Airline Insight
John Strickland and Garth Lund break down the latest developments and economic realities of the global airline business.
Airline Insight
Ep 2: How are airlines managing the impact of the Iran conflict?
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Between higher fuel prices, shifting demand, and airspace closures, the Iran conflict has impacted both the demand and supply side of the air travel market.
In this episode, John Strickland and Garth Lund look at how airlines are managing the effects of the crisis.
What we dive into:
- Fuel price impact: How fuel hedging policies have influenced airlines' responses
- Revenue opportunities: Can airlines drive higher revenue to offset higher costs?
- Gulf mega-hubs: Medium and long-term impact on the Gulf carriers
- Network opportunities: Route adjustments by European airlines
- Taking tough decisions: Airlines coming out of the crisis as stronger businesses
Welcome to Airline Insight. This is the second in our new podcast series taking a look at the airline business with a European slant. I'm John Strickland. I've been around the industry for over 40 years. I've got experience in and working with different airline business models from network carriers to low-cost airlines, and I'm always interested in what's going on.
SPEAKER_00And I'm Garth Lund. I've been working in the industry as well for the last 14 years, mainly with low-cost airlines and commercial and finance roles.
SPEAKER_01Great. In this episode, we're going to take a look at the uncertainties and challenges coming out of the current Gulf conflict. Fuel, what the future may mean for the big three Gulf carriers, and whether there are some real permanent opportunities for other airlines outside the region. So let's dive in. Now, fuel, as I mentioned, the first challenge to talk about. We've seen prices of kerosene rocketing to some extreme levels in recent weeks since this conflict began. And one particular challenge, of course, is something called the crack spread, meaning that airlines pay proportionately higher than the price of crude oil. Now, that gap between crude oil prices per barrel and kerosene has been in the region of $75 above. So it's a real headache to deal with. It's a challenge for all airlines, isn't it, Garth?
SPEAKER_00Yeah, and I think for comparison, that crack spread pre-Ukraine war was in the range $10 to $20 per barrel typically. Post-Ukraine war, probably more like $20 to $30 per barrel. But now this increase to $70, $80 per barrel is really substantial. And on top of the higher underlying crude price, this has substantially increased expenses for airlines.
SPEAKER_01Yeah, I mean that really brings it into sharp relief, as you said, by contrast with uh the Ukraine uh conflict. Very much uh more challenging than that. And again, the question of hedging, you know, some airlines are hedged, uh, i.e., buying their fuel at an agreed price for a forward period, sometimes uh a year, sometimes even a percentage of fuel requirements for more than a year. But you know, hedging, I don't know about you, Garth, to me, it seems like something of a dark art. It's not a science, and it can be done in many different ways, which are certainly beyond my competence. What's your thought about hedging?
SPEAKER_00I think like any good European, I'm probably slightly in favor of hedging. Right. I would say that one can debate the merits of hedging or or not hedging. Broadly, probably it makes sense to do whatever your competitors are doing. So you tend to see most European airlines who are able to have quite extensive hedge policies, whereas if you look at North America, there is very little hedging. So there is quite a big geographic difference in hedging policies, I would say, across the industry.
SPEAKER_01Yeah, it's interesting. I mean, the American carriers seem to have had that philosophy that over the long term they say they haven't benefited, there's been ups and downs, that they've acknowledged certainly right now they would have been better off to do so, but they they are where they are. I mean, for me, the the person who has summed it up best in terms of the real logic of doing it, it's not about gaming the market, trying to get in at the right price, at the lowest price. You know, that's really requiring you to gaze into the crystal ball. But Michael O'Leary from Ryanair has always talked about certainty, you know, given that fuel is such a big part of airline costs, you know, let's say ballpark 25-30%, he's always said, you know, we want to be certain of that cost in our planning for the year ahead. And if you think about an airline like Ryanair that uh dives in and out of the market all the time with pricing, they really need to know where they stand on fuel. They can judge all their other costs, but if that was catching them out every few weeks or months, that may be in a real mess in terms of their pricing approach.
SPEAKER_00Yes, I always remember one comment. This is probably from about 10 years ago at least now, but uh it was from the CFO of Ryanair saying that when they go into the start of their financial year, they know what their costs are for the full year. What they don't know is the revenue. And I think that is quite helpful to have that planning certainty over an extended horizon.
