Falling Oil Prices Bad for Airlines? Nonsense!

A couple days ago, a research analyst from Wolfe Research issued a report claiming that falling oil prices are actually destructive to the airline industry. The report, written by Hunter Keay, suggests that as the price of oil falls – as it has recently by nearly 25% – the airlines will return to the dark side in the form of reduced capacity discipline. Interesting contrarian argument but it is a failure on many fronts, in my humble opinion.

Mr. Keay writes that “high oil prices are good for airlines,” adding that they force the carriers to look at hard choices regarding long-term outlook. He claims that falling oil prices will pressure the industry to increase capacity, creating what he calls a lack of “capacity discipline.” In the end, he believes the industry will return to their bad ways in the face of lower jet fuel costs. “Oil is a disciplinarian,” he writes. As research analysts are prone to do, he cut his rating for the airline sector from “overweight” to “market weight.”

Mr. Keay and I agree on a few things. First, short-term profits will skyrocket with low oil prices. Delta has already said that each one cent decline in the price of oil adds $10 million to their bottom line. Now this may not be as helpful for their refinery investment but that’s another matter.

GasPrices

Second, we agree that historically, the airlines have had a difficult time controlling capacity. And we agree the industry did increase capacity a bit too much back in 2010 in the face of dropping fuel costs.

After this, it’s all differences between us. What Mr. Keay does not say is that in this sector historically, marketing chiefs wore the crowns of kings as airlines fought for passengers. Fare wars were common and frequent flier programs were ablaze with benefits, most notably easy elite upgrades. Even less than a decade ago, they didn’t care that capacity was under 70%, often 60% or less on some routes. It’s only been in the past five years that the focus has changed and revenue management now wears that crown. Yes, there have been some capacity adjustments that haven’t worked out perfectly but the industry is in a position to tweak as they have never been before.

Also, contrary to his claim that capacity will increase 4% next year, no major airline has offered a figure above 3%. Even then, that’s only the high end of a range that begins at .5%. My guess, American and Delta will be in maybe the 2% range with United a bit lower because they still need to work through some existing capacity issues.

Also not mentioned is the economy overall. Obviously this will have an impact on the airline industry as it will on everything else but again, the carriers are in a much better position than ever to forecast trends. While this does not bode particularly well for frequent fliers, there is nothing on the horizon to suggest the airline industry will go back to their old ways of doing business as usual.

What does your crystal ball predict?

 

Disclosure: I do not own any airline stocks outright though they may be owned through mutual funds.

 

 

 

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  1. The airlines have proven time and time again that they will indeed go back to their old ways. The only caveat now is the consolidation which has occurred. However, even with consolidation, I see no reason the airlines won’t resort to their old ways. I think the analyst makes some excellent points. Decreased costs equals decreased risk.

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