Thursday, July 3, 2008

Fuel Prices Cause Fear of Flying

Plane fares have been rising since the beginning of summer due to a continuing crisis on the aviation fuel market. Rising fuel prices have threatened airlines’ survival and they are looking for every possible way to pass the increased cost onto passengers. However, it looks as though the carriers will not void losses completely, which may result in the bankruptcy of some of them.

Waiting for the Price Rise

At the beginning of June, Russians found that airplane tickets cost 40-50 percent more than in winter and a $40-45 surcharged was being applied to tours purchased in advance to relatively close destinations. RataNews, the informational resource of the Russian tourism industry union, reported that the Lantra-Tur Travel Co. had informed its partners that ticket all VIM Avia Moscow-Salonika flights will cost €30 more after June 25. Tez Tour said that the fuel surcharge on flights to Turkey from Moscow will increase by $40 on June 16. “Because of the constantly growing prices for fuel, tour operators are forces to increase the fuel surcharges practically by 10 percent a month,” says Capital Tour general director Inna Beltyukova. She calculates that prices for airline tickets to popular destinations have already increased in price by 30-50 percent compared to last year, and they continue to rise.

Tatyana Vand, general director of the travel agency Vand International, says that Russian charter airlines flying to the most popular summering countries are demanding supplemental payments to air tickets practically every ten days because of rising fuel prices. According to Vand, a year ago, it cost €270-290 to fly from Moscow to Rimini and back. This year, it costs €350. Tickets from Moscow to Barcelona have risen by €70-80. Tour operators demand for distant trips to fall. “Tourists with high incomes have already been to Thailand and Cuba more than once, and tours there will become simply inaccessible for middle-income clients because of the price,” Beltyukova predicts.

Fuel surcharges are not the only reason for rising airfares. Oleg Pantaleev, head of the Aviaport analytical service, mentions that fees for aviation navigational services and airport services have risen substantially this year as well, forcing carriers to increase their base fares. “Second, ticket prices are always higher in summer because airlines compensate for losses they suffered in the winter, including autumn kerosene price hikes,” he adds. The airlines confirm that. Mikhail Poluboyarinov, financial director of Aeroflot, says that the company planned for average growth of base fares by 6 percent but, in connection with a worsening economy because of fuel, they will be raised by no less than 10 percent by yearend. That is likely to be the case for the entire industry. “We set our fare policy by market analysis and depending on how our competitors behave. If Aeroflot raises its fares by 10 percent, then we can raise ours to the limit of that number,” S7 (Siberia) Airlines financial director Ilya Alexandrovsky explained.

Fuel Dependence

It seems that air passengers will have to pay in full for the fuel crisis that is hobbling the airlines. The average profitability of air carriage usually does not exceed 10 percent and fuel accounts for more than 50 percent of the cost of a flight. Airlines introduced a system of fuel levies as fixed markups added to the base fare after the fuel crisis four years ago, when the price of kerosene almost doubled in a year and a half. Some airlines were able to defend themselves against unexpected price hikes for fuel then that would have been disastrous to them before. The current crisis has forced even those companies that had created completely different models of income management to follow suit. In particular, Russia’s first and so far only low-cost air carrier, Sky Express, imposed a 500-ruble fuel surcharge for the first time on January 1 and it has already raised it twice, before the May and June price increases for aviation fuel. Now the surcharge is 1000 rubles, which twice the airline’s lowest fare.

Large airlines today say that fuel surcharges cannot save them from losses. A fuel charge cannot keep up with the dynamics of kerosene prices, because the majority of tickets are sold by the airlines significantly before the flight date. Poluboyarinov estimates that the fuel surcharge does not even cover half the losses from rising fuel prices. Therefore, he says, in the coming years Aeroflot will not be able to repeat the financial success that it experienced last year. Worse still, if prices continue to rise at their current rate, the airlines net profit will be cut by at least $100 million. That is almost a third of Aeroflot’s profit in prosperous 2007 ($313 million). Rossiya state transport company, S7 and other aviation companies expect a big drop in profits this year.

Industry experts foresee another misfortune coming for Russian aviation. Most of the fleet of airplanes belonging to Russian airlines is soon to be obsolete. There are hundreds of Soviet-made Tu-134 and Tu-154 models that, at current fuel prices, are unprofitable to operate because of their kerosene-guzzling engines. A Tupolev burns 5600 tons of fuel per flight hour, while a Boeing of the same class uses just 3200 tons.

