BY EKELEM AIRHIHEN.
African airlines will need to look inward and find collaborative solutions across the industry value chain to stay in the skies as fuel prices begin to pose an existential threat.
McKinsey, the global consultancy, in its July 15, 2022 article (Why rising fuel prices might not be bad for the airline industry as it seems) believes that high fuel prices are not necessarily a bad thing. for the airline industry. Although rising fuel prices have put a strain on the airline industry, it could prompt airlines to limit overcapacity in order to achieve better returns and remain stable.
It traces the history of rising costs. Between 2010 and 2012, fuel prices were relatively high. The cost of jet fuel was on average about 70% higher than it had been between 2003 and 2005.
Since the start of 2022, the price of jet fuel has increased by around 90% while costs have increased by an average of 120% compared to 2021. Now, fuel, he says, is often the operating cost the most higher and can represent up to 25% of total costs for airlines.
Since 2021, there has been a steady increase in the price of crude oil and jet fuel. It reached a new high in 2022, reaching around $111 per barrel as of June 27, 2022. This represented an increase of around 135% since the start of 2021. The same is true for refined products, including jet fuel. .
Some of the reasons attributed to this are: decline in refining capacity after Covid-19. Falling demand in the wake of the pandemic has led refineries to shift refining capacity from jet fuel production to other fuels. In addition, the crisis between Russia and Ukraine has led to a decline in exports of crude oil and refined products. These, coupled with local logistical constraints, have led to higher prices for crude oil as well as distillates such as diesel and jet fuel.
McKinseys gives three reasons why high jet fuel prices may not be so bad for airlines: First, the short-term problem airlines have against rising fuel prices with a shortened booking window since the pandemic. This means that few tickets would have been sold on the assumption of lower fuel prices only for passengers who had to travel at higher fuel costs.
Second, McKinseys found a correlation between unit revenue and fuel costs for US industry and a sample of carriers that shows airlines can pass on some of the price increase to consumers.
Third, fuel prices, he says, drive up the marginal cost of flying, which can lead to greater capacity discipline.
Airline economics are such that between 30 and 35% of an airline’s operating costs (kerosene is one component of operating costs) are fully variable depending on the flight. Airlines therefore have an incentive to add capacity because most of these costs, such as aircraft leasing, flight crew salaries and overhead, have already been incurred. This means that an additional flight does not result in a significantly higher cost. The effect was that airlines were incentivized to chase after increasing their market share. Now, with rising fuel prices, the marginal cost of operation increases and there will be more discipline in capacity deployment. The airline industry has always viewed overcapacity as one of the main challenges to sustainable profitability. This type of response would therefore benefit the industry.
African aviators will need a collaborative solution to keep airlines flying. Costs will need to be looked at holistically by all players in the value chain to agree on who gets what piece of the pie.
The constraints imposed on airlines transferring their assets also need to be considered to ensure that the assets are fully utilized in the most profitable way by all stakeholders.
African countries with refining capacity should step up their refining efforts with a focus on jet fuel for the African market to help pass on the cost advantage to airlines. The same would also happen with an MRO and aircraft leasing company to achieve economies of scale and cost reduction in the African aviation sector.
Capital and labor costs, including insurance costs, pose a challenge for airlines. Lower interest rates and long-term facilities, lower insurance costs, and effective deployment of human resources by all stakeholders will lead to lower operating costs and better industry performance.
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