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Soaring fuel prices pose new challenge for airlines; how high ATF prices hit airlines profitability

The prices of jet fuel have been hiked for the fifth timethis year. Although this has been on expected lines, considering the impending oil scarcity from the war between Russia and Ukraine, airlines in India are in a quandary as it could chomp on airlines revenues.

The prices of jet fuel were increased once again by over 3% to Rs 93,530.66 per kl on Tuesday. To be precise it is the fifth time that prices have been hiked this year. (File Photo: PTI)

The prices of jet fuel were increased once again by over 3% to Rs 93,530.66 per kl on Tuesday. To be precise it is the fifth time that prices have been hiked this year. Although this has been on expected lines, considering the impending oil scarcity from the war between Russia and Ukraine, airlines in India are in a quandary. Rising aviation turbine fuel prices (ATF) further dim the prospects of the airline sector and will chomp on airlines revenues, analysts say. Shares of InterGlobe Aviation Ltd, the company that runs Indigo airlines, are down 3% from Tuesday’s close and nearly 8% down YTD. For Spicejet Ltd, stock fell 2% from yesterday’s close in intraday trading and fell over 12.5% YTD.

Higher fuel prices squeeze revenues but can airlines pass on the price hike to passengers

ICICI Securities said high fuel prices will likely squeeze gross spreads of airlines. “Airlines tend to enjoy higher gross spreads when fuel prices are low. However, they are unable to completely pass on the rise in fuel prices through higher fares,” the brokerage said, citing historical data. Gross spread is the difference between revenue and fuel prices. Fuel prices account for roughly 40% of an airline’s costs and hence rising costs (such as fuel prices) will cut their earnings. Crude oil prices topped $110 per barrel mark on Wednesday – highest since 2014.

Airfares are higher than that in 2014, when fuel prices were even higher than the current levels. Taking example of IndiGo, ICICI Securities said current passenger RASK (or revenue per available seat kilometer) stands at Rs 3.51, in comparison to passenger RASK of Rs 2.5/2.7 in FY10/11 when crude was in the range of $100-120 per barrel. This is because of the pent-up demand of passengers who now are willing to pay higher prices for a ticket following the COVID-19 pandemic. But since airlines already have higher fare levels, they may not be able to increase any further. “As such, incremental scope to raise fares may be limited unless there is supply correction in the system,” the brokerage said.

What happens to the Passenger Load Factor (PLFs) when oil prices rise

Another metric of an airline’s profitability is PLF or the Passenger Load Factors. It refers to the percentage of available seating capacity that has been filled with passengers, according to Investopedia. ICICI Securities said PLFs work inversely in comparison to crude prices adding that the PLFs are distinctly low during a high crude price regime.

“For instance, crude prices rose at 7% CAGR between FY11-14 when PLF for Indigo declined from 85% to 77% and for SJet (SpiceJet) was down from 83% to 72%. Comparatively, PLFs of IndiGo/SJet were average 85.6/92% between FY16-19,” the brokerage said.

What impacts profitability: demand-supply balance or fuel prices?

Historically, supply demand balance has been a bigger driver than fuel prices for airlines profits. In fact the ability to pass on the increase in fuel prices will also be dependent on overall supply demand, experts said. 

For instance, Indigo and SpiceJet saw an improvement in RASK in 2020 when Jet Airways was grounded, ICICI Securities said. In the first quarter of 2020, following the grounding of Jet Airways, RASK for Spicejet increased to 4.4% from 4.1%, while for Indigo it improved to 4% from 3.6% in comparison to the previous quarter, the brokerage said.

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