Why airline profits are in trouble
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Brace yourselves. We’re about to hit a spell of turbulence.
Only 2 weeks after carriers Eos and Hong King Airlines went to the wall, Easyjet Chief Executive Andy Harrison warned yesterday that a couple of others were headed in the same direction. Airline profits are at the mercy of the oil price, he said. And where that’s headed is anyone’s guess.
“The price of jet fuel has risen 35 per cent over the last three months and is now 80 per cent higher than last year”, said Harrison. “What is certain is that if these fuel increases are maintained many of our weaker competitors will disappear.”
Easyjet and Ryanair, its larger rival, have little to shout about though. Sterling is weakening and UK consumers more thrifty, with both expecting less passengers on European routes in the coming months. And as the oil price embarks on what looks like an unstoppable flight to $200 a barrel, there seems to be little doubt that all airlines are caught in a vicious, inescapable circle.
First, lets take the weakening UK consumer. Although both airlines carried more passengers in April, up about 15% for both from the same month last year, their load factors were down. Load factors are a measure of how well an airline is filling seats. Last April, Ryanair boasted an 83% load factor. This year it’s fallen to 79% as the Dublin-based airline failed to fill the seats on newly acquired airplanes. “There is a correlation between consumer spending and airline spending”, says one Dublin based analyst, who declined to be named. “In fact, the effect is exaggerated”, he says, as people begin to spend more on essentials. What’s more, with house prices falling, people are likely to feel less wealthy, meaning they’ll splurge less on non essentials like flights to marbella.
Secondly, there’s sterling. Over the last 12 months, Sterling has plummeted almost 20% against the Euro, making it more expensive for your average Briton to pop down to Spain or Cyprus for the quick one-week break they’ve come to aspire to. Already, the newspapers are full of stories on where to go to beat the euro. Poland says one, Albania, (God help us), says another.
Lastly, of course, there is the oil price. Easyjet reckon that for every $10 a tonne the oil price rises, they are being stung for £2.5m. And here’s the nasty bit. Airlines can’t offset higher oil prices by charging their passengers more. As Easyjet’s Harrison said yesterday, the demand simply isn’t there to raise prices.
So now, the focus is on the oil price. Standing at $122 a barrel, Goldman Sachs are forecasting a move to $150-$200 over the next two years on the back of supply constraints. If you’re to believe the word of analysts, that’s a pretty significant statement, given that Goldman’s were the first to predict the $100 barrel.
However, the latest run up in oil, as we point out in this week’s MoneyWeek looks a tad overdone. Shell boss Jeroen Van der Veer said last month that investment going into oil had soared to $3.4 billion a week by Mid-March, while Lehman brothers noted that $40 billion had flowed into commodity funds this year. That suggests there’s quite a lot of hot money out there, looking for a hedge from inflation and a weak dollar.
That’s some news that should ease the airlines flight plan ever so slightly.
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