Soaring oil fuels fears of a corporate aviation disaster

After September 11 and Sars, high fuel prices could finally ground an airline
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Geoff Dixon, the chief executive of Qantas, left the world in no doubt yesterday about the growing crisis that is threatening to engulf the aviation industry.

Geoff Dixon, the chief executive of Qantas, left the world in no doubt yesterday about the growing crisis that is threatening to engulf the aviation industry.

"The rapid escalation of the price of crude oil is the major factor facing Qantas and the aviation industry worldwide," was his stark message at the company's half yearly results.

Speculation is mounting that as crude oil pushes through the $48 a barrel level, this will be enough to push a large airline out of business. So could this be the year we see a corporate disaster in the aviation industry?

Breaking off from dealing with his latest union dispute, Rod Eddington, the chief executive of British Airways, told The Independent: "I think the answer has to be yes to that question, if for no other reason than a lot of airlines were under substantial pressure when oil was under $28 a barrel.

"Imagine what it's like at nearly $48. The industry was already fragile. It has lost more money since 9/11 than it ever made before."

Mr Eddington still has the words of Giovanni Bisignani ringing in his ears.

In June, the chief executive of the International Air Travel Association (Iata), said that an average crude oil price this year of $33 a barrel would mean the global airline industry breaking even.

Anything above that, he warned at IATA's annual meeting, and the industry would be plunged into the red for the fourth year running.

Mr Eddington said: "This says clearly that this is another year of major difficulties for airlines worldwide. There have been and there will be failures."

In fact, Iata's chief executive had an even more colourful way of expressing the threat posed by fuel prices. Mr Bisignani said: "Last year, we survived the four horsemen of the apocalypse - Sars, conflict in Iraq, terrorism and the economy. But a fifth horseman, the price of oil, could add up to $1bn per month to our costs, and deny us profitability yet again."

A year that was looking cautiously optimistic for the airline industry has quickly turned into a nightmare as the rising price of crude oil feeds through to the kerosene market.

Chris Avery, an airlines analyst at JP Morgan, said: "It's more than unfortunate, it's turning into a disaster. The year was going reasonably well and then they got hit by a doubling in the fuel price."

The chart shows how the kerosene price has soared this year. Such a rapid increase is having a devastating effect on industry profitability, raising the prospect that the oil crises could be the final straw for at least one operator.

Investors yesterday did not have to look far for a big airline in crisis that might finally buckle under rising fuel bills.

In an interview published in The New York Times, David Bronner, the chairman of US Airlines, warned that unless an agreement with the unions over new wage and benefit cuts was agreed then the airline might have to be liquidated.

The fund manager, who took the chair at the airline after helping finance a rescue from Chapter 11 slightly more than a year ago, said liquidation was the outcome everyone wanted to avoid. But he warned: "It's a whole lot cheaper for me to have the assets and start over than to have the liabilities."

When an airline is already on the brink, with cost cuts of $800m a priority, surging fuel prices simply add further pain.

American airlines have long been seen as particularly vulnerable because they are generally unhedged when it comes to their fuel exposure.

In other words they have failed to buy, at fixed prices, their future fuel requirements. The table shows the hedged position of the major European airlines. Although hedging can afford some protection, it is an expensive exercise that can eventually outweigh the benefits.

Another form of insurance that all the world's major airlines have been using are fuel surcharges. Singapore Airlines yesterday said it would be slapping $4-$12 (£2.20-£6.60) on the cost of tickets to try and claw back money lost because of higher fuel prices.

Air France-KLM, Europe's biggest carrier, did the same on Wednesday along with El Al Israeli Airlines. But even this strategy is only of limited use.

Mr Eddington said: "Globally, if airlines recover a quarter of the increase in fuel prices through surcharges, then they will be lucky."

BA itself has put a £6 surcharge on its long haul but BA's chief executive was in no doubt that it will have only a marginal impact.

He said: "Our fuel bill will increase by £225m this year [the total bill will be well over £1bn]. The fuel surcharge we put on that will bring us £70m."

Ray Webster, the chief executive of easyJet, the no frills airline that has been hit by a series of profit warnings caused at least in part by rising fuel bills, has refused to levy surcharges. "The consumer will respond to the so-called price and trying to Mickey Mouse around with surcharges won't fool anyone."

But Mr Eddington is also acutely aware that oil price increases will erode airline economics in other ways as well as simply putting up the cost of fuel.

"The other thing that hits airlines is that if people's fuel bills rise, that means higher petrol prices for cars and higher heating costs for homes. It hits disposable income. Sustained higher oil prices is an attack on the economy that reduces consumer spending in other discretionary areas."

Sir Michael Bishop, the chairman of BMI, takes a slightly more sanguine view on oil, pointing out that in real terms, the oil price is still a long way from where it was during the 1973-74 oil crisis.

He also argues that technological changes have improved fuel consumption in aircraft, which means the fuel costs as a proportion of total costs have fallen dramatically.

The green lobby might well disagree with Sir Michael. Its efforts to force a clean up of the airline industry could still pose yet another threat to airline profitability in future.

Anyway, jet fuel is generally an airline's second largest cost after labour, and accounts for 10-20 per cent of overheads. It now stands at a 14-year high, a level not seen since Iraq invaded Kuwait in 1990. It poses a very serious threat.

It seems, however, the oil price alone cannot be blamed for putting an airline out of business. Michael O'Leary, the chief executive of Ryanair, said: "A lot of low-cost airlines that are going to go bust this winter will be blaming the fuel price instead of the fact they have stupid business models that have no prospects of working.

"At these levels, fuel prices will exacerbate the losses of what are already loss-making airlines."