HOW AIRLINES MANAGE OIL PRICE VOLATILITY; OR NOT
The airline industry is one of the sectors that has been hit the most with bankruptcies over the last decade. The list of airlines going bankrupt is increasing each year at the fastest rate ever.
Quantifying the exact number of bankruptcies remains quite challenging as legal status may be different from one country to another. That said, 18 airlines temporarily or permanently stopped flying in 2018 and at least 30 in 2019. Most of them were regional airline but some larger national airlines or charters were also affected such as Jet Airways in India or Thomas Cook in the U.K.
Although each of these bankruptcies are unique, strong dollar, higher fuel cost and difficulty to compete with low-cost companies are often factors mentioned when discussing the reasons behind the failure of an airline.
Aviation is a very competitive industry. In order to improve profitability, airlines can either increase revenue – by selling more tickets or raising prices - or reduce its costs.
The first option is extremely challenging especially since the expansion of low-cost airlines. Passenger revenue and cargo revenue are the two main sources of income for airlines. Price elasticity has improved over the last decade mostly due to stronger competition and better access to information. During that period, low-cost airlines have been gaining market share against full service airlines.
The second option is to reduce costs. Airlines’ expenditures are more diversified than incomes. The main ones are employee costs, aircraft operating lease cost, landing fees as well as route charges, taxes, engineering and maintenance aircraft costs and finally fuel and emission charges. Strong dollar may also have a negative impact on airlines that sell tickets in other currencies, as kerosene and aircraft are usually traded in dollar. American airlines would usually have a more negligible forex exposure due to the natural hedge from dollar revenue.
Another challenge for airline is to cope with the seasonality pattern in the demand. In Europe for example, tickets sales usually spike in summer and then drop in winter. This pattern is usually reflected in the quarterly income and cash flow statements of the airline and would also partially explain why the majority of European bankruptcies in the sector tend to happen in winter.
The combination of the above challenges in addition to the fact that airlines generally operate with tiny margins may explain how they can meet financial difficulty through the year – and in the worst cases – this can lead to bankruptcies.
One cost that is not possible to anticipate is the future price of crude oil which will drive kerosene prices either up or down. The same applies to currency rates and carbon prices. Airlines have the possibility to lock the prices of those three assets and hedge market exposure by trading derivatives. By doing so, airlines will control the main part of their expenditure and be able to run more accurate liquidity stress tests and therefore have better visibility of future cash flow and profitability.
18 AIRLINES TEMPORARILY OR PERMANENTLY STOPPED FLYING IN 2018 AND AT LEAST 30 IN 2019.
10 | ADMISI - The Ghost In The Machine | Q1 Edition
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