Seat 2B By Joe Brancatelli
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Why Fares Aren't Falling As Oil Prices Drop
November 6, 2014 --Oil prices are plunging and have reached four-year lows on world markets. Gasoline prices have fallen below the $3-a-gallon plateau and the AAA says average prices may drop another 5-15 cents in the weeks ahead. Jet-fuel prices are 15-20 percent lower than they were a year ago.

Inquiring business travel minds want to know: So when are airline fares coming down?

The answer is never. Fares will never fall so long as you keep buying tickets at prevailing prices.

Before the deep-dive analyses and mind-numbing numbers and before you shake your fists in rage at those price-gouging airlines, can I make an obvious observation? As business people we understand that there is no incentive to lower prices when your product is in demand and you're selling all of the inventory you're manufacturing.

So why be angry because the airlines are doing what good businesses do? Maximizing profit by keeping fares at the highest level travelers are willing to pay makes impeccable business sense. Since when is any business required to pass cost savings onto consumers, especially when those consumers are lapping up the product at prevailing prices?

I get the confusion, though. Airlines haven't acted much like normal businesses for decades, so it's disorienting to see them acting rationally now. In the not-so-different past, fast-falling fuel prices would have led to swiftly slashed fares. But a new generation of managers who talk persuasively about return on invested capital and market discipline run airlines now. They're not about to pass along lower fuel costs on to you unless you prove to them that you're not buying at the posted prices.

"In a strong demand environment, we don't plan to go off and just proactively cut fares," American Airlines Group president Scott Kirby told security analysts late last month during the company's third-quarter earnings call.

Now that you understand where airlines are coming from, some of those mind-numbing numbers I promised.

The average domestic airfare was $396 in the second quarter, according to statistics compiled by the Department of Transportation. That's 2.5 percent higher than the second quarter of 2013 and 17 percent higher than the adjusted-for-inflation, Great Recession low of $334 in the second quarter of 2009. Airlines are also raking in billions in ancillary fees for checked bags and ticket changes. The fees and unbundled ticket prices makes an apples-to-apples comparison difficult, of course, but it's hard to claim your price to fly has skyrocketed when you consider that the average fare in the second quarter of 1999 was an inflation-adjusted $472.

My back-of-the-envelope math suggests that the average fare plus today's extra fees are about equal to the bundled price we paid in 1999. It's hard to think of any other non-digital product that costs no more in 2014 than it did in 1999. (And a disclaimer: Average fares are specious because literally no traveler pays the "average" fare, but it's hard to talk rationally about airline prices without using some benchmark. I know that your mileage and your fares may differ.)

Given the fact that airlines aren't really reaping more sales dollars per ticket, it's understandable that they have tried to reduce costs. They've done it any number of ways: cheapening or eliminating their service, stuffing more coach seats onto aircraft and driving down employee wages and benefits.

But energy costs can wipe away almost all of those savings. When oil hit $147 a barrel in the spring of 2008, the prevailing estimate was that energy costs alone consumed as much as 40 percent of a ticket price. It also drove a record number of airlines out of business.

But with the price of oil now around $77 a barrel it started at $80+ when I began writing this on Tuesday morning energy costs are probably "only" 20 percent of an airline's expenses. Since airlines aren't cutting prices, every dime of that saving flows to their bottom lines, which shattered records in the third quarter.

Airlines also manufacture less of their product now, better matching supply to demand. Estimates vary wildly, but the capacity of the nation's airline system shrank dramatically during the Great Recession and never fully recovered. Carriers now routinely fill more than 80 percent of the seats they fly. They are being very careful about adding additional capacity. And they face a nasty backlash from hawkish analysts when and if they do add seats, so much so that executives at Delta Air Lines, the nation's most profitable airline, lashed out at ultra-conservative stock watchers during a recent earnings call.

But the bottom line is, as it always has been, demand. If travelers fly less, airlines are forced to lower fares. But there's absolutely no indication that fliers are balking at current prices. All of the carriers are bullish on fourth-quarter demand, too. So lacking a reason to cut fares to induce fliers to book tickets, the airlines are holding the line on prices. In fact, several even managed to nudge fares upward in October.

There's one other bit of analysis worth considering: Now is a nearly perfect time to launch a new airline and new carriers are guaranteed to bring lower prices and new ideas to the market.

Airline start-ups have been rare since the terrorist attacks of September 11, 2001. And the only notable one, Virgin America in 2007, is just now generating quarterly profits in front of its initial public offering. It's been a long dry spell for entrepreneurs looking to launch the next JetBlue Airways, which was created in 2000 and remains the very model of a not-by-the-book domestic carrier.

Yet conditions for new airline start-ups are extremely favorable: passenger demand is strong, fuel prices are down, airline profits are high, existing carriers are circumspect about adding flights and passengers(rationally or not) expect fares to be cheaper.

Just in the last week, I've heard from four groups looking to start airlines and investors are sniffing for opportunities in a market where the three "legacy carriers" Delta, United and American/US Airways and Southwest Airlines control 70 percent of the domestic traffic.

"It's a great time to be in the airline business," a veteran investor told me in an email. "When was the last time we saw robust demand [and] the chance to lower fares and still make a profit?"

This column is Copyright 2014 American City Business Journals. All rights reserved. Reprinted with permission. JoeSentMe.com is Copyright 2014 by Joe Brancatelli. All rights reserved.