June 4, 2018, by Jamie Freed and Victoria Bryan
SYDNEY (Reuters) – Airlines are locking in fuel hedges, lowering capacity, raising fares and retiring older jets to cope with rising costs alongside the highest oil prices since 2014, industry executives say.
The squeeze from fuel costs, which have risen much faster than ticket prices, poses a particular threat to the industry’s profitability.
The International Air Transport Association on Monday forecast airlines’ combined profits would be 12 percent lower than it had expected in December, at $33.8 billion in total, in large part because of costlier fuel.
Brent crude is trading at around $76 a barrel, up nearly 50 percent from a year ago.
“At this point with rising fuel, you control costs, raise prices and you may have some fall off in demand and reduce capacity,” Air New Zealand chief executive Christopher Luxon told Reuters on Monday.
“I think we are seeing pricing move up internationally and certainly yields come up as well,” he added.
IATA forecast passenger yields, a proxy for airfares, will rise by 3.2 percent this year, in the first annual gains since 2011, as airlines look to recoup rising costs.
American Airlines CEO Doug Parker also forecast that fares could rise as capacity is reined in amid higher oil prices.
China Eastern Airlines Corp Ltd has said it would consider using newly launched yuan-denominated oil futures to hedge oil for the first time in a decade, but others, like Emirates and Delta Air Lines have no plans to return to hedging as a result of the recent oil price increases.
“I think rushing to get hedged when the prices go up is a bit dumb and when they go down they get complacent again,” CAPA Centre for Aviation Executive Chairman Peter Harbison said.
IATA chief economist Brian Pearce said hedging only delays the impact.
“It stabilizes earnings; it doesn’t stop the rising costs happening,” he said.
Other carriers, such as Singapore Airlines Ltd and Air New Zealand Ltd, are well-hedged at lower prices but are being forced to hedge at higher prices as those contracts end, in keeping with their internal policies.
For example, London-listed IAG, the parent of British Airways, hedges up to three years in advance on a rolling basis. That means 80 percent of its fuel is hedged for the current first three months, a number that drops to 10 percent in the final quarter of the three-year period.
“Whilst most of us have hedging in place, that hedging eventually runs out or gets replaced by new positions you have got, and it is a question then of what do you do?” Virgin Australia Holdings Ltd CEO John Borghetti said. “If you look at history, typically some of that cost has to be passed on at some point because you just simply can’t absorb it.”
European carriers are also hedged between 50 and 90 percent as a way to give them better control of costs.
“We take a simple view that hedging is about buying time; it gives you time to address volatility,” said IAG’s chief executive, Willie Walsh.
The higher oil price is also expected to drive a new cycle of airlines’ replacing older jets with more efficient newer generation models like the A320neo and 737 MAX narrowbodies and the A350, A330neo and 787 widebodies.
Australia’s Qantas Airways Ltd is retiring gas-guzzling Boeing Co 747s more quickly than it had originally forecast and replacing them with twin-engine 787s.
“It will be a bittersweet moment when those aircraft will go but it also helps us manage the increase in fuel prices,” Qantas CEO Alan Joyce said Monday. “The 787s are going to give us a big benefit this year on our international operation.”
Boeing Commercial Airplanes vice president of marketing Randy Tinseth said on Sunday that replacement makes sense for airlines when oil reaches $65 a barrel.
“Fuel is definitely an issue and it is eating into profitability,” said Mylene Scholnick, principal at consultancy ICF. “When fuel comes down, the airlines keep aircraft longer, so we had seen ages pushed to 28, 30 years. Now with fuel back up, it won’t bring down the retirement age drastically but will stabilize it at around 25 years.”
Reporting by Jamie Freed and Victoria Bryan; Editing by Gerry Doyle