SPEAKER_01Oh, absolutely. And then there's the pricing side, uh, hedged or not, you know, what can airlines do? And we've again seen a bit of a divided approach in recent weeks, uh, a number of European airlines, as you said, that are well protected, including Ryanair, including largely the big network groups who are not feeling immediate pressure to increase prices. Of course, they're exposed to the amount of fuel they do buy in the spot market. But some airlines, you know, by quite diverse geography, have introduced surcharges on tickets. And interestingly, making an approach about the ancillary costs as well.
SPEAKER_00Yes, I think we see quite a big difference in terms of the responses of airlines, depending on their fuel hedge policy, as you say. So even if we look just within Europe, we see a divergence between SAS, which discontinued their hedge program last year, compared to the other major European airlines. So SAS has had to cut, I think, around 1,000 flights from their April schedule. They've also been talking about raising fares quite substantially. So I think they cited that short-haul flights see an increased cost of about 50 euros per person with the higher fuel price, long-haul flights getting towards 300 euros per person, higher fuel expenses, and consequently they have to raise their fares. But that leaves them potentially uncompetitive versus other European airlines, which, as you say, are more protected in terms of their fuel hedging program. In contrast, if we look at the North America market, all airlines have kind of moved in unison to raise more revenue. And, you know, as as you say, on the ancillary side, I think we've seen over the last few days several airlines coming out with, in particular, higher bag fees, which are very a very obvious concrete measure. Let's say so Delta, United, Southwest, JetBlue have all raised bag fees by about $10. And I'm sure their ticket prices are also rising, but that's more dynamic, so perhaps a bit less uh easily measurable than something like a bag price increase.
SPEAKER_01Yeah, and it's interesting, as you said, that that need to remain price competitive. I mean, SAS is in this position of uh, as you said, cancelling over a thousand flights and putting, I mean, fifty dollars or fifty euros on the face of it doesn't sound that much, but that could be not much more than the average fare for an airline like uh Wizair or Ryanair net of ancillaries. So it's extremely impactful on demand as we move into the summer peak. And I've certainly seen a couple of airlines uh, if not uh overtly, but uh more or less tacitly acknowledging that uh some of the ancillary fees like bags are relatively inelastic. People may complain, but once they've been hooked in and booked that cheaper ticket price, they are going to fork out and pay for that bag fee. And uh a couple of them, I think Delta is one where uh the incremental bag fees vary. So the first bag is one price, the second one goes up, and the third one is an enormously uh higher price.
SPEAKER_00I think what'll be interesting is to see if or when the fuel price does uh come back down. Are those higher bag prices sticky? Do they stay at the new higher level or will they um come back down to where they were before? I suspect they will be higher than they were going into the crisis.
SPEAKER_01Yeah. Well, it's interesting because you know, coming out of the pandemic, uh I must admit for myself, I'd never seen a situation in my career. Uh as we saw coming out of a pandemic, we we had high load factors and increasing yields. And maybe this, maybe that could be a possible silver lining if uh this lever, this necessity of this crisis uh right now dictates these increases, and as you said, they stick beyond uh the current day. I think another interesting point to to just reflect on, Garth, for me, is uh certainly we've seen low-cost airlines do less in terms of price increases and surcharges. They've simply used, as you touched on there, on uh revenue management. And I think that's what's happening now, uh, and of course there are many sophisticated ways of uh adjusting inventory with now without officially changing prices. Long-haul carriers have not tended to do it. I mean they lay themselves open for this criticism, as you said, of putting fees up when there are high oil prices, but not putting them down or not taking surcharges off. Do you think that's a fair point to make?
SPEAKER_00I think so. It may also come down to some extent to to geography again. But um because we haven't seen the likes of Ryanair or Wizair or or EasyJet really making any uh kind of big statements around pricing or putting in in place fuel surcharges. I know Flair in Canada has introduced, I think, a $20 fuel surcharge for some domestic flights. Uh but generally speaking, from an RM perspective, probably long haul is usually more dependent on the pricing and the fair structures, and short haul is more dependent on inventory management. So I think I think that is a fair comment.
