Why Is Flying Still Expensive Even Though Fuel’s Gotten So Cheap?
This is what it looks like when a market isn’t very competitive.
The far-reaching consequences of the recent drop in oil prices have been a testimony to just how central crude is in American life: With cheap gasoline bringing more drivers onto the road, traffic deaths were up nearly 10 percent in the first nine months of 2015. Meanwhile, after remote towns in North Dakota surged with thousands ready to work the Bakken, the luxury apartments built to accommodate them are half-vacant now that demand has died down. And recycling companies have seen their business dry up as oil’s impact on the math of producing plastic has prompted manufacturers to just make their own.
But there’s one nook of the country’s economy where the plummeting price of oil hasn’t yet been felt: plane tickets.
Jet fuel—which accounts for a good portion of airlines’ expenses—currently costs about a third of what it did two years ago. Yet ticket prices have been declining much more modestly, falling roughly 3 percent per quarter over the last year.
How much do airlines stand to gain from a drop in oil prices? A good estimate, according to Volodymyr Bilotkach, a senior lecturer in economics at Newcastle University, is that fuel has typically made up about a third of airlines’ operating costs. As the price of fuel has dropped, it’s been taking up a smaller and smaller share of these expenses, to the point that now, he estimates, fuel only makes up about 15 percent of airlines’ spending (assuming their other costs have remained roughly equal).
A change of that magnitude greatly improves airlines’ bottom lines: Last year the four biggest U.S. carriers—American, Southwest, Delta, and United—brought in $22 billion in profits.
It’s not surprising that airlines would be slow to forfeit the gains they’ve seen from all those fuel savings, but, curiously, they haven’t been lowering ticket prices very much, which would be a natural way to start trying to steal customers from one another. Even some surcharges that were concocted when times were tighter—charging customers for sitting in aisle or window seats, for instance—still remain in place. Cruelly, even fees that were originally conceived to cover fuel costs have stuck around, even if they now go by different names.
So why isn’t a bigger chunk of these savings being passed onto travelers? This sort of thing isn’t supposed to happen—there’s supposed to be at least one company that’s willing to lower its prices and steal away its competition’s customers.
But that’s not what’s happening. Instead, airlines are spending their money on buying new planes and on moves that please shareholders, such as share buybacks.
“There is not much competition left in the U.S. airline industry,” says Bilotkach. Over the past decade and a half, the industry has witnessed a ton of consolidation (most notably in mergers between Delta and Northwest, United and Continental, and American and U.S. Airways), which means that airlines are less likely to try to undercut one another on price. Yes, it’s true that a low number of carriers doesn’t necessarily imply that there’s a lack of competition—what matters is whether they’re competing on certain routes. But, Bilotkach says, it’s rare for two airlines to compete directly on a nonstop U.S. flight path.
There’s another reason that airlines aren’t competing fiercely on ticket prices: There’s a good deal of overlap in their ownership. For instance, the five biggest American fund managers together own about 17 percent of each American and Delta. As an analysis by José Azar, a senior associate at the consultancy Charles River Associates, found, ownership-overlaps like this cause tickets to be about 10 percent steeper than they would be otherwise.
Could any of this change? The Department of Justice launched an inquiry last summer (before it was clear that the precipitous fall in oil prices would last longer than a few months) into whether American airlines’ pricing decisions qualify as collusion. But to prove anything like that, federal prosecutors would need to find evidence that airlines coordinated with each other—which probably doesn’t exist. More likely, investigators will find a happily uncompetitive industry in which no formal coordination is necessary.
“There is little that the regulators could do, except for waiting for the new entry in response to the profits currently being made in this market,” says Bilotkach. What might help, then, is if U.S.’s airline industry resembled Europe’s more closely. In Europe, low-cost carriers such as Ryanair nip at the heels of large incumbents such as British Airways, making ticket prices more sensitive to major drops in operating costs. There, airlines’ margins are about half what they are in the U.S.
But it’s relatively hard for new entrants to get a foothold in the U.S.: Market share is hard to accumulate when takeoff and landing slots at major airports are in such short supply. And besides, when it comes to regulation, as The Economist pointed out, “having approved the wave of mergers, it would be a bit rich for officials to complain that there are not enough big airlines to ensure competition.” So for now it’s unlikely that airline executives will do much to lower ticket prices.