Rising airline fuel costs could lead to higher fares

Rising fuel costs have added $39 billion to airlines' bills over the last year. Photo / AP

Jet fuel prices are now 20 per cent higher than they were a year ago, opening the possibility of increased fares.

Fuel prices are almost double what they were at the start of 2016 when there was a surge of new airline growth into New Zealand and carriers around the world, even those with less efficient fleets were able make good returns.

The rising fuel price has added about US$28 billion ($39b) to the industry's US$130b fuel bill during the past year.

Fuel can make up to 40 per cent of the cost of the flight depending on the operator's model and the route flown and this could lead some airlines to reconsider where they fly, said Shane Solly, an analyst at Harbour Asset Management.

Air New Zealand was facing a higher fuel bill but was in a better position to cope than some of its competitors.

"Some of them will keep growing but one or two will think about whether to put their metal (aircraft) into other locations where they get better returns when that fuel price creeps up," Solly said.

"There's no doubt that Chinese and Middle Eastern carriers may grow their services but others may shrink around it."

Ticket price rises were possible. Relatively low fuel costs of the past two and a half years have given airlines more scope to slash fares on promotional deals.

"Air New Zealand's investment in a more efficient fleet may hold it in a reasonable position if that fuel price stays higher for longer whereas others will have to absorb some of that or pass it on in terms of higher ticket prices," Solly said.

Air New Zealand's investment in a more efficient fleet may hold it in a reasonable position if that fuel price stays higher for longer whereas others will have to absorb some of that or pass it on in terms of higher ticket prices

Shane Solly

Air New Zealand's widebody fleet is young and includes a growing number of Dreamliners which are up to 20 per cent more fuel efficient than the aircraft they replace.

The airline in September forecast pre-tax profits in excess of last year's of $527 million, but that was based on an average jet fuel price of US60 a barrel — a level it has been above for months.

Although more efficient planes and hedging will help reduce the impact of elevated fuel prices, they will still be felt by the airline.

Solly said the airline had proved itself to be adept with fuel hedging.

Capa Centre for Aviation analysis said during the past year the airline industry had been in a "sweet spot" in contrast to its turbulent past, but rising oil costs would affect fares.

"Buffeted by uncontrollable external input costs and regular assaults on traffic demand, it has rarely achieved even modest profitability.

"Where profitability has occurred, it was usually at the expense of traffic growth, inhibited by protectionist regulation," the analysts said.

During the past two or three years, almost every facet of the industry had excelled with profits at record levels, ($65b last year), high load factors even though there had been strong traffic growth, thanks in part to some airlines retaining older less efficient planes that may otherwise have been parked.

"2017 has arguably been the sweetest spot for combined airline profitability and traffic growth ever experienced."

Global economic growth, with historically low fuel prices and interest rates, had allowed airlines to lower fares, stimulating passenger traffic growth.

"Now the core ingredients for the future of this phenomenon may be at risk. Rising oil costs will stall fare decreases, dulling demand in what has become a highly price sensitive market. And interest rates too are gradually increasing," Capa said.

Oil prices have risen in the past year as supply curbs between Organisation of Petroleum Exporting Countries and non-Opec countries have held steady, and global growth is fuelling demand.

However, barring global shocks, prices are not forecast to return to the US$100-plus levels last seen in 2014 and which have historically forced some airlines to the wall.

Shale oil drillers in the United States come into play when the price of oil hits US$55 to US$60 a barrel, and this helps keep a lid on prices.

In the longer term, airlines are working on biofuel to help replace some of the 330 billion litres the industry uses a year.

While the necessary huge volumes of sustainable biofuel that can be added to standard jet fuel are yet to be produced, progress is being made. Qantas this year plans to launch a project using industrial mustard seed-derived fuel on its Dreamliner flights between Melbourne and Los Angeles.