To begin with, as an important note, a plethora of unqualified people on social media are continuously stating strong opinions which come across as facts, so it is imperative to stick to facts or else clearly state opinion on this topic. Beyond that, many others that are stating strong opinions on the travel industry have little qualification to claim to be “travel experts” so be careful which advise you listen to.
The main issue facing airlines is a total slump in demand due to uncertainty in the travel space. Markets are incredibly volatile right now, and it seems that decisions are currently being made sporadically from day-to-day. As an additional note, we can expect to see financial markets gain a large amount of their losses today as equity index futures point to a 3-4% gain in the Dow Jones and S&P Indices. We are in times of extensive volatility and facts can become stale very quickly.
With Brent Crude futures prices falling by more than 30% at one point on Monday you would be forgiven for thinking that this would be a much-needed sigh of relief for airlines. Many airlines around the world are feeling the hard effects of the Coronavirus not only impacting demand but strict bans on flights to certain countries and destinations affecting routes.
With fuel making up between 20-30% of an airline’s operational input cost, lower prices would surely provide respite?
Unfortunately for most airlines the lower oil price won’t actually benefit them in reducing costs, and could actually be more burdensome on some carriers than beneficial.
With stiff competition in aviation, even small market shocks and price variables can mean that a profitable airline quickly falls into the red and begins to burn up cash reserves.
Because of this and the volatility of the oil price, many airlines tend to hedge their requirements for jet fuel. This ensures that sudden price moves don’t negatively impact an airlines bottom line.
However, when the price drops drastically, similarly to what the market has just experienced, those airlines that are hedged will be paying the hedge price and not the lower market price.
Although this gives airlines price certainly, the issue comes with the few airlines that are not as hedged and more exposure to the global oil price. These airlines can afford to cut ticket costs and become more competitive as they are saving on fuel.
As an example, Singapore Airlines is currently hedged at $76/barrel on 80% of their total oil requirements until March, and with the current market price at $33/barrel, the airline is essentially paying more than double the prevailing market price.
In Europe, the low-cost airlines Ryanair are the most hedged carrier due to their budget model. As much as 90% of Ryanair’s curling needs are hedged, with Lufthansa hedging 73% and EasyJet at 71%.
On the other end of the scale, airlines that could greatly benefit from lower oil prices include low-cost carrier Norwegian who despite facing its own difficulties has only hedged 25% of its fuel needs.
Despite the lower oil costs, virtually no airline is celebrating reduced costs, as demand has been hugely affected largely due to the uncertainty with countries turning back arrivals from certain countries, which is evolving each and every day.
The International Air Transport Association has increased the potential impact that COVID-19 could have on the airline industry by a factor of four from its estimate two weeks earlier, stating that airlines may lose $113 billion in sales in 2020.
Asian and Middle Eastern carriers also tend to hedge less of their fuel requirements. However, in the case of Cathay Pacific, for example, there has been an incalculable reduction in demand that has grounded such a large proportion of the fleet.
Similarly, in the Middle East, although the airlines actually benefit directly from lower oil prices, the business demand of passenger traffic into the region suffers as oil prices sell-off, especially as low as $30 a barrel.
Meanwhile, U.S. carriers have traditionally not hedged as much of their fuel needs. American Airlines does not hedge its fuel at all so is due to make substantial gains on the reduction in oil prices, which should serve to offset any waning demand.
Delta Air Lines also removed a lot of fuel hedges in 2016 and will serve to profit from declining oil prices.
However, until doomsday media headlines abate and more data is known about the Coronavirus, lower oil prices will only serve as temporary relief to many airlines around the world.