SPEAKER_01I certainly think in the long haul arena, if airlines were to do that more, just to use the sophistication of their tools, they would lay themselves uh less open to criticism when there is a downward movement in fuel. And just in terms of uh, we mentioned again SAS as one example, we've we've heard uh I think United is an example in the USA and New Zealand. We've seen at some of these higher fuel prices, flying just appears to them to become much more, if not completely marginal, on a part of their output. So they've had to go through swaves of cancellations. There's been some UK domestic airlines, for example, in the Channel Islands, have had to do the same thing. That's it's quite uh dramatic and quick pruning, isn't it, uh Garth, that we're seeing there?
SPEAKER_00Certainly we have seen airlines take very proactive measures in the face of the higher expenses. So, as you say, United came out very quickly with about a 5% reduction in their schedule for Q2. Delta has also spoken about trimming its schedule, particularly the weaker flights, so red eyes or midweek flights. Probably the response in Europe again has been more muted, at least in the short term. But I think the airlines which move the quickest are probably going to manage this the best, I would expect, if they are exposed without a hedging profile.
SPEAKER_01Yeah. And then separate to the issue of uh fuel price itself is the question that is uh somewhat uh murky as we speak, uh, of actual fuel supply. And we know that uh the Gulf is a major shipper of jet fuel west to Europe and indeed east to uh parts of Asia, uh I believe, including China. Uh and I've heard the figure recently of upwards of a hundred million barrels of uh oil, or rather kerosene being trapped, refined kerosene in the Gulf, uh, that cannot be shipped because of the conflict as it uh elapses right now. So the question comes about what that will mean for different uh airlines and geographies in the weeks ahead. I also believe there are some very tight situations on fuel availability in parts of Africa, uh Nigeria, for example, and Ethiopia and in Asia, we've heard in the Philippines and uh Vietnam and airlines they're cutting capacity because of that, or government edicts restricting uh travel. But in Europe, uh we don't yet know what's going to play out. There've been some people rather stirring up uh uh kind of a hysteria about this, about imminent uh loss of supply. Now, you know, we're talking about a real-time situation, and it's certainly a serious challenge. But uh it sounds like uh, you know, there is certainly one to two months of known supply, depending on where you are in Europe, but it will become a challenge uh as we move into the summer peak.
SPEAKER_00Yes. I mean I'm not an expert on fuel supply, but I believe around one-third of Europe's jet fuel is imported, and of those imports, about half come from the Gulf. So it is potentially exposed to, as you say, kerosene being trapped in the Gulf region. I think we've already seen over the Easter holidays a few airports in Italy which had to start rationing uh fuel from one fuel supplier. I don't know to what extent that was more related to high demand over Easter or fuel supply from the Gulf, maybe a bit of both, but certainly uh it does seem like there is uncertainty going forward on fuel supply in the region.
SPEAKER_01Now, there are things that airlines can do short of cancellations to an extent. So, you know, the techniques such as tankering, much like if you saw a good petrol price, a gas price for your car, you might fill it up. Even if you don't need it, fill it up to a full tank. Uh uh, airlines can do that. They normally do that on the basis of price, but now maybe out of necessity, if there are shortages in one airport versus another, they may have to tanker. Round trip fuelling could be possible, certainly on some short haul flights. Long haul, of course, this is not so easy, but we could see tech stops. I mean, uh one example, not driven by availability, but by these longer routings of this current uh Gulf conflict is you know uh the um quantist non-stop flight or normally non-stop flight from Perth to London is currently operating via Singapore. So there could be examples of that kind, but challenging to manage, I guess, on a day-to-day basis.
SPEAKER_00Yes, I think so. I think we've also seen some surprises. For example, Alaska Airlines, in their uh updated Q1 guidance, cited that they actually import 20% of the group's fuel from Singapore, which was not something that I was aware of personally, and the the refining premiums in Singapore have increased by several hundred percent. So as we know, the Asia region is um more exposed to fuel coming from the Gulf. So I think there will be things which crop up that um probably no one was perhaps expecting from an airlines having to take mitigating measures to counteract those those impacts.
