Rising oil prices do mean higher airline ticket prices, but the link is not as direct as you think

Mar 7, 2022

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The price of oil has been on a meteoric rise since Russia’s attack on Ukraine, hitting its highest levels in more than a decade. That’s sure to pinch consumers — especially by sending prices up at the petrol pump — but will it do the same for airfares?

Rising oil prices do put upward pressure on fares,  but the cost of oil isn’t the only factor in determining airline ticket prices.

In the U.S., at least, strong demand had already enabled U.S. carriers to raise prices, with travel booking app Hopper saying this week that domestic airfares have risen 21% since the start of the year, while international airfares have risen 13%.

But it’s been a different story in Europe, where demand recovery since the depths of the pandemic has been less robust. Some European carriers, such as Lufthansa and Ryanair, have tried to compensate for that with significant fuel hedging — or the practice in which airlines buy a contract for fuel in advance at a fixed or capped rate, one that doesn’t change even if oil prices spike or drop.

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Eduardo Mariz, a senior analyst for London-based Ishka, a global aviation information and advisory business, said that both hedging strategies and demand patterns influence ticket prices — sometimes in ways that don’t directly mirror related increases in the cost of crude oil.

For domestic U.S. carriers, the stronger overall demand for tickets means airlines can pass the rising costs of fuel on to customers with less worry that travellers will baulk at the increase in prices.

“Demand has recovered so they can raise fares without losing customers,” Mariz said. “U.S. carriers tend to be unhedged, but the recovery has been stronger than for others, so we will probably see them raising fares faster.”

By contrast, he added, “In other markets, where airlines still want to promote demand, they may be reluctant to raise prices right away” for fear of blunting the slower recovery in travel there.

As for the hedges, they can help inoculate airlines from rapid swings in fuel costs — allowing them to keep fares steadier even if oil prices rapidly rise or fall. Southwest famously employed fuel hedges during the 2000s which allowed it to lock in jet fuel prices that were dramatically lower than what competitors were paying — something that gave the carrier a huge competitive advantage in setting fares.

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Among Europe’s carriers, Lufthansa said Thursday that it has hedged 63% of its fuel needs for 2022 at £56 a barrel, while Ryanair said Wednesday that it is 80% hedged at £48 a barrel through March next year. British Airways has said it is 60% hedged for the rest of the year but did not specify the price cap. That ability to lock in those prices means that those carriers will feel less pressure to immediately pass along any jump in fuel costs.

Still, as Lufthansa reported earnings Thursday, Chief Financial Officer Remco Steenbergen said that despite hedging, the carrier will need to boost ticket prices to offset the cost increases.

The three big global U.S. airlines — American, Delta and United — are unhedged. However, Delta operates an oil refinery. Additionally, Southwest Airlines and Alaska Airlines both have hedged some fuel needs.

At the same time, Mariz said that fuel prices fluctuate. “In the coming weeks we will see a lot of changes, so we still don’t know how fast and how far they will increase.”

“If oil production does increase, we could see the opposite,” he noted. An Ishka report on Thursday said, “While fuel price increases are one of the most direct impacts of the current situation, they are also potentially the one that could be reversed the fastest, provided other oil-producing nations increase output.”

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Regardless, fuel costs are a major concern for airlines — even if changes in oil prices don’t show up as quickly for passengers’ airfares as they do for drivers at the gas pump.

Hopper economist Adit Damodaran said in an email, “On average, 30% of an airline’s operating costs are from fuel costs. This means historically a 10% rise in jet fuel cost would be associated with a 3% increase in operating expenses for the airline.”

And, aside from the war in Ukraine, fuel prices had already been on a steady climb.

With the cost of jet fuel up 113% since the start of 2021, “We expect higher jet fuel prices to contribute to higher consumer airfare for 2022,” Damodaran said.

Underscoring the complexities that can at least partially decouple fares from a direct tie to oil prices, he added: “The final ticket price travellers see for their trip may also vary depending on various factors like the fuel efficiency of a carrier’s fleet and how much that carrier has hedged against jet fuel price increases.”

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Oil prices continued to inch up Friday, with Brent crude oil trading around £85 a barrel. As of midday Friday, oil had surged above £85 on the West Texas Intermediate crude exchange, the oil benchmark for the U.S. That’s the highest price on that exchange since 2008.

Wall Street analysts have steadily raised estimates for how high those prices could go, with Goldman Sachs suggesting £91 a barrel while J.P. Morgan has mentioned £140 a barrel.

Before the Ukraine invasion, the last time oil prices traded at £76 was 2014. Prices have climbed steeply since 2020 when they averaged about £30 a barrel.

In the U.S., at least, airlines may try to pass some of those eventual fuel-cost increases on to customers as travel demand continues to be strong. The Transportation Security Administration said that 2.04 million people cleared security on Thursday and the numbers have been close to 2 million per day for some time now.

Featured photo by Cravetiger/Getty Images.

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