The airlines will be unable to add modern foreign airplanes to their fleets. The sinking operating profit will force the companies to cut back on modernization programs. Companies that did not order a sufficient number of foreign planes in better times (today there is a severe shortage of aviation equipment on the world market) are going to suffer. Those small, often regional, airlines may begin to disappear from the market by the end of the year. Aviaport’s Pantaleev adds that the fuel crisis will unavoidably lead to lower financial discipline in the airlines’ dealings with its partners as well. “The majority of air carriers will be strapped for cash, and not all of them will be able to come up with it. Obviously, the fuel crisis will induce a payment crisis that will turn into a series of bankruptcies by previously quite successful airlines,” he said. The disappearance of the Chelyabinsk Aviaprad can be considered a foretaste of things to come. It stopped flying February 11. One of the reasons was its huge debts for fuel.

Russian air carriers are not alone in this. The high cost of fuel is shaking up of the airline business around the world. Practically all participants on the global market are preparing for serious losses and some are taking urgent cost-cutting measures, shortening routes and laying off employees. Air Canada, that country’s national airline, has announced that it is laying off 2000 people and reducing its routes by 7 percent. The American carrier United Airlines recently announced similar measures. The IATA (International Air Transport Association) has already reconsidered its recent forecast of losses from rising fuel prices. The global aviation market, worth $500 billion, may lose more than $6 billion this year.

Fueling Records

The main question, which no one can give a good answer to, is why are the prices for petroleum products in an oil-producing country with powerful refineries comparable to the prices on the European and American markets, where they are imported. The fuel crisis raised its head again at the end of last autumn, when domestic oil companies decided that the time had come to raise domestic prices for aviation fuel to the level of those in Europe. In November and December of last year, factory prices at refineries for fuel for civil aviation rose almost 30 percent. Fuel prices seemed to stabilize during the pre-election months at the beginning of the year, and air carriers calmed down. But in April fuel prices in Russia began to react much more quickly to world market conditions and rose at record speed. At the beginning of every month, oil companies bring their prices up to European levels, and induce shock in aviation financiers. The cost of a ton of airplane fuel in Moscow today, including taxes and service charges, is more than 36,000 rubles per ton. Airports around the country have raised their prices in step with Moscow.

The panic in the aviation industry has focused public attention on the fuel supply market at airports and their pricing policies. Russian Deputy Prime Minister Sergey Ivanov expressed concern about overpricing, as have officials in the Transportation Ministry and Rosaviatsia. The oil companies called their actions “market” and their prices “competitive,” and declined to comment in detail. Airline heads have begun publicly to accuse oil producers of conspiring to form a cartel, pointing to the amazing correspondence between factory prices among the largest producers of aviation fuel – Gazprom Neft, LUKOIL, Rosneft, TNK-BP and others. Moreover, the purchase by oil companies of fuelling operations at large airports and their creation of fuel trading companies as wholly-owned subsidiaries has aroused concern on the market as well.

The government, which can do nothing except make noise about it, is no happier. “Today we are observing a strange asymmetry between the actions of government authorities and oil companies,” notes Aeroflot general director Valery Okulov. “The state lightens the tax burden on the oil companies, creating a favorable situation for them on the world market, and in response they raise prices for fuel for Russian consumers.” Independent fuel suppliers, who buy aviation fuel wholesale from the same oil companies, unexpectedly joined the air carriers’ chorus of disapproval. “The problem isn’t that the price is high, but that there are no market foundations and nothing stops the oil companies from raising it higher still, except society’s psychological tolerance,” says Airport Fuel Supply trading house general director Evgeny Ostrovsky. His company occupies about 35 percent of the aviation fuel market, the total volume of which is $3-4 billion. In Ostrovsky’s opinion, the oil companies would not be able to break the law on competition if the fuel had not been sold at the whim of company managers, but in a marketplace where the price would be established by supply and demand – in other words, an exchange. That idea has the support of Transportation Ministry officials, but it has not made any progress, even though, in Ostrovsky’s opinion, it is that state’s responsibility to create a real market.

Unenviable Regularity

The conflict came to a head in the middle of June, when the price of aviation fuel in most Russian airports was 6-8 percent higher than in the largest airports in Western Europe. The reason for that was simple. In Europe and the United States, airplane fuel is traded on an exchange, and after it reached a high at the end of spring, it began to creep down slowly, leading the slower-moving Russian oil companies at the forefront of pricing on all markets. Airlines that made many international flights were able to economize on fuel slightly by increasing the volume of their fueling in foreign airports. “If the tendency develops the same way, Aeroflot will be forced to fill its planes abroad more and more, because it is simply cheaper,” says company head Okulov. “We are practically giving our profit to foreign companies and states. That’s taxes we could pay in Russia.” Airlines that mainly fly domestic routes have nowhere to turn.

