Oil prices put business travelers over a barrel
— -- Once upon a time air travel was a luxury reserved for the rich and famous. With sustained oil prices over $100 per barrel, we may be headed that way again, and the impact on business travel could be enormous, as cash-strapped airlines raise prices, cut capacity and try to squeeze alternative revenue sources out of the flying public.
A confluence of several factors increases the likelihood that oil prices will stabilize at current levels or worse, go higher still. According to the U.S. Department of Energy (DOE) oil consumption will grow by more than 40% over the next quarter century fueled largely by emerging giant economies in China, India and other rapidly industrializing nations. Refineries around the world are already operating at or near capacity. Even if refiners can boost future capacity, it is unlikely they can keep pace with demand.
Ten countries hold 85% of the world's known petroleum reserves. Eight of these are OPEC members. Even in the most congenial (and unlikely) future political scenario with no disruptions in the supply chain, oil producers have no incentive to boost production and sell their cash crop at lower prices as long as consumption continues at current levels.
In 2004, the world consumed 30 billion barrels of oil. By 2030, DOE projects annual world oil consumption will reach 43 billion barrels and continue to climb. At that rate, we will deplete existing oil reserves within the next 50 years without benefit from significant new oil field discoveries or development of alternative energy sources to curb the world's appetite for oil.
All this points to the fact that $100+ per barrel oil is here to stay for the long term. And at this price point only one major U.S. airline can make money in the short term, as a recent USA TODAY analysis reveals. Hedged at $51 per barrel for 70% of its 2008 fuel requirements, Southwest Airlines should be profitable this year even in the worst case scenario. But sustained oil prices over $100 per barrel will eventually affect Southwest's economics as their fuel hedges roll off in future years.
Airlines faced with $100+ per barrel oil have four choices according to Rick Seaney, Chief Executive Officer at Farecompare.com: Increase revenues, decrease costs, consolidate or liquidate assets.
Many airlines have already adopted a la carte pricing for in-flight meals and most other amenities. They are also generating extra revenue from excess baggage charges and premium seat fees, but such add-ons can only go so far. In 2007 U.S. airlines successfully raised fares 17 times, according to Seaney, and there have been nine successful fare increases so far this year. "But they can only increase fares to a certain level before consumers start to push back."
That push back may have already commenced. In a cooling economy, discretionary travel spending is usually one of the first areas to be cut, and some businesses are already cutting. Seaney says Northwest Airlines reports strong bookings through summer, but with declining house values, a credit crunch, and higher prices at the gas pump, nervous consumers will likely postpone vacations and family visits, deploy alternative modes of travel, or just stay home if fares rise much higher.
During an economic crisis, airlines typically reduce costs through pay cuts, headcount reduction and outsourcing. But these cuts alone are unlikely to compensate for $100+ per barrel oil prices. Some airlines will seek further economies in passenger service reductions, but many of the possible gains here have already been realized.
So airlines must simultaneously raise prices and bring down capacity to survive the oil crisis. Unprofitable routes and destinations will be first on the hit list. Routes with substantial competition and low fares are likely targets. This may also hurt smaller communities, according to John Heimlich, Chief Economist at the Air Transport Association, who spoke at an airline industry symposium in Phoenix last week.
Airlines may also reduce frequencies and substitute one larger, more fuel efficient airplane for two smaller planes. Older airplanes, which are fully paid off, and less fuel efficient aircraft may be parked in the desert. Seaney believes airlines may try to sell these older, gas guzzling airplanes or spin off assets, like frequent flier programs. Some of these initiatives are already underway.
Larger airlines, with more assets to sell, and those with lots of cash on hand, are better equipped to weather a sustained period of elevated oil prices. But if this oil crisis persists for a year or more, many airlines may run low on cash even after liquidating assets and scaling back operations.
Seaney hopes oil prices will stabilize below $90 per barrel, "but if it ends up in the $120 or $130 environment it will be a completely different air travel system."
A "completely different air travel system" will have fewer flights and possibly fewer airlines through combination or liquidation. Mergers, like Delta-Northwest, thwarted by disagreeing pilot factions, may be resurrected with less opposition in desperate times.
Historically, competitors move in to replace capacity and backfill airports and routes abandoned by other airlines. But in a world of $100+ per barrel oil, with every airline focused on survival, this capacity replacement cycle will likely be broken and many communities may suffer permanent air service losses.
In a prolonged fuel price crisis the era of the regional jet may be waning and larger airplanes may be back in vogue again, but fewer frequencies equates to more wasted time and inconvenience for business travelers.
Higher air fares will further drive travel demand down in both business and leisure markets, but airlines must still sell every seat in this hostile environment, so Seaney believes flying will continue to be a cramped experience.
But some good could still emerge from this nightmare scenario. Fewer flights and fewer travelers could have a beneficial effect on our overburdened air transport system. Some face to face meetings may be moved to video or virtual environments or companies may decide some meetings are just not worth the expense. A severe crisis might hasten the development of alternative fuels or spur growth of more fuel efficient transportation, like high speed rail lines. If $100+ per barrel is what it takes to kick our oil dependency, perhaps there may be a silver lining after all.
Send David your feedback: David Grossman is a veteran business traveler and former airline industry executive. He writes a column every other week on topics of interest and concern to business travelers. E-mail him at travel@usatoday.com.