Fuel has historically been the single largest expense at most airlines. Now, with fuel costs declining, employee labor has become the greatest expense for airlines. Declining fuel prices in the past two years drove carriers to record profits—a development very few predicted.
With unexpected capital available, airlines returned profits to owners, signed new labor agreements with big pay hikes, and made significant investment in new planes and products—from upgrading premium offerings to returning amenities previously eliminated. The question remains, how long will this last? More importantly, how well positioned are airlines to absorb costs if fuel prices return to previous levels?DOWNLOAD IMPACT OF CHANGING FUEL PRICES ON THE US AVIATION INDUSTRY [PDF]
Given the perception that fuel is an airline’s single largest cost item, industry insiders were surprised when fuel costs plummeted and income statements took off. But not all airlines were able to enjoy low fuel costs equally.
While all carriers benefitted from the downturn, costly fuel hedging contracts purchased years before kept many airlines from achieving profits. Airlines spent billions on hedging contracts, locking in prices and reducing their exposure to fuel price increases, thus better managing risks associated with their greatest cost. Unfortunately, these contracts prevented airlines from lowering their fuel tab once prices collapsed.
There is a risk that fuel prices rebound and airlines find themselves in financial strain. Higher prices could put pressure on recently signed labor contracts, and force airlines to think more about replacing aging planes with more fuel-efficient aircraft.
During the last cycle, airlines resorted to aggressive restructurings—and even faced bankruptcy. While the industry has changed, the underlying economics of operating an airline have not. Fuel and labor cost cannot be ignored. As evidenced by airlines getting burned by hedging contracts, fuel cannot be managed by the same degree as less opaque factors, such as labor. Taking proactive steps to position the airline for scenarios where higher fuel prices return will be fundamental to long-term prosperity.