the fuel costs. Second, they cut capacity on unprofitable routes, driving up prices on those flights.
Raising prices may seem like an obvious response to higher costs, but it isn’t that easy. Most travelers pick their flight based on the lowest cost, so if one airline raises prices but a competitor doesn’t, the more expensive one will lose business. Thus, for the first few dollars of a price in the cost of oil, airlines just eat it. But eventually, the impact on profits grows too high, especially for the low cost and ultra-low cost carriers, whose lower employee wages means that fuel makes up an even higher percentage of their total costs. Once the Spirits of the world start raising prices, the carriers who fly against them have the ability to do so, as well. We’ve reached that point.
Sometimes, though, airlines don’t even have to raise prices. Instead, they simply cut capacity. A flight from A to B may be profitable for the airline if oil is at $40 per barrel, but at the current $70+, that same route doesn’t make sense. Cutting out one flight on a route doesn’t even require raising prices on remaining flights. The airlines will simply carve out the cheapest seats.* The fare you pay will likely go up.
Bottom Line: Summer travel is, for the most part sold, and they won’t cut capacity through August, since the planes are full. But, if history’s any guide, there will be fewer seats available for sale in the fall, and they’ll come at higher prices.
*Think of it this way (highly simplified): Sunny Airlines flies three flights per day from A to B. 1/3 of the tickets sell for $100, 1/3 for $200 and 1/3 for $300. If the airline cuts one of those three flights, demand will stay relatively stable, but there will be far fewer seats available. Most of the tickets will sell for $200 or $300, with the $100 fares getting eliminated.
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