Soaring jet fuel prices threaten to raise airfares and limit air travel demand

Key Takeaways

High jet fuel prices caused by the Russia-Ukraine conflict are projected to hinder the aviation sector’s recovery from the COVID-19 pandemic.

Airlines are likely to pass on a portion of rising costs through higher airfares, constraining travel demand.

Airfreight prices are projected to remain high through 2022-23, with rising costs likely to flow through the supply chain, particularly for time-sensitive goods.

International airlines have re-entered Australian skies, to the delight of travellers and businesses. However, it’s not all good news, as airlines are likely to face strong headwinds in the form of soaring jet fuel prices.

The reopening of Australia’s international borders to fully vaccinated visitors on 21 February 2022 signalled a turning point for the broader Australian aviation and tourism sectors, who have spent the better part of two years eagerly awaiting this moment.

High jet fuel prices to weigh on airlines’ thin profit margins

Unfortunately, airlines have been knocked off their flight path once more – and the timing could hardly be worse. Sanctions imposed on Russian oil since the Russia-Ukraine conflict commenced have driven up the world price of crude oil. These developments pose a significant obstruction to airlines’ path to recovery.

Jet fuel prices fluctuate in line with oil prices, and have been rising steadily since they plummeted in early 2020. According to the International Air Transport Association (IATA), jet fuel prices fell below US$30 per barrel in April 2020, rising to over US$100 in early 2022. The Russia-Ukraine conflict has accelerated this trend, with the IATA reporting jet fuel prices at US$174.4 per barrel as of 29 April 2022.

Airlines’ profit margins are commonly described as razor-thin – and that’s under normal conditions. Fuel accounts for approximately one-quarter of an airline’s operating costs. As a result, any notable rise in fuel costs significantly hinders airlines’ ability to remain profitable. Consider the below overview of Qantas’s pre-pandemic spending, for example:

So, are airfares going to increase due to rising fuel costs?

The simple answer is yes: airfares will become more expensive. However, the effect of rising jet fuel prices on airfares will likely be delayed and less steep than the sharp rise commuters saw at the petrol pump in March. Additionally, airlines are likely to limit airfare rises by instead charging more for ancillary services, such as lounge access, baggage fees, food and beverages, and seat upgrades; and by implementing a range of cost-cutting strategies.

Furthermore, international routes are expected to be more severely affected than domestic routes, due to fuel accounting for a larger share of operating costs on longer flight routes. As a result, international airlines will face stronger pressure than domestic airline operators to cover costs by lifting their prices.

However, fuel hedging practices are likely to delay airfare increases. Airlines typically circumvent the effects of fluctuations in oil prices by locking in fuel prices at a particular market rate. Doing so limits airlines’ exposure to sharp rises in jet fuel prices. Hedging strategies differ across the industry, but often involve having oil highly hedged in the short term, where the proportion of an airline’s fuel needs that is hedged tapers off over a 12- to 24-month period. An airline’s level of fuel hedging will affect how quickly, and by how much, they need to raise their airfares to cover rising fuel costs.

Shifting strategies: Airlines to abandon discounted airfares

Following two years of severely limited passenger numbers, airlines were hoping to entice consumers back in the air with discounted airfares. Domestic airlines have employed this strategy over the past 12 months.

However, rising jet fuel prices will force airlines to shift their approach. While airlines are keen to get passengers back on board, their priority will be to avoid incurring further profit margin losses on top of those suffered over the three years through 2021-22.

If oil prices remain high beyond the expiry date of airlines’ oil hedging contracts, industry operators will have no choice but to pay up. In this scenario, consumers will also have to pay up as airlines pass on these costs to protect their margins. The ACCC, and Australian airlines Qantas and Rex, have already warned the market about impending airfare rises.

The message is clear: Airfares will rise, and discounts are set to depart.

Sales, business development and other verticals that rely on air travel to meet with prospects will be directly affected by increased fares. However, people have become increasingly accustomed to online videoconferencing since the COVID-19 outbreak, and these systems are now engrained in business practices, reducing the importance of air travel. Nevertheless, the flow-on effects of rising jet fuel costs through the economy are expected to be significant.

Airfreight prices to remain high for longer than hoped

Airfreight is mostly transported in the cargo holds on passenger flights. As a result of the COVID-19 pandemic, restricted flight numbers since March 2020 have drastically reduced airfreight availability. Subsequently, airfreight prices have skyrocketed.

The Air Freight Services industry is typically used to transport time-sensitive and valuable goods, such as pharmaceuticals and perishable foods, and has increasingly been used for transporting non-bulk retail products following the rapid expansion of the Online Shopping industry. Airfreight is generally faster, but more expensive, compared with freight services provided by the Road Freight, Rail Freight and Water Freight industries.

