Impending oil shortage spells doom for airlines

Wednesday, October 16th, 2019 07:52 |
Oil pipeline. Photo/Courtesy

By Chris Wangalwa

If airlines in oil producing countries and their neighbouring states have historically operated at the mercy of jet fuel, airlines in countries that do not produce oil should be crowned for staying in business.

As of 2016, India was Kenya’s single largest supplier of fuel before losing ground to United Arab Emirates (UAE). In August 2018, Jet Airways, India’s second-largest airline reported a massive first-quarter loss, blaming high fuel prices.  

Emirates, the largest international carrier and whose country produces and exports oil, saw its profits slump by 69 per cent in the 2018/19 financial year as it faced higher fuel prices and slowing travel demand in regional economies.

Earlier this year, Qatar Airways reported an annual loss of Sh63.9 billion attributed to, among other factors, higher fuel costs. The airline had made a Sh6.9 billion loss in 2018.

Unlike Kenya, not only does Qatar produce its own oil, it borders oil producing countries such as Saudi Arabia by land and UAE, Bahrain and Iran by sea. It goes without saying that Qatar Airways should be the last airline to link fuel prices to its losses.

Data from Kenya National Bureau of Statistics indicates that the country’s imports of petroleum products from its leading source Saudi Arabia increased by 61 per cent to Sh132.6 billion in 2018, up from Sh70.4 billion the previous year.

The recent attack on Saudi Arabia’s oil infrastructure had as of September 15 seen a 10 per cent surge in world’s oil prices. An increase in oil’s relative price often causes an adverse shift in the aggregate supply that produces a higher price level and lower output. Four of the last five global recessions were all triggered by increases in the price of oil. Saudi’s recent attack is a reincarnation of the 1991 global recession.

Whereas profits of the transport sector are set to shrink tremendously following the Saudi incident, airlines will bear the bigger share of losses.

A comparison between the Saudi attack and just one of the last five global recessions will be enough to show a striking similarity and to confirm that airlines are set to make losses in the quarter.

In 1990, Iraq invaded neighbouring Kuwait, accusing it of siphoning crude oil from its fields located along their common border and conspiring to keep oil prices low in an effort to cater to Western nations. The invasion and the ensuing Gulf War combined both a war and an oil shock as sanctions from the United Nations forbade any country from importing oil from both Kuwait and Iraq, thus knocking out two of the world’s biggest oil producers.

Last month, days after imposing sanctions on Iran, the US announced it would be sending military reinforcements to the Gulf region following attacks on Saudi oil facilities which it attributes to Iran.

The Saudi attack will have detrimental effects on the cost of aviation turbine fuel. Higher oil prices result in higher jet fuel and diesel prices and since fuel is the largest operating cost center for airlines and one of the key expenses, a spike in the cost of fuel is surcharged to consumers through higher airfares.

It is in anticipation of such turbulent times that airlines hedge against rising fuel prices by buying the right to purchase oil in the future at an agreed standard price. Hedging can be a great advantage when fuel prices are low or falling but can greatly increase costs when the price of oil quickly increases.

Since April, fuel curve projections have pointed to an increase in fuel prices but airlines like Kenya Airways will benefit from fuel hedging as the current fuel prices are approaching Sh8,000 a barrel. According to a report presented to Parliament in June, KQ volumes are hedged at rates lower than Sh6,800 a barrel.

Airlines that see little value in hedging have paid a heavy cost. Last year for instance, despite fuel costs accounting for 28 per cent of Emirates Airline’s expenses, the airline ruled out plans to return to fuel hedging as the carrier does not fuel hedge. Consequently, Emirates’ fuel bill recorded a 25 per cent increase in the 2018/19 fiscal year compared to the previous year. 

Higher fuel costs will weaken the aviation industry further.  If not, other cost cutting avenues will include staff downsizing, extensive pay cuts and closure of nonproductive routes.

The writer is a strategic communications consultant at P&L Consulting

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