January 13, 2014
Credit: Alasdair McLellan
The most fundamental change in the aviation industry in recent years is the rise in the price of fuel. A decade ago, the world's airlines spent $44 billion on jet fuel, accounting for 14% of operating costs. Today, the collective fuel tab is $211 billion, a whopping 31% of operating costs. Most industry executives assume that oil prices will remain at or around $100 per barrel for years to come—a driving force behind the record backlog for new, fuel-efficient aircraft.
Yet there is mounting evidence that consistently high oil prices may not be a certainty after all. Consider the following:
•Oil demand in the 34 developed OECD (Organization for Economic Cooperation and Development) countries is declining and, at 44 million barrels per day, is 10% lower than in 2005.
•New energy-efficiency standards in everything from buildings to new car models and continued growth in renewable energy sources promise to ameliorate oil demand.
•New oil-production technologies including horizontal drilling and hydraulic fracturing could add 3 million barrels a day of supply in the U.S., and are just now being deployed in other countries.
•Current geopolitical trends, from a potential U.S. rapprochement with Iran to a significant change in the Mexican constitution allowing foreign investment in the energy sector, will likely boost global oil supply.
The Economist magazine recently cited the possibility that demand for oil could peak in the not-too-distant future. What a change from the peak oil supply fears of several years ago. Whether or not this outcome is rosy-eyed optimism, it behooves industry executives and stakeholders to at least consider a lower-fuel cost environment as a plausible scenario for capital allocation planning. Financial markets are leaning this way, with the 2019 futures price of Brent Crude Oil at $85 a barrel. This begs the question: What would $85 oil mean for aviation?
The answer: Airlines could reap a bonanza. A 15-20% decline in fuel costs could mean about $35 billion in lower annual operating costs. This would have a major impact on airline profitability, particularly compared to today's paltry aggregate profit of just $12 billion. Airline shareholders would be major beneficiaries, as would passengers if ticket prices are reduced. This might also provide the means for wage adjustments for long-suffering airline employees.