Oil Price effect on Aviation Industry
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Oil Price effect on Aviation Industry Document Transcript

  • 1. Economics 1st Assignment Name: Chandra Mohan Verma Roll. No. 56, PGPM508 The following article appeared in The Economic Times, Oct.18th 2008 (Saturday) News paper: Domestic Air traffic plunges to a 5-year low on fuel prices (18 Oct, 2008, The Economic Times, Saturday) NEW DELHI: Hit by high aviation fuel prices and a meltdown in the financial sector, domestic air traffic has plummeted to a five-year low traffic declined by a whopping 19% in September 2008. This is the fourth consecutive month of negative growth in air traffic since June. Airline companies, which have been feeling the pinch, are now resorting to large-scale downsizing to cut costs. Almost all domestic carriers saw their load factor sharply declining during September this year. Faced with further uncertainties, airline companies are rationalising routes, surrendering aircraft and cutting costs. The recent layoff plans by Jet Airways and Kingfisher, and Air India s plan to offer its staff voluntary leave schemes, only highlights the extremity of the situation. According to industry sources, Kingfisher Red (formerly Air Deccan) saw the sharpest fall of around 20% in its load factor in September. Air India s seat factor declined by 10% to 53% during the same period. The average load factor of airlines came down to 55% in September this year, as against over 65% during the same month last year, a source said. The domestic carriers carried about 2.6 million passengers during September 2008 as against close to 3.3 million passengers in the corresponding period last year. The sharp month-on-month fall in air traffic is forcing airlines to reduce capacity and trim manpower. The domestic carriers, which have cut down over 20% of their capacity, are weighing the option to cut more. The average flight movement has come down to less than 8,000 per week now from a peak of around 10,500 during the April-June period. Industry experts maintain that the current round of crisis in the domestic aviation sector is severe, but may not continue for long. The current downturn in the sector is temporary and may not prolong for more than 6 to 9 months, Boeing vice-president (sales) Dinesh Keskar said. In a bid to tide over the crisis, two of India s largest private airlines Jet Airways and Kingfisher Airlines have decided to form an alliance for cross-selling of seats, common ground handling and code-sharing. The sector is expected to post a cumulative loss of over $2 billion in the current financial year.
  • 2. Analysis of the Article based on Consumer Behaviour The above article primarily highlights the current gloomy conditions in domestic aviation sector. The domestic airlines are passing through a low demand phase & are forced to decline in air traffic operations. The average load factor for domestic airlines has fallen to 55% in Sep.2008 against over 65% in Sep.2007 (annex.-8). In the analysis of this article, the main focus has been kept on the changes happening in the domestic aviation sector during the last one year and the correlation of these changes with consumer behavior. The analysis will deal about how the hike in ATF prices and then in air fares have played a key role in the reduction of demand. In the conclusion part of this analysis, I have also brought out the measures taken during the last two months by these airlines to boost the consumer demand. The first question arises is that how have these airlines come to such a bad phase wherein, despite reducing the air traffic operations they are experiencing a fall in their load factors? Today the demand of consumers for air travel has went down steeply from what it was a year back. What has actually happened to the global & domestic clues which are forcing these airlines load factor to decline continuously since last one year. Before we move ahead with detailed analysis let us have a look on the prominent news during the last one year period from domestic aviation industry. These news clearly exude one of the major reasons about the downward trend in the airlines demand. These news have been taken from Economic Times and arranged in chronological order in the table below. The detailed news are supplemented in their respective Annexure.