Airfreight prices will likely descend as the number of international and domestic flights gradually returns to pre-pandemic numbers. However, high jet fuel costs and limited capacity are projected to keep airfreight prices high through 2022-23. This trend will be detrimental to many businesses that rely on airfreight for domestic and international imports and exports. Rising airfreight costs will likely place upward pressure on the price of transported produce and goods. Businesses will likely find it difficult to pass on higher costs to consumers, which will constrain profit margins throughout the supply chain.

For example, price increases associated with transporting perishable produce may cause a ripple effect that flows through the agribusiness sector and beyond, increasing costs and constraining margins for many firms including:

Primary producers
Food manufacturers and processors
Food-service establishments
Food retailers
Supermarkets and grocery stores

Exporters will need to rely more heavily on the strong reputation of Australian produce to support demand amid high export costs. Procurement professionals will also be challenged by elevated freight costs. Businesses may need to explore new strategies to successfully navigate these precarious conditions. Firms should remain open to new markets and suppliers – for example, by looking towards more local sources. In addition, firms may opt for the flexibility offered by SME freight and freight-forwarding service providers. While smaller firms offer higher freight prices compared with their larger counterparts (due to their lack of economies of scale), it may be advantageous to avoid being locked into long-term contracts that offer little flexibility in a rapidly changing environment.

For retailers, wholesalers and manufacturers of non-perishable goods, sea, rail or road transport will remain more cost-effective. These firms may have to forgo the benefits of increased customer satisfaction from fast shipping times to save on costs. When airfreight is not a viable option, firms can reduce shipping times and costs by optimising their logistics to create an efficient supply chain.

Tourism outlook

The underlying demand for air travel is undeniably strong. The prospect of imminently rising airfares provides a solid incentive for consumers and businesses to book upcoming trips sooner, rather than later. This unique scenario presents a great opportunity for the tourism sector to encourage people to travel now, before things change. A large share of this demand is likely to be directed toward domestic trips as limited capacity on international routes and continuing COVID-19 safeguards reduce the appeal of international travel. Along with increasing airfares, international airlines’ deliberate capacity growth strategies are expected to prolong the recovery of international travel to Australia and international travel by Australians.

Tourism operators face both good and bad news in this regard. Although the international market is projected to remain limited in 2022-23 and beyond, demand from the domestic market will likely be much stronger in comparison. Domestic tourist visitor nights and business tourist visitor nights are forecast to exceed pre-pandemic levels in 2022-23.

Federal and state governments are likely to continue investing in marketing and incentives to boost domestic tourism, particularly to draw people back to Australia’s major cities. Entertainment, accommodation and food-service firms can capitalise on this opportunity for increased demand by implementing effective marketing strategies that get consumers in the door. For firms that typically rely heavily on international markets, realigning their marketing strategy to the local market may prove instrumental to business success in the short term.

Many food-service, arts, and recreation service industries will need to prepare for a possible influx of domestic tourists, including:

As operators focus on regaining their footing as they recover from COVID-19 closures, they may have limited money available to invest in nice-to-have services, such as consultants and other professional services. However, a projected rise in the business confidence index and capital expenditure by the private sector in 2022-23 provides an opportunity for consultants to market their services as the way forward to recovery. Within the professional services sector, consultants who have done their homework in researching industry and economic shifts are better positioned to assist businesses in adapting to these rapidly changing environments.

Operators in the tourism industry must ensure they have skilled workers available to provide tourists with quality services during peak times, which may be challenging amid labour shortages. According to NAB’s March 2022 Quarterly Business Survey, the availability of suitable labour was the most influential issue affecting business confidence. Providing a high-quality service increases the likelihood of word-of-mouth recommendations and repeat visitors. Domestic tourists tend to favour regional destinations, while international tourists favour capital cities. Enterprises located in capital cities can entice tourists through effective marketing and promotions. However, the sector’s instability and uncertain supply costs make it difficult for firms to commit to a marketing strategy spanning beyond six months at a time.

A turning point

The outcome of the developing Russia-Ukraine conflict remains up in the air. The duration and extent of sanctions imposed on Russian oil will largely determine how long airlines will be contending with high jet fuel prices, and just how high those prices may be.

Despite these disruptions, there's good news on the horizon. Following the turbulence of the COVID-19 outbreak, the reopening of Australia’s international borders has paved the runway for aviation and tourism operators to begin their journey to recovery.

IBISWorld reports used to develop this release:

Australian industry reports

Business environment profiles

Australian enterprise profiles

For more information, to obtain industry reports, or arrange an interview with an analyst, please contact:
Nikola Brajdic
Content & Media Manager – IBISWorld Pty Ltd
Tel: 03 9906 3647
Email: mediarelations@ibisworld.com