In 1974 my favorite band (Tower of Power) released one of my all-time favorite tunes called “Only So Much Oil In The Ground”. Although known more for their unique and hard driving music, Tower was prescient in its message; there isn’t an endless supply of oil, so we better find something else. [If you want to see the band doing it at the 2006 Montreux Jazz Festival, check this out]. TOP is STILL my favorite band.
Thirty-four years later we can add to that “There’s Only So Much Cash In My Checking Account”; we’ve still got oil but it is just expensive as hell.
There’s a neat chart put out by the California Energy Commission that compares the annual and peak price of gas for the years between 1970 and today, adjusted for 2008 dollars. Using that chart you can see that until sometime in 2006 the average price for a gallon of gas never exceeded the level attained in 1980. At it’s peak in 1981, the cost of oil topped out at $87 a barrel (in 2008 dollars).
Oil is now at ~$110 a barrel and last week four U.S. airlines went toes up, with rumors rampant about the imminent demise of a few more.
At some point (some would say we’ve already reached that point) the effect of high energy costs become ubiquitous, making everything from a loaf of bread to electricity more expensive. But although airfares have inched up, they’ve obviously not been raised sufficiently to offset the increased fuel costs. There are lots of reasons for this, but I believe there are three primary causes; 1) Demand for air travel is somewhat elastic and therefore raising prices could temper demand, 2) There is a significant amount of excess capacity, and 3) Airlines typically have high fixed costs.
Items 1 and 2 are somewhat related, since a reduction of demand caused by raising fares will exacerbate the capacity problem. I don’t totally buy that argument, but I will concede the point. Although four domestic airlines did cease service last week the capacity impact was minimal. Capacity pruning has been announced by several carriers. Whether or not the reductions are sufficient to return the industry to profitability is dependent on whether the price of oil continues to rise or not.
Which brings us to item 3; high fixed costs. Reducing capacity removes the variable costs involved in flying an airplane, but not the fixed costs. For an airline with a fleet of fairly new airplanes, the cost of ownership can be as onerous as putting fuel in the tanks. Airlines with older and less costly airplanes can afford to park those airplanes more readily and ride out the storm, so to speak.
However, even with airplanes temporarily parked there still is the question of what to do with flight and maintenance personnel made superfluous by parking airplanes. Personnel costs can be absorbed more easily than bleeding red ink on losing routes, but there’s only so much training and maintenance that can be done before negating the savings of parking the airplane. In an environment where oil prices are volatile, temporarily parking airplanes is a good strategy, as long as the cost of oil comes back down to a level at which those parked airplanes can be flown.
If oil prices stay high however, the capacity reductions need to become permanent. Whether these are done through mergers or more airlines just closing their doors, capacity needs to be significantly reduced so that fares can go up. There, I said it. Fares are too damn low. Consumers who pay $60 a week to put gas in the SUV can not expect to pay $99 one way for a 1,000 mile trip.
To date, higher gasoline prices have not significantly affected the consumer’s appetite for driving their personal car, though at $3.50 for a gallon gas we may be at the brink. Most experts agree there is too much airline capacity, so maybe the high oil prices will provide both the opportunity for airlines to cut losing routes as well as the justification to raise fares on those routes still operating.
Perusing the web for some archival fare information I found an old PeoplExpress timetable, which although crude, makes a point about airfares in 1981. On their June 1981 timetable they advertised weekday flights from Newark to Jacksonville for $79, which in 2008 dollars is just shy of $188. Each way. And that was when oil was at $87/barrel, adjusted for inflation.
Thinking any airline can offer $99, $89, or $79 fares, even when charging $50 for checking a bag, is illogical. Ancillary, schmancillary, if an airline can’t make money selling air travel I just don’t see how it can be a viable business for anybody.