  • 3. Appearing Date News Title in ET Detailed Sl.No. (Excerpts from Economic Times) (in chronological News in order) 1 ATF hike in offing, air fares set to go up 21 Nov, 2007 Annexure- 1 2 SpiceJet hikes fares after aviation fuel price 4 Jun, 2008 Annexure- 2 hike 3 Air travel to become costlier as airlines 31 Jul, 2008 Annexure- 3 hike fares 4 Jet, Kingfisher hike fares by 10% 1 Aug, 2008 Annexure- 4 5 Airline sector in trouble as number of 4 Aug, 2008 Annexure- 5 passengers drops 6 Jet, SpiceJet to drive fares still higher 27 Aug, 2008 Annexure- 6 7 Jet Air lays off 850 flight attendants 15 Oct, 2008 Annexure- 7 8 Air traffic plunges to a 5-year low on fuel 18 Oct, 2008 Annexure- 8 prices 9 Jet, Kingfisher to reduce number of flights 22 Oct, 2008 Annexure- 9 10 Jet, Kingfisher staff scout for work / AI 22 Oct, 2008 Annexure- 10 Offers voluntary leave to 15000 As the article suggests that the domestic air traffic has crashed to 5 year low. One of the major factors for this crash is the decline in consumer demand for air travel. The decline in consumer demand has primarily due to slowdown in global economy and rise in airfares. The major happenings of this phenomena has been brought out in the following points: Ø The slowdown in economy has made a negative shift in the consumer demand as mentioned in the graph below. This shift is due to decline in demand due to prevailing negative sentiments among consumers and companies.
  • 4. Negative Shift in Demand Curve due to Global Economy Slowdown Price / Airfare Demand curve before slowdown Demand curve after slowdown Qty./ Load Factor / Air traffic Ø The rise in the base fare and fuel surcharges together was ranging from 30% to as good as 100% from June 08 to Sep.08 (annex-4, 6). This has directly hit the demand in economy class where economy class has a hefty portion in the total domestic aviation business. The rise in air fares has made a movement along the demand curve leading to decline in demand as mentioned in the graph below: Movement along the demand curve due to hike in Air fares Price / Air fare Shows the demand movement along demand curve Qty./ Load Factor / Air traffic
  • 5. Ø The ATF accounts for nearly 40% of the input cost of airlines (Annex.-3). From Oct.07 to Jun08, due to the spiral rise in the international crude oil prices and consequent rise in the ATF prices the domestic airlines were forced to increase their fares to either maintain their profit margins or even to sustain their businesses. The rise in Input costs (ATF primarily) has made a fall in supply or cut in operations by service providers/airlines as mentioned in the graph below. Negative Shift in Supply curve to rise in Input Cost Price / Air fare Supply before rise in input costs Qty./ Load Factor / Air traffic The rise in these fares directly affected the demand in the sector. After this period, the major decline in the demand started from June 2008 onwards when the consumers directly felt the heat of the hike in air fares. The passenger load factors dropped to 77.6 percent in June 2008, down from 78.8 percent recorded for June 2007 (Annex.-5). The situation further worsens in the coming months. The average load factor for these airlines has fallen to 55% in Sep.2008 against over 65% in Sep.2007 (Annex.-8). This scenario clearly follows the Demand curve the relationship between Price and Quantity demanded. No doubt, the decline in demand was not only due to hike in fares but also due to slowdown in the international economy & financial crisis. However, the hike in the air fares was one of the major reasons resulting a decline in the consumers demand.
  • 6. Due to this sudden decline in demands in Jul.-Sep.2008, The airlines have taken serious steps to tide war the crisis and regenerate the demand. These measures are primarily focused to reduce overhead costs to sustain any declining demand scenario. To absorb the rise in the input costs the airlines are taking serious measures to improve efficiency and cut the operation expenses. Few of the measure are as below: · Airlines, struggling to combat the rising costs are trying for joint operations to synergize their resources. This has lead to serious consolidation and mergers in aviation industry i.e Joint Operations by Kingfisher & Jet Airways, Kingfisher and AirDeccan, merger of Air India & Indian Airlines, Acquiring of Sahara by Jet Airways (Annex.