“For air transport to exist under these circumstances, it is necessary to cancel import duties on foreign planes. That will create more favorable conditions for renewing the fleet with economical aircraft,” says S7’s Alexandrovsky. His company is the Russian leader in domestic flights. “Additionally,” he added, “it is necessary radically to reform the existing system of air navigation and air traffic control, which have long been obsolete. Our planes fly crooked routes and are kept waiting for a long time in the airport holding zone, which increases fuel expenditures.”

Only after Russian kerosene became more expensive that European and the topic occupied a central place in the mass media did the Federal Antimonopoly Service finally begin an investigation into possible violations of fair competition law. Specifically, airport fuelling operations in Novosibirsk, Krasnoyarsk and Yuzhno-Sakhalinsk (where a ton of fuel with VAT and service charges costs more than 41,000 rubles) are being investigated. Regional departments of the Federal Antimonopoly Service are checking airports in Petropavlovsk-Kamchatsky, Ulan-Ude, Chita, Makhachkala and other cities in which especially high fuel prices have been noted. Deputy head of the FAS Anatoly Golomolzin did not rule out the possibility that cases will be started against the oil companies as well, if FAS inspectors find monopolization in their relationship with the airport fuel suppliers. In addition, it has become known from the official reports of the FAS that the Russian Prosecutor General’s Office has taken an interest in the high prices of international charters and has instructed the FAS to study the operations of tour agencies as well. They are suspected of raising their own prices disproportionally to the size of their losses.

The hopes of many are riding on the FAS. It is the often last hope of private companies fighting state-connected and other forms of monopoly. However, no one on the market has any illusions about its investigations. “As can be seen from the FAS’s first statements, the service can only response to concrete violations of competition in specific airports, and that will not settle the systemic problem of fuel pricing. As a result, it will be repeated with unenviable regularity,” Aviaport’s Pantaleev suggests. “They have grasped the tip of the iceberg,” agrees S7’s Alexandrovsky. Aeroflot head Okulov is even more pessimistic. “Personally, I do not believe that the case begun by the FAS has any promise,” he says. “Air carriers have been raising the problem of aviation fuel trading to the authorities for several years, and in response we heard declarations on demonopolization and the creation of a competitive environment at the airports and trading on an exchange. In my view, all of those announcements are an imitation of activity to cover up helplessness before the oil lobby.”

A Predictable Future

This is the paradox: prices for fuel and tickets are rising sharply, but the number of passengers flying in Russia is not only not falling, it is growing rapidly. A preliminary calculation by the Transport Clearing Chamber shows that, in the first five months of this year, airlines carried 22.3 percent more passengers than the previous year. The average increase in 2007 was only 18.6 percent. Large air carriers are doing phenomenal business. Transaero, the second largest airline in Russia after Aeroflot, carried almost 1.5 million passengers between January and May of this year, exceeding last year’s indicator by 51 percent.

This is partially explainable by the well-known cunning of statistics. Industry analysts note that the total number – 45 million statistical passengers carried in 2007 are about 10-15 million real people who fly more than once a year. Most of them are business travelers, who are the least sensitive category of consumer. But airlines worry that that resource is not unlimited. In the end, ticket prices will reach a critical level at which people will either refuse to travel or use other forms of transportation.

On the whole, the experts explain the continuing passenger increase with the fact that personal incomes are growing faster than ticket prices. In the long-term, their prognosis is negative, based on the experience of the fuel crisis four years ago. With prices growing at approximately 50 percent per year, the passenger flow in civil aviation dropped by up to 1 percent. The price rise for fuel now promises to be more extreme. Since last autumn, kerosene has gained 70 percent in price and no one has taken it on himself to predict where prices will go in the next two months. But everyone agrees that kerosene will be more expensive and no signs of approaching price stabilizations are present. Even if the government finds a way to solve the fuel pricing problem, it will not be able to put its plans into action before the end of summer. So anyone who can reschedule his August vacation for July should do so now. Otherwise, it will be more support, willing or unwilling, for domestic fuel producers.

Alexey Ekimovsky

All the Article in Russian as of June 30, 2008

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