Airlines Take a Crude Hit

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The political instability in Libya shows how interconnected the global economy really is. With the Arab crisis engulfing Libya, analysts are worried that crude oil supplies from Libya could be curtailed. The International Energy Agency estimates that oil companies have idled 500,000 to 750,000 barrels per day of production, or less than 1% of global daily oil consumption.

Italy's Eni (NYSE: E  ) , the biggest foreign oil producer in Libya, is set to cut Libyan oil production further. The company might stop production entirely because storage tanks at export terminals are at full capacity, and it's getting increasingly difficult to load the tankers to export as oil storage space is running out.

Everything at this juncture indicates that crude oil will become more expensive in the coming future. Investors and companies in all spheres better pay attention.

The immediate effects
Any adverse movement in crude oil prices has an immediate effect on the airline industry. Until last year, oil constituted 30% of the industry's total costs. But that figure has shot up to 40% this year already.

There are alternate ways in which these rising costs can be dealt with. Obtaining fuel efficient planes is one way out, but that's more of a long-term solution. Building an aircraft takes time and involves huge capital outlay. With the industry already under margin pressure, the airline players had to pass on the rising cost to the consumers. Even low-cost airlines had to raise prices when they had no other option left.

Last week, Southwest Airlines (NYSE: LUV  ) hiked fares on a majority of its routes by $10 roundtrip. Other airlines, including AMR's (NYSE: AMR  ) American, Delta Air Lines (NYSE: DAL  ) , and JetBlue (Nasdaq: JBLU  ) , have followed suit and raised their fares. The desperation of the airline companies is evident as they had to even raise fees that accompany the travel fares. US Airways (NYSE: LCC  ) recently raised its fees for overweight and oversize bags by 75%. These are indications that airlines are looking to milk every source they have to increase their revenues.

So will this hike in prices affect demand?
How sensitive will the consumers be to an increase in fares and fees? The underlying rationale is that the airline industry will need more customers who can pay higher prices. Airlines are desperately searching for passengers who can fill their more expensive seats. This means the number of cheaper seats might get slashed. As long as corporate America is doing well and sentiments are positive in the market, the airlines will have no problem selling seats to business travelers, since they're the source of inelastic demand that ensures revenues even during high-cost periods.

This trend could mean that individual passengers who seek out bargains will have to stretch their travel budgets in the near future. In the last three months, each increase had averaged $5 to $12 for the least expensive tickets, according to the CEO of FareCompare, an airline research service.

What will be interesting to observe is how long Americans will bear these high prices, especially in light of all the political and economic volatility in the Middle East and Africa. Will corporate CFOs agree to boot high travel cost for their executives? For the time being, the answer is yes -- but for how long?

The recovery has started to kick in. Even the down-and-out automobile sector has seen a revival. If one misses out on opportunities to grow business now, it will be a big and lasting setback. In every sector, demand is surging and companies are making a mad rush to garner businesses. In times like these, travel cost is a small overhead that needs to be endured. But longer term, the U.S. relies on cheap energy to fuel its economy, and that worries me. The long-term consequences of overly expensive airfares are not something anyone wants to consider.

The Foolish bottom line
All of this means one thing: The interconnection of businesses and global economy coupled with Arab politics has made flying expensive for the common man. Airline travel had always been viewed as a relatively elite mode of transport. I think that it's going to get more elite, given the fare increases. Passenger demand in the retail segment will surely be hit. Of course, the airline companies know this. They had it all chalked out when the first cry of revolt went up in Tunisia. Here is wishing the airline companies the very best.

Sarosh Nicholas doesn't own shares of any of the companies mentioned in the article. Southwest Airlines is a Motley Fool Stock Advisor pick. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. 

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  • Report this Comment On February 28, 2011, at 11:06 PM, screwme wrote:

    "Airline travel had always been viewed as a relatively elite mode of transport. "

    I am laughing my backside off at this comment by the author. Where have you been for the last 15 years?

    Airline travel has for the last 15 years become the equivalent of riding a greyhound bus.

    In recent times, one could buy a plane ticket for less money than:

    1.) it would cost to park the car at the airport for a week.

    2.) cab fare from the airport into the local metropolitan city served by the airport

    3.) a three star hotel for one night ON the airport property

    4.) a bad sandwich and three beers IN the airport

    ...the list goes on and on

    Thats the problem with the airline industy, they haven't raised prices to cover their fuel costs. But, I will tell you one dang thing: Fedex and UPS sure as hell have!

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