Airline failures are a constant theme in the aviation business. It doesn’t matter how long they’ve been around either, time is of no importance.
The fact is there is only one thing that keeps an airline in business – profit margins. And there’s only one thing that can add or subtract to them at such a speed even the best can wander from exceptional profits to massive losses in weeks: fuel prices.
When it comes to fuel, bigger airlines with more cash and income have more leverage. Take two examples of how to manage fuel.
Qantas in Australia hedged its fuel prices at a level that saw it paying less than the actual cost for an extended period of time.
Hedging is where the airline sees a price for fuel – say $1 a litre – and agrees to pay that amount for say the next two years. If the price rises above $1 it still pays $1. If it drops to $0.8 it’s still pays $1.
Qantas hedged it’s fuel buy under the overall rate. Virgin Australia got it wrong and paid far more. The later is slashing 750 jobs and unprofitable routes.
Delta Airlines manages things differently. It shocked many by buying a disused ConocoPhillips refinery in New Jersey and converted it to produce avgas to supply New York regions airports – not just for itself but others. Elsewhere it both hedges and pays for fuel on a regional basis, but it’s such a huge airline it can afford to get the best rates.
British Airways and American Airlines both hedged until their contracts ran out and then went open market. But with risks – Iran and the Saudi Arabia incidents recently for example – increasing, hedging looks more attractive, but you could still end up paying more if things return to stability and prices drop. And if you buy hedging options at the wrong time – during high risk – you pay more than buying at a point of low risk. It’s a hard judgement call.
And if you don’t have the money to pay the up-front hedging costs, these options aren’t open to you at all.
When you set a ticket price 12 months ahead of the actual flight, you have no idea how much you’re actually going to pay for fuel the day it flies. You can guess, but all the algorithms in the world don’t know what Iran will do next or Houthi rebels in Yemen. Or if there’s a bad winter and fuel supplies are disrupted.
When you have a per-seat profit of less than $10 on a long haul flight in economy that can quickly vanish.
Add to the variability in fuel prices – which in ULCC world accounts for 60% of their costs, around 50% at an LCC and around 30% on a full service airline, the last thing you need is other costs rising.
Pilots and cabin crew want more pay, airports charge more for landing fees, costs rise. Fuel spikes, costs rise.
Overcapacity in the market means prices of tickets drop, costs rise and the margins on the tiny profit per seat are squeezed into a loss.
All you need is a change in rules – like holding back more advanced cash from ticket sales – that you can’t spend, and a drop in bookings at seasons end, with lower than expected demand for the winter – and you’re in trouble.
Quickly things slide. One more blow, like an engine recall, a couple of aircraft out of action, new ones not delivered, routes generating cash not coming on line – and the spiral turns into a nose dive to the bottom and certain oblivion.
So, when you’re totally dependent on cash income and spending money now paid by customers for flights up to a year in advance, their travel, is your risk. Few people realise that the money they spend on a ticket ahead of 30 days is instantly spent by the airline on day to day operations.
They hope – and you trust they’ll be there in a years time if you book tickets ahead. When you don’t know their real state of affairs, the Thomas Cooks, AirBerlins, Alitalia’s, Monarchs, Norwegians, Germania, even possibly the Etihad’s and Cathay Pacific’s of this world, can be a short step away from oblivion in the right circumstances.