-8). · There has been a drive to cut the operations to decrease the losses. The airlines have ceased their flights in unviable, highly competitive and seasonal routes (Annex.-9). · During the last two month, the main private companies of aviation sector have tried to lay off their employees to reduce the operation costs (Annex- 10). The govt. owned company like Air India has come up with novel concepts like voluntary leave for few years for their employees (Annex-10). · The airlines have also either ceased or defer their plans to buy new air planes to control the current operational costs. Also, there are plans to use small aircrafts for operation to reduce operation costs and meet the changed demand. These moves are clearly to cut the expenditure and a way to absorb the rise in input costs instead of directly passing any further increased input cost directly to the consumers. This way the airlines will be able to tide over the current crisis. The End
  • 7. Annexure-1 to Annexure-10 Annexure 1 ATF hike in offing, air fares set to go up 21 Nov, 2007 NEW DELHI: Cost of air travel within the country is all set to go up once again as airlines are bracing up for another hike in aviation turbine fuel (ATF) prices on December 1. The two options under consideration are a hike in basic fare or another increase in fuel surcharge which is already hovering at Rs1,350. Either way, cost of air travel would increase by Rs.200 or at least Rs150 per sector for economy class travel between metro cities. The actual increase could be far higher as discounted fares also being reduced to the bare minimum. Airline sources said the current apprehension is ATF price would go up by 10% at the beginning of December and efforts by civil aviation minister Praful Patel and petroleum minister Murli Deora have failed to goad public sector oil companies to cut fuel prices. Right now we are in the middle of the peak season. Also, ATF prices are at a peak. Therefore, hike in fuel prices would be passed on to passengers, an airline veteran said on condition of anonymity. Most airlines are in favour of another hike in fuel surcharge as it is simpler to implement and chances of undercutting are minimum, said another sources familiar with the development. Hike in basic fares is more complicated and it may not suit the current strategy of the industry. Ever since ATF prices starting hitting new highs this year, airlines have been effecting identical fare hikes through fuel surcharge. Under such circumstances, there is no hope for relief on ATF prices and a hike in December is certain, the sources said. Representatives of major airlines like Air India, Jet Airways, Kingfisher, SpiecJet and IndiGo are expected to informally consult each other on the issue. While private players are in favour of a hike of around Rs.200, it is understood that Air India wants to keep such hikes to the minimum. Therefore, the consensus could finally settled at Rs.150 hike in fuel surcharge. ATF accounts for nearly 40% of the input cost of airlines and the unrelenting spiral in curde prices is giving sleepless nights to domestic carriers. The Federation of Indian Airlines (FIA) has been drawing the government s attention to ATF prices being nearly 70% to 95% higher in India in the case of fuel uplifted for domestic operations. Even in the case of ATF bought for international operations, Indian carriers pay 30% more. Airlines are hoping for a profitable third quarter as demand is high during October-December period. As demand slows down by the middle of January, they bank of third quarter profits to balance the losses suffered in the last quarter. Therefore, the ATF situation is being watched with serious concern. Annexure 2 SpiceJet hikes fares after aviation fuel price hike 4 Jun, 2008, 1947 hrs IST, PTI MUMBAI: Low cost airline SpiceJet has hiked its fare following the recent hike in aviation fuel price. Confirming the hike, a Spice Jet spokesperson told the media on Wednesday: "The hike in our basic fare is Rs.300 for short routes and Rs.550 for long-haul sectors." While other airlines have increased their fuel surcharges in the wake of the aviation fuel price hike, New Delhi-based SpiceJet has increased the fare as its officials feel it would sound weird to have tickets that cost RS.500-Rs.1,000 and then taxes and surcharge totalling over Rs.3,000.
