Prepare for Higher Airfare as Airlines Deal With Increasing Fuel Costs

Jan 25, 2018

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Despite the Great Squeeze in Economy and introduction of Basic Economy by many airlines, in many ways we are living in a golden age of travel. Economy airfares to Europe and Asia that once might be considered incredible deals are now practically standard. Meanwhile, airlines are battling to provide the best offerings in the forward cabin.

Low-cost carrier competition and cost-cutting by legacy airlines has helped to drive these lower fares. But, no cost may be more important than fuel in driving flight prices low and keeping them there. The trouble is, those fuel prices aren’t so low anymore, and airlines aren’t going to continue to shoulder the rising costs.

In Thursday’s earnings call, Doug Parker — the CEO of American Airlines, the world’s largest airline — stated an open secret: “Fares are too low for oil prices this high.”

Sure enough, American Airlines’ passenger revenue per available seat mile — a decent stand-in for airfares — increased just 3.3% from 2016 to 2017. Meanwhile, the airline’s average aircraft fuel price (including related taxes) jumped over 21%. For the full year, that meant over $1 billion of additional fuel costs for the airline on under 1% growth in capacity.

Stating the obvious, that’s a huge headwind for an airline.

In setting expectations for investors, American Airlines has been open that it’s compensating its officers based on pre-tax earnings of at least $3 billion, with $5 billion in earnings being the expectation. In 2017, the airline earned “just” $3.1 billion.

Fuel prices are expected to continue to rise, many costs have already been cut, sneak fare increases via Basic Economy already realized and American Airlines only expects to grow capacity by 2.5%. So, there’s not much more than can be done besides raising airfares to meet these earnings expectations.

The good news? Competition is going to limit how much the airline can raise fares. As admitted outright by United this week — sending airline stocks tanking — the full-service carriers realize that they have to match ultra low cost carrier fares. The legacy airlines realize that they just aren’t differentiating themselves enough to demand higher fares. And in this competitive market, no single airline is going to be able to raise its prices too quickly.

Parker knows this. That’s why, immediately after getting investors’ hopes up about higher fares to come, he cautioned that “over time [fares] will adjust, but it takes time.”

Sure enough, when the earnings call turned to crunching numbers, stock analysts calculated that earnings guidance factors in a 5% increase in average fares from 2017 to 2018. AA management countered that the numbers will be just 3-4%. But, either way, airline fares are going up.

If you’re reading TPG, hopefully you won’t be as affected by these higher fares — as you’re earning miles from credit card sign-ups and redeeming them for free flights when availability opens up, by taking an extra stop to get there and by taking advantage of mileage discount programs.

Featured image by Saul Loeb/AFP/Getty Images

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