Schumer Questions High Airfares Despite Weak Oil Prices - Analyst Blog

Senator Charles Schumer has questioned the logic behind air tickets being expensive despite plummeting crude prices. The senator has asked the Department of Justice (DOJ) and the Department of Transportation (DOT) to investigate into this apparent abnormality as fuel costs account for a significant chunk of an airline's operating expense.

With Christmas and the New Year round the corner, air travel is expected to increase. High airfares will be a pain in the neck for fliers according to the Senator.

Lower jet fuel prices have been a boon for the airline industry given the inversely proportional relation between crude prices and aviation stocks. The airline sector is going through a purple patch with stocks having rebounded strongly from the Ebola-induced lean period (September to mid-October) aided by healthy earnings reports and weak oil prices.

In fact, nine major carriers – Alaska Air Group, Inc. (ALK), Allegiant Travel Co. (ALGT), American Airlines Group Inc. (AAL), Delta Air Lines Inc. (DAL), Hawaiian Holdings Inc. (HA), JetBlue Airways Corp. (JBLU), Southwest Airlines Co. (LUV), Spirit Airlines, Inc. (SAVE) and United Continental Holdings, Inc. (UAL) – have earned roughly $6.8 billion in the first nine months of 2014, up 51.1% year over year. Airlines are running net profit margins of 5.7%, a level last seen in 2009.
 
The senator has basically questioned as to why the carriers are not providing some relief to the passengers in this scenario in the form of lower ticket prices.

Plummeting Oil Prices Form the Basis of Schumer's Argument

Schumer has based his argument on the fact that crude prices have been plummeting for the last few months due to an over-supplied oil market especially in the face of lackluster global demand. Moreover, the international cartel of oil producers' – Organization of the Petroleum Exporting Countries (OPEC) – decision against an oil production cut on Thanksgiving Day added fuel to the concern.

The concern of oversupply has dragged the oil price by more than 40% since June and is currently around $55 a barrel. This has benefited the airline stocks immensely as the cut in oil prices has reduced their operating expenses significantly thereby aiding the bottom line.

According to a report in the Associated Press, falling oil prices have caused U.S. airline companies to save $1.6 billion on jet fuel in the 12 months ended Sep 30, 2014. In the same period, average domestic airline ticket prices have climbed 3.5% to $372.21, also according to a report in the Associated Press.

Rosy IATA Forecast

The forecast by the research firm, International Air Transport Association (IATA), suggests that the airline industry will continue to see good times in 2015. IATA has projected that global profit for the industry will increase to $25 billion in 2015 from the estimated 2014 figure of $19.9 billion (higher than the $18 billion projection made in June).

The research firm has also predicted that airline companies will earn $7.08 per passenger in 2015, up 17.6% year over year. The equivalent number was a mere $3.38 per passenger in 2013.

The firm predicts that oil prices will continue to fall in 2015 with the average price in the year around $85 per barrel. Falling oil prices coupled with improved GDP are the key drivers behind this rosy forecast. GDP across the globe is expected to grow by 3.2% year over year as opposed to the 2014 projected growth rate of 2.6%.

The above rosy forecast has also formed the basis for the Senator's call for investigating the high airfares. In fact, Schumer has said that air ticket prices have gone up 10% over the last 5 years.

Schumer Questions Extra Charges

Schumer observes that when fuel prices had been high, airline companies had comfortably passed on the high fuel costs to passengers by charging more. However, the Senator has alleged that fuel surcharge continues to be a part of ticket prices even when oil prices are collapsing.

Moreover, major players in the industry have been charging fees on check-in bags from 2008. JetBlue Airways has become the latest player to follow this practice following its announcement last month. According to a Bloomberg report, bag fees have helped U.S. airline companies raise approximately $1.7 billion in the first six months of the current year.

Such extra charges should be done away with in times of falling oil prices to provide some relief to fliers. However, this has not been the case which has irked the Senator.

Are Mergers Responsible?

Schumer has asked DOT and DOJ to investigate whether the mergers and limited competition in the airline industry are accountable for the high ticket costs. For example, American Airlines Group, formed after the 2013 merger of American Airlines and U.S. Airways Group Inc., has become hugely profitable since the merger.

We note that the company is also facing labor problems. Last month, flight attendants at American Airlines Group voted down a joint five-year labor contract (tentative agreement), which would have covered approximately 24,000 stewards of American Airlines and U.S. Airways, by a narrow margin. The tentative agreement covered guaranteed pay raises but did not include a profit-sharing plan. Interestingly, some leading carriers have shared profits with their employees.

Airlines for America View

However, according to A4A, fuel costs are one of the many expenses borne by carriers. The nine major carriers referred to above recorded a 3.1% increase in operating expenses for the first nine months of the year.

Carriers are making substantial investments to upgrades planes and other facilities to improve the flying experience of passengers. They are constantly adding additional flights to increase customer convenience. Carriers will add 317 planes to their fleet in 2014.

Moreover, carriers are utilizing their improved financial health to pay off their debt. The A4A report also suggests that the companies are reinvesting in excess of $1 billion per month in the business and retaining only 6 cents as profit per dollar of revenue earned, which is much below the Standard & Poor's average profit margin.

Conclusion

In view of the argument put forward by A4A, we believe there are sufficient reasons for high ticket prices in spite of falling oil prices. We believe carriers in the capital intensive airline industry are utilizing their funds well with a focus on benefiting passengers. Consequently, we won't be surprised if investigations following Schumer's call fall flat.