  • 8. Another low cost airline, InterGlobe-promoted Indigo, is likely to take a decision on a fare hike next week. Earlier this week, the state-owned Air India and private airlines Jet Airways, Kingfisher Airlines and Deccan hiked their fuel surcharge by Rs.300-Rs.550. The fuel surcharge for travel distance up to 750 km (short-haul) has gone up by Rs.300, while for the travel beyond 750 km, it would be Rs.550.According to figures obtained from Indian Oil Corp (IOC), aviation turbine fuel (ATF) in Mumbai will cost Rs.71,759.06 per kilolitre, up from Rs.60,468.28. In New Delhi, ATF will cost Rs.69,227.08 against Rs.58,387.92 per kilolitre. With global oil prices spiralling, the airlines have hiked fuel surcharge five times in the past five months. Annexure 3 Air travel to become costlier as airlines hike fares 31 Jul, 2008, 2253 hrs IST, PTI MUMBAI: Private air-carriers, Kingfisher and Jet Airways, today announced a hike in their fares, making air travel costlier. Jet Airways said that it was hiking its economy class fares by 10 per cent. "Economy class fares have been hiked by 10 per cent and business class by five per cent," a Jet Airways spokesperson said here on Thursday. The hike had nothing to do with the 2.8 per cent increase in air turbine fuel (ATF) price announced by state-run oil firms earlier in the day, the spokesperson said, adding that, "the decision has been taken after a commercial review of the pricing." However, the airline's subsidiary, Jetlite, has so far not effected any hike. Vijay Mallya-owned Kingfisher also announced a 10 per cent hike in base fares across the board. In Mumbai, the city which hosts the nation's busiest airport, the price has been hiked to Rs 73,673.56 as against Rs 71,630.53 per kilolitre. Annexure 4 Jet, Kingfisher hike fares by 10% 1 Aug, 2008, 0812 hrs IST, ET Bureau NEW DELHI: Air travel will get more expensive from Friday with both Jet Airways and Kingfisher Airlines increasing basic fares by as much as 10%. Th is will result in a Rs 300 to Rs 500 increase in Delhi-Mumbai economy-class ticket fare. The cheapest, non-discounted, fare on this sector offered by these airlines is around Rs 6,850, which will now go up to around Rs 7,200. Jet Airways, the country's largest private carrier has hiked fares by 10% for the economy class and 5% for its premier business class. For the Kingfisher-Deccan combine, it's a 10% increase in basic fares across the board. Agency reports said national carrier Air India too was contemplating a 10% hike in domestic fares from Friday. A report quoted the airline spokesperson as saying, "In view of the hike in sale prices of air turbine fuel today, we are considering a hike in our fares from tomorrow." Other airlines like SpiceJet and Indigo have not made any announcements, but are expected to go in for a similar hike in the next few days. "A 10% hike in basic fares will be effective from Friday morning. All fresh tickets issued after midnight will bear higher fares. We have spared passengers of any increase in fuel surcharge and there is no change in taxes and surcharge at this moment," a Kingfisher Airlines' spokesperson said. This is the fifth round of air-fare hike this year and domestic air fares have almost doubled in 2008. These hikes have
  • 9. been caused by in-creasing operating costs and ATF prices. The steep increase in airfares has resulted in negative growth in air traffic. Annexure 5 Airline sector in trouble as number of passengers drops 4 Aug, 2008, 2146 hrs IST, IANS NEW DELHI: The airline sector is in trouble as the number of passengers falls and rising fuel costs inflict a huge loss on the industry this year, ac cording to an aviation agency. The International Air Transport Association (IATA) said Monday in a statement that the industry so far this year has suffered losses to the tune of $6.1 billion, up from last year's $5.6 billion. Releasing the international traffic data for June, the IATA said the cargo demand growth decreased by 0.8 percent compared to June 2007, while the passenger growth fell to 3.8 percent, the lowest level since 2003. The passenger load factors dropped to 77.6 percent in June 2008, down from 78.8 percent recorded for June 2007. "Airports and air navigation service providers must come to the table with efficiencies that deliver cost savings. Labour must understand that efficiency is the only path to job security. The governments must stop taxation and give airlines the freedom to merge and consolidate where it makes business sense," it said. According to the IATA, Asia Pacific carriers saw their international passenger traffic growth fall to 3.2 percent in June from 4.5 percent in May. Middle Eastern carriers' traffic growth was down to 9.6 percent in June from 12.8 percent in May. This is sharply down from the 18.1 percent recorded in June 2007. International freight traffic growth for the first time saw the decline since May 2005 by 0.8 percent. Annexure 6 Jet, SpiceJet to drive fares still higher 27 Aug, 2008, 1135 hrs