SPEAKER_01I mean there has to be an awful lot of contingency planning underway or already done, or indeed been revised by the day, because airlines don't want to be caught out at the last minute. But it's it's interesting that uh as we speak GAF, I think the only airline leader who's commented more openly uh about this possible challenge is Michael O'Leary again from Ryanair, and certainly what I heard him saying matched very much with what I was uh talking about with uh different contacts uh in the industry myself. And he said that, well, maybe one to two months is looking okay in Europe. There's no immediate challenge about supply. But beyond that, maybe he might have to cancel up to five or ten percent of his flights, and he wouldn't, if he did, necessarily have much choice or warning. It just depends what airport has what supply at what time.
SPEAKER_00Yes, I think it will be challenging for airlines. Probably there are going to need to be schedule changes taking place in quite a short window relative to the departure date. So it will be challenging for airlines to manage this going forward.
SPEAKER_01And especially as we certainly in the northern hemisphere, we're talking about moving into the the summer peak months now, when of course all airlines would want to be flying all their fleet, operating all of them as much as they could. And I guess it's gonna have to be a kind of a prioritization, a kind of pecking order about what ideally would operate versus what might have to be cancelled. And maybe some lessons learned again coming out of the pandemic about which aircraft would be used, uh, both to optimise fuel efficiency. And certainly some airlines are now in a better position, particularly say short to medium haul operators with Airbus fleets where they can, if there's a choice, at least substitute uh 320, 321 NEOs for CO aircraft and giving them a up to a maybe a 25% reduction in fuel burn. And that's the same with A350s and 787s on some long-haul flights.
SPEAKER_00True. I think um what we've seen, for example, with Air New Zealand, where they've been cutting some domestic or regional capacity, but trying to consolidate frequencies onto larger aircraft, I think that's also a similar move. But um airlines will have some flexibility in their fleet, and probably they're going to want to fly modern technology aircraft like the Neos, as you say, or the Maxes as much as they can without contravening any um lease agreements uh for other aircraft. But that is certainly a tool that they have in their arsenal to mitigate some of the fuel price impact.
SPEAKER_01Absolutely. And I think Lufthansa has indicated they've done some scenario planning, driven uh actually, I think, more by their impressions of demand uh than the now perhaps the emerging fuel challenge of maybe cancelling or rather grounding anything from 10 to 40 of their aircraft. And of course, they've got a very mixed fleet in terms of quite a lot of older generation, especially long-haul aircraft, so they would probably focus on that, I guess. And I think just maybe a last thing on this, Garth, uh, I'm certainly picking up, and not surprisingly, airlines would really like to see some government focus on this. You know, that there needs to be work with governments in different countries in terms of contingency plannings, not just to suddenly have a surprise happen, given the importance of airlines to economies. And if we also think about the kind of flying, you know, in terms of if there is a prioritization, there are many cases where there are lifeline uh air services which need to be prioritized because there is no other way for people to get around in certain geographies.
SPEAKER_00Yes, that's true. I mean, for particularly for island nations or remote communities, air services, as you say, are lifelines. So, and it is something that is strategically important to the region or to the country. So potentially in the in those cases, as you say, they might need to be government intervention or government support to maintain those lifelines going forward.
SPEAKER_01Absolutely. So let's turn the thoughts now uh to the Gulf carriers themselves, and by by which uh I mean the big three uh Emirates, uh Etihad and Qatar. There's lots of speculation out there about uh the countries, about these airlines. I think we touched it on it even briefly in our our first podcast about what is the future for these airlines. They have, as we speak, managed to increase their flying, particularly those airlines in the UAE. Uh I think Emirates and uh Etihad are up to around about 60% uh the time we're uh talking, uh less so for the Qatar. And of course, uh Emirates, if we start with them, is the airline that's been around longest, around about 40 years. Uh it's built up a large scale, which gives it a lot of flexibility about where it deploys its planes, and it has a a sizeable home market in Dubai, even if that may be being eaten away at at the moment because of uh uncertainties about uh maybe some people choosing to leave that uh country. What are your thoughts about the relative situation between the three, Garth?
