The oil price plunge exposes the great airline rip-off

The collapse in oil prices and fuel costs since July has been dramatic and far greater in magnitude than any analyst predicted. It has triggered sudden, seismic repercussions across all financial markets: equities, commodities and currencies.

For businesses that rely on fuel as a major input cost, the slump has been a massive and unexpected gift that will flow through to the bottom line.

Yet the stunning 57 per cent plunge in Brent crude from $107 last July to $46 now has made Qantas chief executive Alan Joyce's position on the fuel surcharge untenable.

Most industries don't try to pass on their input costs directly to their customers, but airlines in recent years have become the exception. Airlines introduced modest 'fuel surcharges' when the cost of oil wandered higher in 2004, and have kept increasing them ever since.

When Qantas introduced its fuel surcharge, the price of Brent crude was around $48 a barrel and the surcharge was about $30 on a return international flight. The surcharge was initially intended to help cover the increase in fuel prices above 'normal' levels, whatever they are.

Since then, the airline has increased the hated surcharge 13 times and only lowered it once, in 2009 after the global financial crisis, according to FuelTrac managing director Geoff Trotter.

The surcharge was last raised in July 2014 to $680 on an economy return flight to the US. Virgin charges the same. That is around one-third of the cost of the airfare. For a roundtrip to the UK, the charge is $570 at Qantas; Virgin only charges on the route to the US.

Somewhere along the way, the surcharge morphed from being a contribution towards the airlines' extra running costs into a payment for a large portion of the entire fuel bill. Analysts estimate the surcharge contributed about $1 billion to the airline's revenue last year, while the international business spent $2bn on fuel.

Qantas's original forecast last August of a return to profit in the December half included a forecast that fuel costs would be in line with the costs of the previous first half.

On December 8, Qantas lifted its first-half forecast to underlying earnings of $300 million to $350m, and said that included a $30m benefit from lower fuel prices.

It will receive a much larger boost in the second half. Some airline analysts believe that a $1 per barrel fall in oil results in a $36m lift in the airline's profit before tax.

The slide in oil prices does not directly match the decline in airlines' fuel costs. Most airlines hedge their fuel costs to some degree. For the unlucky ones that locked in a large amount of their fuel bill at oil prices much higher than the current spot rate, they could actually be losing money on the price drop. After all, $70 and $80 a barrel was looking cheap in the fourth quarter.

Singapore Airlines, for instance, is believed to have hedged at an average of $116 a barrel last year, resulting in massive losses that will be revealed in the company's results. Other airlines reported a similar outcome when oil collapsed in 2008-09 and they were hedged at higher prices.

That does not appear to be the case for Qantas, which is thought to be hedged against rising oil prices but retains exposure to price declines through the spot market.

About 70 per cent of Qantas' fuel needs will be bought at spot rates in the second half, an airline spokesman told me. “We don't disclose exact pricing of our hedging in relation to the other 30 per cent,” Andrew McGinnes added.

Curiously, Qantas said last month the decline in oil prices would need to be “sustained” to affect the fuel surcharge. Yet it last hiked the impost in July with great alacrity after a brief spike in oil in June to $111. By December 1, oil had fallen to $70 a barrel.

Virgin Australia has more long-term hedging in place, and told the AGM in November it was too early to discuss relief from lower fuel costs. A spokeswoman said the airline's fuel requirements are 72 per cent hedged this financial year.

Qantas shares more than doubled last year as its fortunes improved while Virgin shares, which are more thinly traded due to its four major shareholders holding around 80 per cent, rose a moderate 12 per cent.

Some Chinese airlines, which generally buy fuel at spot prices, have reduced fuel surcharges several times already. Some believe the competitive price pressure on airfares may eventually force Joyce's hand.