IST,Mithun Roy, ET Bureau MUMBAI: Domestic airlines, pummelled by surging crude oil prices in the past two years, are planning to hike fares for the seventh time this year. The steady rise in jet fuel prices has made it tough for the airline industry to stay afloat without fare hikes. Jet Airways, the country s largest full-fledged carrier and low-cost airline SpiceJet, are considering fare hikes ahead of the start of the peak travel season in September-October. Existing fares are not justified: We need to increase fares by at least 20% over the next two months to minimise losses, Jet Airways chief commercial officer Sudheer Raghavan told ET. Jet will increase fares by 10% early next week and another 10% from October, Mr Raghavan added. On the Mumbai-Delhi sector, Jet s economy fares may rise by Rs 350, while business class fares may climb by Rs 300. Crude oil s strong surge to nearly $150 levels over the past two years has badly affected the profitability of airlines. Carriers have increased fares six times this year with hikes in fuel surcharge. But that has not been enough to wipe out the red ink from most balance sheets. Airlines will have to increase their base fare to minimise the gap and achieve break-even. For a long-distance flight, a
  • 10. passenger now pays Rs 2,900 as fuel surcharge, Rs 150 as congestion surcharge and Rs 225 as passenger-service fee, besides the basic fare. Annexure 7 Jet Air lays off 850 flight attendants 15 Oct, 2008, 1015 hrs IST,Manju V, TNN MUMBAI: The largest lay-off in the history of Indian aviation is expected to take place on Wednesday when as many as 850 Jet Airways cabin crew members, mostly on probation, will receive termination letters. The airline couriered these letters late on Tuesday night. The tremors brought about by the worst downturn yet in the airline industry were felt on Tuesday itself, hours before the first Jet Airways flight of the day took off. Said a crew member, About three and a half hours before a flight, the office transport reaches your home to pick you up. In the wee hours of Tuesday morning, hundreds of cabin crew members in Mumbai who were rostered for early morning flights waited in their uniforms to be picked up. When the worried flight attendants started calling up the airline dispatch office they were told they had been derostered till further notice. Though the Jet Airways spokesperson declined to comment on the extent of the lay-off , she did confirm that terminations were in the offing . Because of the slowdown in traffic, both on international and domestic routes, we have announced discontinuation of a number of flights. As a professional organisation we had to do a comprehensive rationalisation of our network by taking into account the current traffic demand, our capacity utilisation, etc. Consequent to this we will have to release the unconfirmed staff to match up with the changes, the spokesperson said. The laid-off crew are said to have taken it very hard, particularly since they were given a verbal job assurance as recently as two months ago by the top management. Chief commercial officer Sudhir Raghavan in one of his weekly Friday interactions with the cabin crew had said that their jobs were insulated . Irrespective of whatever cost cuts we make, Mr Goyal has told me not to touch the cabin crew, he had said, a crew member recalled Raghavan saying. So no one pressed panic button when Naresh Goyal and Vijay Mallya shook hands and made the tie-up announcement , he adds. We ll save Rs 1,500 cr annually: Mallya to TOI What does this mean for the passenger? Fliers don t expect air fares to drop despite assurances from Goyal and Mallya. It s hogwash to say that consumers will benefit. The two airlines together will be controlling 60% of the market share and prices will shoot up, said president of Air Passenger Association of India Sudhakara Reddy. And while the number of flights will be cut, frequent fliers will be able to combine their mileage points on both airlines. Low-cost flying is truly over now after this operational alliance. Both Mallya and Goyal have in the past scoffed at the concept of LCCs in India as all carriers have to pay the same charges. Calling LCCs low-fare airlines , Jet and Kingfisher had raised fares of the LCCs they had taken over Sahara (now JetLite) and Air Deccan (now Kingfisher Red). Together, they will command over half the domestic market shares. Any move by them to raise fares further will force other independent LCCs either tofollow or become unviable and perish, said an airline official. Due to the sharp hike in operating costs in the last few months, Deccan today carries about three lakh passengers a month as compared to seven lakh a year ago and loses twice the money now. This is nothing but hogwash to say that consumers will be beniffited. The two airlines together will be controlling 60% of market share and prices will shoot up. Passengers will be victims of this, said Air Passenger Association of India president Sudhakara Reddy.