SPEAKER_00I think at the moment, uh as you say, in terms of capacity, it looks like Emirates and Etihad are operating relatively similar kind of proportions of their pre-crisis capacity. We did also see a comment from Etihad that they're flying with 75% load factors, which I think is good. Qatar, probably a bit of a different situation, as you say. Looks like they're operating around 25-30% of their pre-crisis capacity. They've announced that they are parking their 380 fleet through till the end of May. But I would say that probably Emirates is well positioned here. They do have that home market to draw on, and particularly going into the summer season, where generally there is less inbound demand anyway, and there is more outbound demand as people look to travel back to Europe and escape a bit of the desert heat over the summer months, that travel demand will probably be less impacted, I expect. So I think they are relatively well positioned with that strong home market, at least through the next few months. And uh hopefully by the time we get back to the next winter season when the inbound demand starts to increase again, hopefully um, you know, things are relatively back to normal.
SPEAKER_01Mm-hmm. And as you said, I mean Qatar storing some aircraft, you know, it's been uh quite public. They've taken a number of uh 350s and 787s to this uh airport in Spain, Tourel. Maybe I'm mispronouncing that, but uh it's known as a place where aircraft are stored for whatever period of time, being a a dry environment, uh, and moves the aircraft, I guess, away from the conflict zone as well for as long as they feel they need to do that. But quite significant changes there. I know they were reluctant to bring the 380 back anyway after the pandemic, but they did, and as you said, now sitting on on the ground again. And Etihad, although able to fly a higher level of services uh than Qatar, uh as we said for Emras, a much smaller market than Emirates has in Dubai, the the Abu Dhabi market, the local market being smaller, and so much more reliant on transfer. And I think um it's really good news to hear they're getting 75% load factors, but I I think we've also seen evidence of some discounting out there, haven't we?
SPEAKER_00Yes. I mean I think right now we do already see uh discounting on fares from the likes of Etihad as we go, you know, as we look into the next few months. If things do normalize and uh those airlines are able to increase their capacity again, that'll probably mean that there is a lot of inventory coming into the market with a relatively short selling window. So again, it's likely they'll have to be discounting to shift more of that inventory. This is very anecdotal, but I was looking at flights this week from Geneva to Johannesburg and Etihad was uh available for 360 francs for a return flight from Geneva to Joburg, which is probably an unprecedentedly low fare from the market. Probably hardly covering the taxes, Garth. Exactly, yes. So I do expect that uh there will be discounting coming out of that market, which may then in turn put more pressure on other airlines, European carriers, for example, who I think right now are enjoying the ability to price at a premium to where they were before. But if on the markets which are competing with the Gulf carriers we start to see more discounting, then that'll probably impact the European airlines as well, potentially.
SPEAKER_01And the question is uh I mean, personally, I believe the Gulf carriers will recover. I mean, you know, we hope this this conflict will be over and done with as soon as possible. But certainly some damage has been done. Definitely this summer, as you said there about booking levels or the need to discount. There is there is damage inflicted, people will have booked away. But uh I think there'll be recovery. But we've heard from some of the European carriers, uh, particularly Air France K. Lem and Lufthansa, who have long had a view that the Gulf carriers are damaging to their business and that Europe is withering on the vine and uh maybe seizing this chance, especially in the case of Lufthansa, to add additional services to Asian cities and indeed into Africa down to South Africa. Do you think we're going to really see a long-term switch of capacity? Uh I'm a bit more sceptical. You know, I think there are opportunities now, and BA indeed has a number of aircraft displaced that they would normally be operating to Dubai and the Gulf. They're doing a couple or so extra Singapore's now, and there's some more structural change, medium term they've announced to come back to Sri Lanka and second Australia serves to Melbourne. But is there really that much opportunity given their own constraints on fleet uh and constraints of their airports with slots as well?
SPEAKER_00I think that the argument that uh Lufthansa was making before the crisis around not allowing the German government to further liberalize the uh air service agreement with the UAE, which would have allowed more service from Emirates, that's probably going to get more traction now than perhaps it um it would have otherwise, as perhaps there is more recognition of air service as a strategic asset for countries. But on the other hand, I do think that um the Gulf carriers will will come back. They are also strategic assets for the development of their own respective home economies and will play a key part in the recovery once we kind of come out of the crisis. They will have strong support from their respective governments, and they'll continue to be a tool for regional development. So, you know, certainly the next few months will be tough, but long term I would continue to see those airlines playing a major role within the competitive landscape. As to what uh perhaps some of their competitors do. Yes, I think we'll on the margins see some more direct services launched by, say, the European Airlines, as you mentioned, the likes of BA adding Melbourne or Colombo, also higher frequencies to markets which might have gone through the Gulf, like a third daily frequency in the upcoming winter season to Cape Town. But fundamentally, I um I do think that the traffic flows between Europe and Asia will largely continue to go through the Gulf once we come out of the crisis.
