As Oil Prices Fall, Airfares Still Stay High
New York Times, 23 March 2015
Just over two years ago, one of the nation’s airline trade organizations called the industry “hypercompetitive” and declared “airfare remains a bargain.” At the time, the Justice Department was weighing the competitive implications of a merger between American Airlines and US Airways, around two years after the merger of United and Continental. Fast-forward to the present.
Far from “hypercompetitive,” the airline industry is increasingly looking like an uncompetitive oligopoly.
For proof, look no further than airline ticket prices.
Over the last year, oil prices have dropped by more than 50 percent. Motorists filling up at their local gas stations know that prices at the pump have dropped precipitously.
But consumers who have logged on to Expedia or Priceline or Kayak recently to book tickets saw that airfares had not dropped along with oil prices, an airline’s largest expense.
The answer is that mergers over the last several years have left the nation with only four main airlines — Delta, United, Southwest and American-US Airways — which deliberately don’t compete on some routes.
For shareholders, the industry is finally paying off as an investment after years of losses. But for customers, not so much.
Airline executives insist that the industry is as competitive as ever and that they are just more “disciplined” about pricing and investing in routes. The airlines like to say that they haven’t lowered prices because there is so much demand and so little capacity, an industry term that means available seats. They also point to hedging contracts for oil that they entered into last year, which locked some of them into paying higher prices for fuel. And they say they are investing heavily: American Airlines, for example, is investing $2 billion in its fleet. Delta, too, is upgrading many of its planes.
All of that is true to some degree.
But in a truly competitive marketplace, airlines would add capacity to popular routes where they saw the opportunity to undercut a competitor. And given low oil prices, you would imagine that at least one airline would lower its rates to pick up market share and make it up in volume.
American Airlines, for example, doesn’t hedge its fuel costs, so it would arguably be well positioned to pick up business from its rivals. But it hasn’t tried.
“The idea that U.S. airlines would, once again, devolve into a war for market share is founded on a misunderstanding of the new structure of U.S. airlines,” Vinay Bhaskara, an industry analyst, wrote in Airways News. “We are unquestionably living with an air travel oligopoly.”
He added: “Remember, this is the same management group that (instead of allowing passengers to reap a modest reduction in fares) responded to the F.A.A.’s inability to collect taxes in mid-2011 by gleefully raising base fares to where total out-of-pocket costs were exactly the same (earning a windfall of $28.5 million per day).”
Such behavior is only possible either in an industry with very little competition or one in which members seem to actively avoid it. The cost of air travel has drawn the scrutiny of Senator Charles E. Schumer, Democrat of New York. “At a time when the cost of fuel is plummeting and profits are rising, it is curious and confounding that ticket prices are sky-high and defying economic gravity,” he declared in a statement in December. “The industry often raises prices in a flash when oil prices spike, yet they appear not to be adjusting for the historic decline in the cost of fuel; ticket prices should not shoot up like a rocket and come down like a feather.”
He urged the Justice Department and the Transportation Department to investigate immediately why airline profits are not being passed down to consumers more efficiently. So far, his call for an investigation seems to have gone unheeded. The Justice Department sent a letter to Senator Schumer contending that the merger of American Airlines and US Airways — which it approved contingent upon some divestitures — has led to benefits for consumers through “lower prices and increased service.”
That’s an odd statement because the Justice Department originally sought to block the deal based on evidence that the industry was already seeking to avoid competition. “If, for example, United offers nonstop service on a route, and Delta and American offer connecting service on that same route, Delta and American typically charge the same price for their connecting service as United charges for its nonstop service,” the government found. “As American executives observed, the legacy airlines ‘generally respect the pricing of the nonstop carrier [on a given route],’ even though it means offering connecting service at the same price as nonstop service.”
Senator Schumer, responding to the lack of action in Washington, said in a statement, “The fact that airfares are still at 30,000 feet and climbing, despite the stable gas prices and rising airline industry profits, is extremely troubling, and the federal government has more work to do.”
According to the International Air Transport Association, the industry in the United States is set to post “net post-tax profits” of $13.2 billion in 2015, up from $11.9 billion in 2014. That forecast, however, was based on an average cost of $85 a barrel for Brent crude oil. Today, the price is about $55 a barrel.
American Airlines predicts a pretax profit margin of 12 to 14 percent for the first quarter, and Delta forecasts an operating profit margin of 11 to 13 percent.
There is some hope for a drop in ticket prices this year. The transport association forecast prices will fall about 5 percent globally, though that is still woefully short of the drop in fuel prices.
No one wants to return to the damaging days of an unprofitable airline industry, but those days were largely the result of a free market run amok. Now we might have an oligopoly run amok. With little incentive for new entrants and entrenched players owning most of the main routes, it is hard to argue that much competition exists.
On the few competitive routes that the airlines pursue for market share reasons or to serve their hub-and-spoke model — New York to Los Angeles, for example — prices have remained relatively constrained. Meanwhile, in the front of the planes on those routes, the top airlines have been racing to offer the best lie-flat beds. They advertise full pages in entertainment trade publications like The Hollywood Reporter.
Now that’s a competitive spirit. Too bad it is unlikely to spread to the rest of the country.