African aviation and rising fuel costs

BY EKELEM AIRHIHEN.

African airlines will have to look inwards and find collaborative solutions across the industry value chain to remain in the skies as fuel prices begin to pose an existential threat.

McKinsey, the global consulting firm, in its article of July 15, 2022 ( Why rising fuel prices might not be bad for the airline sector as it seems) believes that high fuel prices may not necessarily be a bad thing for the airline industry. Though the hike in fuel prices have put a lot of strain on the airline industry, it may prompt airlines to limit overcapacity so they get better returns and remain stable.

It traces the history of rising costs. Between 2010 and 2012 there were relatively high fuel prices. The cost of jet fuel on average was around 70 percent higher than it had been between 2003 and 2005.

From the beginning of 2022, the price of jet fuel increased by about 90 percent while costs rose by 120 percent on average than it did in 2021. Now fuel, it says, is often the largest operating cost and can be up to 25 percent of total costs to airlines.

Since 2021 there has been a steady rise in the price of crude oil and jet fuel. It reached a new climax in 2022, reaching about $111 a barrel as of June 27, 2022. This represented an about 135 percent rise since the beginning of 2021. Same also applies to refined products including jet fuel.

Some of the reasons attributed to this are: decline in refining capacity post Covid-19.The decline in demand as a result of the pandemic resulted in refineries shifting refining capacity away from producing jet fuel towards other fuels. Also, the crisis between Russia and Ukraine has resulted in lower crude oil and refined product exports. These along with local logistics constraints have resulted in rise in prices of crude oil as well as distilled products such as diesel and jet fuel.

McKinseys gives three reasons why high jet fuel prices may not be as bad for airlines: First is the short term pain point airlines have against increase in fuel prices with a shortened booking window since the pandemic. This means that not many tickets would have been sold on the assumption of lower fuel prices only for the passengers to be flown at higher fuel costs.

Second, McKinseys found a correlation between unit revenue and fuel costs for US industry and a sample of carriers which shows that airlines can pass on some of the price increase to consumers.

Thirdly, fuel prices, it says, lead to higher marginal cost of flying, which can lead to greater capacity discipline.

The economics of airlines is such that between 30 and 35 percent of an airline’s operating cost ( jet fuel is one of the operating cost components) is fully flight variable. So airlines have an incentive to add capacity as most of these costs such as aircraft rental, flight crew salaries and overheads have already been incurred. It means that an additional flight does not lead to significantly higher cost. The effect has been that airlines had an incentive to run after increasing market share. Now with higher fuel prices, the marginal cost of operating increases and there will be more discipline in capacity deployment. The airline industry has always had overcapacity as one of the key challenges to sustained profitability. So this type of response would benefit the industry.

African aviators will need a collaborative solution to keep airlines flying. Costs will have to be looked at holistically by all players in the value chain with a view to agreeing on who gets what portion of the pie.

Constraints to airlines sweating their assets should also be looked at to ensure that assets are fully utilised in the most cost efficient manner by all stakeholders.

African countries with refining capacity should step up refining efforts with emphasis on jet fuel for the African market to help pass on the cost advantage to the airlines. Same would also happen with an MRO and aircraft leasing company to achieve economies of scale and cost reduction in the African aviation sector.

Capital and labour costs including insurance costs pose a challenge to airlines. Lower interest rates and long tenor facilities, lowering insurance costs and efficient deployment of human resources by all stakeholders will result in lower costs of operation and better industry performance.

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