  • 11. Annexure 8 Air traffic plunges to a 5-year low on fuel prices 18 Oct, 2008, 0424 hrs IST,Nirbhay Kumar, ET Bureau NEW DELHI: Hit by high aviation fuel prices and a meltdown in the financial sector, domestic air traffic has plummeted to a five-year low traffic d eclined by a whopping 19% in September 2008. This is the fourth consecutive month of negative growth in air traffic since June. Airline companies, which have been feeling the pinch, are now resorting to large-scale downsizing to cut costs. Almost all domestic carriers saw their load factor sharply declining during September this year. Faced with further uncertainties, airline companies are rationalising routes, surrendering aircraft and cutting costs. The recent layoff plans by Jet Airways and Kingfisher, and Air India s plan to offer its staff voluntary leave schemes, only highlights the extremity of the situation. According to industry sources, Kingfisher Red (formerly Air Deccan) saw the sharpest fall of around 20% in its load factor in September. Air India s seat factor declined by 10% to 53% during the same period. The average load factor of airlines came down to 55% in September this year, as against over 65% during the same month last year, a source said. The domestic carriers carried about 2.6 million passengers during September 2008 as against close to 3.3 million passengers in the corresponding period last year. The sharp month-on-month fall in air traffic is forcing airlines to reduce capacity and trim manpower. The domestic carriers, which have cut down over 20% of their capacity, are weighing the option to cut more. The average flight movement has come down to less than 8,000 per week now from a peak of around 10,500 during the April-June period. Industry experts maintain that the current round of crisis in the domestic aviation sector is severe, but may not continue for long. The current downturn in the sector is temporary and may not prolong for more than 6 to 9 months, Boeing vice-president (sales) Dinesh Keskar said. In a bid to tide over the crisis, two of India s largest private airlines Jet Airways and Kingfisher Airlines have decided to form an alliance for cross-selling of seats, common ground handling and code-sharing. The sector is expected to post a cumulative loss of over $2 billion in the current financial year. Jet Airways, however, managed to maintain a 64% seat factor during this period, higher than the industry average of nearly 55%. Annexure 9 Jet, Kingfisher may reduce number of flights 22 Oct, 2008, 1656 hrs IST, PTI NEW DELHI: Private air carriers Kingfisher Airlines and Jet Airways, which have entered into an operational alliance recently, may reduce flights as they tighten belts to overcome financial crunch. "We are not going to unnecessarily deploy capacity which we cannot fill...if in non-peak hours Jet flight is not full and Kingfisher flight is not full, it makes sense for us to co-operate and fly one aircraft instead of two. (With this) the economics of airlines will improve substantially," Kingfisher Chairman and CEO Vijay Mallya told reporters here. He also said the two private carriers would co-operate on international routes, even as Kingfisher's plans to start non- stop flights to San-Francisco has been put on hold.
  • 12. "The world is big enough. We have enough routes to operate without clashing with anyone unnecessarily," he said. Jet and Kingfisher had last week announced an alliance to co-operate in seven areas, including joint fuel management, common ground handling and cross-selling of flight inventories. The two biggest private carriers have been facing financial burden, which even prompted them to retrench employees. Emerging from a meeting of Federation of Indian Airlines with Petroleum Minister Murli Deora, Civil Aviation Minister Praful Patel, Mallya said he has dropped plans to import aviation turbine fuel after government promised support to airlines. "Its not required, when the oil companies have agreed to help us, support us, why should he change the whole system," he said. Blaming imposition of sales tax on ATF for the poor financial health of the carriers, Mallya said, "We need reduction in tax...if the sales tax is brought down to four per cent across the board, all airlines would go to black ink from red ink". Annexure 10 Jet, Kingfisher staff scout for work 22 Oct, 2008, 0145 hrs IST,Mithun Roy, ET Bureau MUMBAI: With Jet Airways and Kingfisher Airlines struggling to combat the rising costs, employees of both airlines have begun scouting for jobs in competing, low-cost airlines such as SpiceJet and GoAir. We have started sending our resumes to the low cost carriers as our take-home salaries will be almost at par with low cost carriers once Jet s plan to shift a major portion of our fixed income to the variable component comes into effect in November, said a ground handling staff member of Jet Airways. Full-fledged airlines currently pay higher salaries compared to the low-cost carriers. Both Jet and Kingfisher are planning route rationalisation, which in turn will entail lesser manpower requirement. SpiceJet and GoAir are planning new flights and will therefore need more people, according to company officials. We have no plans to lay off employees. The company has a proper procedure to hire people, unlike others who hire in advance for future route expansion, said SpiceJet Vice-President, HR, Surajit Banerjee. We will hire more people as SpiceJet is increasing routes in the domestic space, said SpiceJet director Kishore Gupta. The Gurgaon based airline operates 94 flights to 16 cities daily.