Oil - a major factor affecting travel demand?

Crude oil prices have increased by around 40% since the beginning of the year, breaking US$50, US$60 and now, US$70 per barrel. Suddenly, predictions of oil prices hitting US$100 a barrel no longer seem farfetched. Indeed, some economists think we’ll see those prices in early 2006.

The rise in oil prices has been attributed to a host of factors including voracious demand from China, fears of terror attacks in Saudi Arabia, problems in American oil refineries and speculative trading by hedge funds and investment banks which regard oil as an excellent short-term bet.

Whatever the reason, the fact remains that supply is struggling to keep up with demand, and until it catches up, consumers can expect oil prices to remain high. Contrary to popular belief, however, higher oil prices don’t necessarily spell bad news for the travel industry. Abacus President and CEO, Don Birch explained, “Travel, especially intra-Asia short-haul travel, has proven in recent years to be resilient to periodic shock events. In fact, FIT bookings on the Abacus system year-to-date show that travel is holding steady despite the increase in fuel surcharges, and even increased by 9% over the same period last year.”

Airlines passing the buck?

Of course, the effects of the rise in crude oil prices have quickly filtered down to the travel industry. Jet-fuel prices have correspondingly gone up – prices have jumped 75% to around US$70 per barrel over the last year, adding a significant sum to airlines’ operating costs.

“Fuel is the second biggest cost for airlines after labour, now accounting for as much as 30% of operating costs,” says Mr Birch. “This naturally has a dampening effect on airline profitability, especially at a time when airlines are just returning to profitability after the shocks of SARS and the Boxing Day Tsunami.”

Recent reports by Reuters and Bloomberg have noted that the global airline industry had already accumulated losses of about US$40 billion in the past five years. With this latest oil price surge, the International Air Transport Association (IATA) says it will have to revise its May forecast that predicated airline losses would reach US$6 billion just for this year.

Not surprisingly, many airlines have already imposed increased fuel surcharges. Those who haven’t are either mulling over the risk of chasing away passengers if they increase their fuel surcharge in as many months, or are finding competition so tough that there is no possibility of passing the extra costs onto travellers.

But while airline passengers baulk at this latest increase, it is worth noting that these fuel surcharges only cover a portion of the airlines’ increased operating costs. According to the US Air Transport Association, every US$1 increase in the price of a barrel adds US$425 million in annual operating expenses for US airlines.

Qantas, for example, has said that even with its latest increase, the current fuel surcharge will only offset their total expected fuel costs of A$1.25 billion (for 2005) by A$600 million.

Travel expected to remain resilient

The higher ticket prices are, however, not expected to have a significant impact on travel demand in the short-term.

In its Annual Energy Outlook released at the beginning of the year, US-based Energy Information Administration said it expected the demand for jet fuel to be insensitive to price increases through 2025 as air travel growth is constrained by the availability of airport capacity in that time frame.

The last round of increases in fuel surcharges by several international airlines in May did not seem to have a significant impact on international travel. Figures from the Association of Asia Pacific Airlines showed a year-on-year increase of 7.5% in international arrivals for the first half of the year, indicating that travel demand was not greatly affected by the higher fuel surcharges.

“Travel is now considered by Asians to be a consumer ‘right’ rather than a luxury. So the impact of higher ticket prices will be more on the duration of leisure trips and on the choice of destination but ultimately, travellers aren’t going to be cancelling their year-end holiday over an increase in the fuel levy, except those at the margin.” said Mr Birch. “It is more likely that the longer distance and hence more expensive trips will be traded for more local journeys. This is supported by our numbers that show a continued growth in intra-regional itineraries.”

“Further, the intense competition amongst LCCs in this region means that there are plenty of good deals out there. So, what we are likely to find is that airlines will try to absorb any further cost increases even if oil prices continue to rise.”

Chinese and Indian airlines have been holding off imposing fuel levies as the competition in those two countries are amongst the fiercest in the region. India has seven domestic airlines and counting, while the Chinese government, notes wire agency Dow Jones, has had to step in on numerous occasions to stop major airlines from offering steep discounts or even operating routes at a loss.

It’s a point that has been highlighted by the World Tourism Organisation. In its June 2005 World Tourism Barometer, the Organisation noted that “it is likely however that in the current framework of fierce competition, companies will try to refrain from passing on a large part of energy price rises to consumer prices, which will necessarily affect the profitability of the sector and may put higher pressure on prices in the destinations.”

Asian airlines, in any case, are in better financial shape than their US and European counterparts (Asian airlines reported a US$2.6 billion profit for 2004, compared with US$1.4 billion for European airlines and a loss of US$9 billion for US airlines) and can probably afford to absorb the higher costs in the short-term.

As Singapore Airlines Chairman Koh Boon Hwee noted at the sidelines of the World Economic Forum’s Asia Roundtable in April this year: “If you are already profitable, then the high prices will shave some of your profit margin but you should be all right.”

Furthermore, corporate travel is likely to remain unaffected by the high oil prices.

“Business travel is just that – required for business,” says Mr Birch. “So while ticket prices may rise, most business travel is non-discretionary and is affected more by general levels of economic activity than ticket prices. Also, business travellers are very loyal to full-service airlines, either because of the loyalty programmes or for the quality of service that they receive, so full-service airlines will have the business traveller market to rely on.”

Oil prices – how much of an impact on travel really?

To the travel industry, oil price in itself is not a determining factor on travel demand. IATA, for example, believes that any dampening effect is more likely to come through the impact of higher oil prices on economic growth and consumer confidence.

The latest oil price surge, say economists, is unlike the previous two in 1973 and 1979 in that the supply of oil has remained strong, as has the supply of inexpensive imported goods, thus acting as a counter to oil-fuelled inflation. Analysts also note that while oil prices are at record levels, in real, inflation-adjusted terms, they are still well below those seen in the late 1970s and early 1980s. This coupled with the fact that consumers are better off today, has cushioned the impact of higher prices on the economy.

And while analysts have reduced their economic growth forecasts for Asian economies, they say that a recession is unlikely as these economies, particularly China, are still very strong.

With the release of MasterCard’s biannual MasterIndex of Consumer Confidence in July 2005, this view is shared by MasterCard International. According to Dr Yuwa Hedrick-Wong, Economic Advisor to MasterCard International in Asia-Pacific, “Regional consumer confidence over the outlook for the rest of the year is relatively strong, especially when seen in the context of worries over the price of oil, economic slowdown in Europe, rising interest rates, and on-going stock market volatility.

At least for 2005, positive consumer sentiments should support double digit growth in retail sales, outbound travel, and household expenditures in general,” Dr Yuwa added.

The World Tourism Organisation expects that Asia-Pacific will continue to post strong results fuelled by intraregional source markets and the Chinese outbound market in particular. The Organisation’s figures show that Asia experienced the fastest growth rate of all the regions in 2004, registering a 29% increase in travel growth over the previous year, albeit that 2Q 2003 was severely impacted by the SARS outbreak.

Longer-term, some good news is on the horizon. The US Department of Energy expects growth in Chinese oil demand to slow, increasing only by 600,000 bpd in 2005 and 2006, as compared with 1 million bpd in 2004. On the supply-side, US President Bush signed, in August, an energy bill containing an estimated US$14.5 billion in tax breaks to encourage oil production.

Given man’s well proven ingenuity, there is no doubt that higher fuel prices will drive both new technologies and new behaviours and in the longer term, this will bring oil prices under control. The energy efficient home or the hybrid car are beginning to look like good investments rather than the demonstration of green responsibility that they were just one year ago.

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