SPEAKER_01Yeah, I think I I share your view, Garf, and it's interesting that uh you know there's been media coverage about all BA is back to Melbourne. Uh uh, I I might have mentioned in in our first podcast that uh the time I worked at BA, we had two widebody 747s and some days three to Australia. An enormous amount of investment of aircraft and and crews in that route. And you know, for some years BA's been operating only uh a 777300 or 787 uh nine to Australia. So Melbourne coming back, it's interesting, it's a second destination, it's it's been on the network before, but it's it's actually an extension of what we already have with uh uh Daily Kuala Lumpa, which itself came back into a network only in the the last year, and uh quite a bit of downtime on the aircraft uh in that uh Kuala Lumpa rotation. So, as I said, it's really adding an incremental day. And thinking about the pace at which uh network carriers do their planning, they are not like low-cost carriers making changes, sometimes almost day-to-day. This would have been, I think, definitely in the works. It was already going to be announced quite probably Colombo as well, before even this uh conflict began.
SPEAKER_00I don't I would be curious in what you think, but I imagine we'll also see some airlines kind of using this crisis. Maybe using is not quite the right word, but using the crisis to take some tougher decisions that perhaps have been put off. Maybe they were very much on the margin before, but with a higher fuel price, the airlines are kind of forced to take more dramatic action. I think we saw something similar in COVID where VA took the up that opportunity to retire the entirety of their 747 fleet, similarly, Air France with their 380s. So we may see some kind of bigger decisions coming out of airlines. For example, I know that um Lufthansa Group is looking more closely now, or it's been reported in the media that they're looking more closely at the future of a Swiss's Geneva base. You know, from a selfish personal perspective, I hope they uh they maintain it, but you know, they may be forced at this point to um to wield the knife a bit there. We might see more marginal routes being cut permanently, potentially some more MA activity, but it may force airlines into taking tougher decisions that perhaps they might have just left otherwise.
SPEAKER_01Yeah, and I mean you know, as we we talk right now and this uh crisis is live uh uh around us. We have to hope that these kind of positive things come out of this, you know, uh in painful, challenging times. As you said, difficult decisions can be confronted and addressed that may not be otherwise, and hopefully the the future of that is a a better, more solid set of airlines around us. And I wonder as well, I mean, we have the endless discussion about the um absolutely essential topic of sustainability and sustainable aviation fuel, which seems to be moving forward at too slow a pace uh for airlines to really make that change, whether this ends up at least getting governments more on side with the sense of urgency that airlines want to have SAF. They they they need this to improve their environmental credentials and make that 2050 net zero target. But governments have not been uh necessarily on their side as much as they might have been. But who knows? Am I being too optimistic in that thought, Garth?
SPEAKER_00I imagine that energy security will be in quite sharp focus coming out of the crisis. Right now, you know, I think everyone's just looking at dealing with the the short-term effects. But uh looking longer term, both airlines and governments and you know their broader economies, I think uh most players will want to try and reduce their dependency on um external factors, and uh we may see more uh attempts to onshore energy production, including uh SAF production, as you say. And depending on where the the fuel price kind of balances out in the next few months, that does also potentially reduce the differential between the regular fuel price and um the SAF prices.
SPEAKER_01No, certainly that's uh to be hoped for, Garth. I think for today we've uh we've really achieved the fact on quite a variety of issues and uh a lot a lot of rather um you know undesirable issues, I suppose you could say, ones we'd rather not have to deal with. So that's all we have time for today in our discussion. Again, we hope you enjoyed listening. If you have any feedback, anything you'd like us to address as a topic or thoughts about future editions of uh Airline Insight, let us know. Uh, we look forward to talking to you again on our next one in a few weeks. But until then, uh it's goodbye for me, John Strickland.
SPEAKER_00And goodbye for me, Gothlin.