For the airline industry and investors, 2011 is shaping up as a bit of a mixed bag. The good news: airline capacity and revenue is up dramatically in 2010, as travelers (particularly high-ticket business travelers) returned to the air. The bad news: fuel prices, which account for at least one-third of airline operating expenses, are skyrocketing and projected to rise even higher.
In recent days, major U.S. airlines such as Delta Air Lines (NYSE:DAL) and AMR Corp.’s (NYSE:AMR) American Airlines have warned that rising fuel prices could increase operating costs by $1 billion in 2011. Other major airlines are expected to feel a similar unpleasant pinch on their bottom lines if fuel prices, now hovering around $86/barrel, reverse back toward the $100/barrel mark in the coming months.
The development hasn’t been lost on investors, who have watched oil prices trend upward. The Dow Jones Airlines Index is down about 10% since late November.
Since that is exactly the scenario many analysts see flashing across their Magic Eight Balls these days, airlines are now under the gun to find ways to reduce the impact of rising fuel prices, or risk a return to the red this year. Here are some strategies that airlines will use to keep operating costs in check:
Hedging: Hedging is an important element of fuel cost management for most airlines. Fuel hedging enables airlines to enter into a contract to pay a set price for their future fuel purchases. The strategy can help minimize the impact of volatile fuel prices on their operating costs. Domestic airlines have different hedging strategies available to them, including the use of both over-the-counter and exchange-traded derivatives.
Greener Fleets: Mothballing the old gas-guzzlers and investing in newer, more fuel-efficient aircraft is a tactic many airlines will employ to tame out of control fuel costs. Delta, for example, has asked aircraft manufacturers for proposals for 100-200 new single-aisle aircraft — and an option to acquire 200 more — with delivery beginning in 2013. The new, more fuel-efficient jets, would replace aging DC-9s, A320s, 757s and unpopular 50-seat regional jets. The newly merged United Continental (NYSE:UAL) also is likely to be in the market for at least 100 new aircraft to replace mothballed 737s, A320s and A319s.
Fare Increases: Wherever you go, no matter which airline you fly, higher fuel costs will mean higher ticket prices. According to FareCompare.com, a half-dozen fare increases since mid-December already have boosted prices by as much as $35 over what tickets cost on the same routes a year earlier. More significant: traditional low-price leader Southwest Airlines (NYSE:LUV) joined in the fare increases instead of sitting on the sidelines.
Extra Fees: Travel light and don’t change your itinerary, because this year, the fee meter is running. Most airlines, including Delta, American and United Continental are offsetting higher costs by charging passengers extra for everything from baggage to blankets. According to CIT’s “Global Aerospace Outlook” released this week, nearly four in 10 airlines now charge passengers for food (41%) and their first checked bag (38%). The trend is more common among U.S. carriers (75%) than among European carriers (17%) and other regions (19%). The notable rebel among U.S. air carriers is Southwest, whose “Bags Fly Free” and low-cost, no-frills business model aims to win over passengers from other carriers.
Shrinking Service: Another tool to help airlines manage the impact of higher fuel prices is the practice of cutting capacity. Simply put, airlines eliminate routes that are less profitable and replace larger, gas-guzzlers with smaller, lower-capacity aircraft. Eliminating flights and grounding older, larger planes reduces operating costs and boosts profitability.
New Technology: Never underestimate the impact of new technology in boosting operating efficiency and managing costs. Southwest, for example, hopes to save $60 million a year with GE Aviation Systems’ TrueCourse flight management system. The TrueCourse flight management system controls the aircraft track to an accuracy of 10 meters (33 feet) and the time of arrival to within 10 seconds to any point in the flight plan. Benefits include the ability to fly shorter flight paths and idle-thrust descents, which reduces fuel consumption, while lowering emissions and noise levels.
Fuel Surcharges: Back in 2008, when fuel prices hit $147/barrel, airlines sought refuge in tacking on hefty fuel surcharges, particularly on long-haul international trips. Fuel surcharges on many international flights added $200-$500 for each round-trip ticket, particularly on U.S.-Asia routes. And higher fuel surcharges are once again on the table. Pacific Rim/Asia-based airlines are once again likely to lead the way, with Singapore Airlines on Tuesday announcing its second fuel surcharge hike in a little more than a month. Qantas Airways and Malaysia Airlines are expected to follow suit soon.
At the time of publication, Susan J. Aluise did not hold a position in any of the stocks named here.