Over the last 18 months, fuel prices have dropped dramatically in the wake of a supply glut after the world’s major oil producers decided not to cut production in an effort to protect market share. Since then, consumers have experienced a major windfall, particularly those who commute to work or live in rural areas.
However, air travelers represent one group of consumers that have not received the same relief in prices. Not only have airfares remained steady, but another pesky element of the total cost has yet to disappear: the fuel surcharge. Travelers are wondering why, in light of record airline profitability and significantly lower fuel costs, the charges continue to be built in. In my view, as unpopular as it may be, fuel surcharges actually continue to make sense for the airlines.
First, the application of fuel surcharges is not universal and varies from market to market. It appears that most domestic routes in the United States no longer have a fuel surcharge, although it’s likely that many routes once had one that has been rolled into the base fare. However, surcharges are still present on a number of long-haul international routes, where fuel makes up for a larger portion of the overall operating cost. A number of outlets have cited New York-London flights with a $458 surcharge, and carriers apply international surcharges on other parts of their network as well, such as to Asia.
Second, the surcharge functions as a sort of insurance policy against volatile fuel costs. Obviously, fuel prices are at historical lows, but they are not quite stable yet. In such an environment, airlines are unlikely to hedge their fuel contracts since it is unclear where prices may head in the near term. However, another way to effectively implement a hedge and “peace of mind” is through fuel surcharges to protect against unpredictable spikes in prices. In fact, this practice is common in the trucking and railroads industries as well, although with greater transparency in some cases.
Third, changes in cost structure do not necessarily imply that savings get passed onto the customer – this concept is present in a number of cases outside of aerospace too. In general, as companies develop economies of scale and go down the learning curve, the unit cost for their product decreases, but only a sliver of those savings, if anything, is passed onto the customer. Using one consumer example, Apple has made tremendous strides in the overall design and manufacturing process for the iPhone. Despite the implied savings across manufacturing and the supply chain that the company has realized, pricing for their products remain firm.
Lastly, with continued strong air travel demand and disciplined capacity allocation, there is simply no reason to change pricing policies for base fares or surcharges. Air travel demand has consistently grown 4-5% annually over the last few decades, even when factoring in recessions and other downturns. Furthermore, flights are fuller than ever, with load factors over 80% due to management’s capacity discipline mentality. This means that even if an airline decides to axe the fuel surcharge, it’s likely to just get rolled into the base fare.
With volatile fuel prices, strong air traffic demand, and full planes, fuel surcharges are likely to remain. Should fuel prices remain low and stable for an extended period, carriers may consider easing the charge. However, in the current environment, no such appetite exists for price relief unless air travel demand subsides.
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