Just because fuel prices have dropped, don't expect lower airfares

With tens of billions of dollars spent each year on aviation fuel, the recent drop in energy prices would seem to be a boon for airlines.

So why is at least one industry ­analyst worried?

It's not because it's thought that airlines will cut fares to match their reduction in costs. The airlines have made clear that isn't going to happen.

But analyst Hunter Keay of Wolfe Research worries that lower costs will prompt airlines to boost ­capacity unwisely and unprofitably. The industry returned to vibrant health after it throttled back its flying. Now, will it push the throttles forward?

But other analysts have offered different views, that companies would be wise to boost output if lower expenses allow it, or that there's ­little sign that capacity is getting out of hand.

In any case, the airline industry has shrugged off suggestions that lower fuel prices should bring lower airfares, as John Heimlich, vice president and chief economist of trade group Airlines for America, explained in a conference call this month.

"The first priority is to make sure you have strong financial health, can pay down your bills and invest in the future and weather the next recession," Heimlich said.

On their third-quarter earnings calls, airline executives also made it clear that they didn't intend to pass on any energy savings.

"Air travel remains a great bargain," said Scott Kirby, president of American Airlines. "We'll continue to keep it a great bargain for customers. But in a strong demand environment, we don't have plans to go off and just proactively cut fares."

Southwest Airlines Chairman and CEO Gary Kelly said he's worried about the volatility of fuel prices, even with the current drop in energy costs.

"You remember 1999. Crude oil I think went down to $10 a barrel, only to be followed with increases every single year for the next decade. It was just an unprecedented spike that took place. So, that's what worries me," he said.

Based on 2013 use of 15.9 ­billion gallons, each penny drop in jet fuel prices saves the U.S. airline industry $159 million annually. Consider that the spot price of Gulf Coast jet fuel has dropped from $3 a gallon at the end of 2013 to under $2.40 in recent days.

When the economy is doing well, fuel prices tend to be higher, but more people will fly and will pay more to do so, he suggests. Higher fuel prices also keep airlines from investing in flights that are marginally profitable, if at all.

"We are increasingly uncomfortable with the ­longer term impact from lower oil prices as it relates to our investment thesis on airlines," Keay wrote in an Oct. 30 report. "For years we've said high oil prices are good for airlines, so it would be intellectually dishonest to say low oil prices are also good for airlines."

Keay noted that a number of airlines have outlined plans to increase their flying in coming quarters. They've pegged their growth to the gross domestic product, saying they'll grow at or below that rate. He is not reassured.

"We're not sure who invented this but many now believe it represents a threshold of what's acceptable," Keay said in a follow-up report Oct. 31.

He noted that network airlines, which had cut their capacity in the face of high energy prices, grew their flying in the U.S. by 4 percent in late 2010 as jet fuel prices were lower and somewhat stable.

As of late October, he was looking at estimates that airlines again would boost their domestic capacity 4 percent in 2015. "We'd be fools to ignore this precedent and honestly rationalize it because jet fuel is cheap, today," Keay wrote.

Taking a different view is analyst Jamie Baker of J.P. Morgan.

He said it makes sense for companies like airlines to increase output — add capacity — if their input costs go down. If current prices hold steady, the industry's fuel bill in 2015 would be $5 billion less than at previous jet fuel prices of $3.05 a gallon, he said.

"We expect firms to maximize profits, and lower fuel suggests incremental growth is warranted. We take umbrage to the view that oil prices and equity values are somehow correlated, that lower fuel is a negative, and that airlines should turn a blind eye to input costs," Baker wrote. "The better gauge of discipline, in our view, is whether managements similarly reduce planned capacity should oil revert to summertime levels."

He noted that American Airlines had originally planned to increase capacity in the fourth quarter by 5.2 percent but trimmed it as the year went on to 1.6 percent.

A third analyst, Michael Derchin of CRT Capital, said that investors concerned about "capacity creep" have nothing to worry about. He analyzed airline schedules for the next six months and found capacity up 3 percent, about as much as the expected growth in GDP.