Here’s something nobody likes to hear, but we now have two CEOs of major US airlines essentially providing the same (somewhat coded) message. Thanks to Ben at OMAAT for first shining a light on this.

1. Primer: airfares are about what airlines can get away with, not the actual cost of transport
2. The war in the Middle East is driving up jet fuel prices, and with that, air fares
3. Delta and United CEOs go on record saying that high jet fuel-induced fares may be maintained
4. When jet fuel prices decrease again, how can airlines possibly keep prices elevated?
5. Summary

Primer: airfares are about what airlines can get away with, not the actual cost of transport

Have you ever been surprised about the fact that your flight ticket from A to B is one price, but your flight from A to B via C may be quite a bit cheaper? The truth is that the pricing is not about how much it costs to operate that flight. Rather, it’s actually about what airlines can get away with:

• Your direct flight is more expensive because people are more willing to shell out the momney for that convenience.
• A flight leaving in the late morning or early afternoon tends to be more expensive, sicne people generally don’t want to get up early.
• Flights to major tourist destinations (e.g. Tokyo, New York, London) are expensive, because people are willing to pay more to visit those destinations.
• Everybody will want to fly out Thursday/Friday and return Sunday/Monday, and so those days will be more expensive to fly then a Wednesday.

On the other hand, people generally don’t want to connect somewhere and unnecessarily lengthen the trip. Similarly, nobody wants to get up at 3am for a flight. And, some destinations on our planet will stay popular for a long time to come, simply because people will keep wanting to go there.

And so, airlines will charge whatever people will pay: if increasing air fare doesn’t impact demand, that’s a reason to keep the price at the higher level in the future.

The war in the Middle East is driving up jet fuel prices, and with that, air fares

We are in a fraught situation right now with the war in the Middle East and the closure of the straight of Hormuz, which has driven up oil prices, and as a consequence, jet fuel prices. This has put many airlines around the world in a tough spot, since fuel is a big cost to airlines, and jet fuel prices ballooning kills airlines’ profits. The airline industry is very low margin during the best of times, so this situation could potentially lead to issues for some of the weaker players.

Slowly we have seen airlines starting to increase prices by increasing fuel surcharges or checked baggage fees. Jetblue was first to increase its checked bag fees by 4$ from $35 to $39, and many airlines soon followed. Similarly, for those redeeming points we have seen the taxes and fees portion of the ticket increase by anywhere from $50-200. However, the actual airfare has not been touched by airlines quite yet, as increases in airfare typically hit demand negatively.

And that brings us to some interesting statements from the CEOs of Delta and United that the traveling public is not going to like.

Delta and United CEOs go on record saying that high jet fuel-induced fares may be maintained

We’re in earnings call season and many airlines are currently reporting on Q1. During Delta’s earnings call, Delta’s CEO, Ed Bastian, has said the following:

Then last week, during United’s earnings call Scott Kirby, United’s CEO, went on record with the following:

So, these are the CEOs of two of the major US airlines saying that they hoping (and even planning) to maintain the higher air fares they will need to impose as a result of the higher jet fuel prices, even if jet fuel prices go back down.

In the case of United, additional details were provided on how air fares were raised. It is primarily driven by capacity cuts: less seats (supply) drives up prices as it turns out demand has remained steady. Apparently, before those capacity cuts, yields were at about 2-3%, whereas now they have increased to 18-20%, which is absolutely remarkable. Perhaps not quite so impressive, but Delta is predicting an increase in margins from ~3% for Q1 up to 6-8% for Q2, which is decent as well. It’s easy to see United (and Delta) would like to keep those yields at those levels for the long term!

When jet fuel prices decrease again, how can airlines possibly keep prices elevated?

The question is, how is this possible? How can airlines maintain the higher air fares as a result of elevated jet fuel prices, even when the jet fuel prices decrease?

It comes down to what I talked about at the beginning of this post: air fare is less based on the actual cost of operating a flight, and more on what consumers are willing to pay. As such, if airlines see that demand is sustained despite higher air fares (whatever the reason), then that argues in favor of keeping prices at higher levels. On the other hand, if increasing air fare drives demand down, that suggests that air fare should also decrease again.

Keep in mind that right now, air fare is not actually being increased ‘on its own’, rather capacity is being cut, which limits supply, and since demand has not gone down, that drives up the price. Apparently, people are willing and able to pay the higher air fare. And keep in mind that not only has air fare increases not driven down demand significantly, yields have also increased. The airline industry is always tough and very low margin, so any increase in yields that airlines can get (‘pricing strength’, as Ed Bastian called it), they’d love to hold on to that in order to turn a higher profit.

The question of whether this is fair to the consumer is of course a completely different matter, and I feel that the answer to that is ‘no’. If jet fuel prices drive up air fare, then airlines should lower air fare once fuel prices decrease.

However, that this is not a 1-to-1 relationship should be clear, since there is a long chain from crude oil prices to the refined product and finally air fare. The fallout of elevated oil prices permeate every part of the airline business, including catering, baggage handling, airport duties… So to say that jet fuel prices go down will immediately lead to air fare decreases would be naive, even assuming airlines are not ultimately businesses whose goal is to make a profit.

Summary

Interesting comments by the CEOs of Delta and United hint that the capacity cuts that came as a result of increased jet fuel prices, have resulted in higher air fares as a result of limited supply in a market where demand ahs remained steady. With that, yields have reportedly gone up and airlines such as Delta and United are hoping they will be able to maintain that, even when jet fuel prices will go down again. The consumers will undoubtedly pay for that from their pockets, while it’s unlikely they will receive a better product for that in return.