What does the past tell us about airlines’ profits when crude oil prices rise?
Premium- Gross spreads are expected to come under pressure as the complete rise in fuel prices cannot be passed on to the end-customer
Brent crude prices are hovering around $100 a barrel. This would lead to an increase in aviation turbine fuel (ATF) prices, which is a big point of worry for airlines as fuel accounts for a lion’s share of airlines’ operating expenses.
Gross spreads are expected to come under pressure as the complete rise in fuel prices cannot be passed on to the end-customer. Spreads is calculated as RASK (revenue per available seat kilometer) minus CASK (cost per available seat kilometer). Both RASK and CASK are unit measures for airlines.
Historically, the rise in fuel prices has adversely affected the profitability of airlines. For instance, fuel prices remained higher during FY11-FY14. “The clear conclusion is that gross spreads were significantly higher for all airlines during periods of low fuel prices compared to those of high fuel prices," said analysts at ICICI Securities in a report.
“In FY12, crude prices rose 31% year-on-year (y-o-y), resulting in a sharp cut in passenger RASK from Rs1.85 to Rs1.49 for IndiGo, Rs1.58 to Rs1.27 for SpiceJet and Rs2.35 to Rs2.01 for Jet Airways. Average gross spreads for IndiGo/SpiceJet/Jet were Rs1.77/1.55/2.4 between FY12-14 compared to Rs2.74/2.7/3.0 between FY16-19" added the report.
Similarly, the passenger load factor (PLF) follows an inverse relationship with fuel prices. “For instance, crude prices rose at 7% CAGR between FY11-14 when PLF for IndiGo declined from 85% to 77% and for SpiceJet was down from 83% to 72%. Comparatively, PLFs of IndiGo/SpiceJet were average 85.6/92% between FY16-19" said ICICI Securities analysts. CAGR is compounded annual growth rate.
As such, the bigger question is if the supply demand balance is a larger trigger for airlines compared to fuel in terms of profitability. “The ability to pass on the increase in fuel prices will also be dependent on overall supply demand. Current fare levels (Q3FY22 IndiGo passenger RASK of Rs3.51) are higher than past (passenger RASK of Rs2.5/2.7 in FY10/11 when crude was in the range of US$100-120)," said the report. In this backdrop, incremental scope to raise fares may be limited unless there is supply correction in the system.
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It is also worth noting that these events come at a time when Omicron hurt January passenger traffic numbers, although February numbers are showing a recovery. A sharper than expected recovery in domestic traffic may alleviate some of the burden of higher oil prices.
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