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7 CHAPTER 2 Project Overview and Motivation The fuel spike and severe recession in 2008 caused a signif- Finally, the United States entered a recession in December icant reduction in air service at many commercial service air- 2007. In that month, the average jet fuel price in nominal ports in the United States. At the peak of the spike, fuel made dollars was $2.69; the price subsequently spiked to $4.11 in up 40 percent of airline operating costs. Airports witnessed July 2008. unanticipated changes in air services, which made both cap- While the correlation between fuel price increases and major ital improvement programs and operating budgets subjects economic recessions is not surprising, the most remarkable of concern. The Airport Forecasting Risk Assessment Pro- feature of Exhibit I-3 is the substantial ramp-up in the real cost gram is designed to help airports account for the risk inher- of jet fuel beginning in approximately 2002 and continuing ent in their future air services forecasts by establishing rea- well after the economy began to rebound in 2003. From Jan- sonable confidence bands around them; an example of such uary 2002 until January 2006, the real price of jet fuel tripled. bounds is shown in Exhibit I-2. It then more than doubled between January 2006 and July 2008. The volatility in the market is illustrated by the fact that, by January 2009, the price of jet fuel had fallen by more than 2.1 Fuel Price Uncertainty 50 percent from its July 2008 peak, and in fact was at a lower and the Economy level than in January 2006. The most recent fuel spike and recession are part of a larger, longer-term story about how the economy and fuel prices can 2.2 Effects on Aviation Markets affect airport activity. Exhibit I-3 shows the history of real jet and Carriers fuel prices per gallon from 1989 through mid-2009. The prices are expressed in 2009 dollars. Also shown on the graph are Clearly there have been secular increases in the price of jet fuel vertical (red) lines indicating the months when the U.S. econ- over time, but how have they affected airlines? Exhibit I-4 illus- omy was in recession, as declared by the National Bureau of trates jet fuel consumption over some of the same time horizon. Economic Research. There were substantial reductions in fuel consumption during The U.S. economy has had three official recessions since the Gulf War (January 1992), just after the events of 9/11, and 1989. Two of them occurred contemporaneously with fuel more recently with the most recent fuel spikes. U.S. industry spikes. In July 1990, the United States entered a recession that fuel consumption reached a peak in June 2001. Consumption lasted until March 1991. In August 1990, Iraq invaded Kuwait, in November 2008 was about 10 percent lower than the peak. touching off the Gulf War. In July 1990, the price per gallon Exhibit I-5 focuses on changes in fuel prices and consump- of jet fuel was 60.3 cents; by November 1990, the price had tion in the period since January 2003. The exhibit shows year- more than doubled to $1.28 (in nominal dollars). over-year percentage changes in both fuel prices and con- The second recession took place between March 2001 and sumption measured on a monthly basis; it therefore provides November 2001. In that period, the events of September 11 a good illustration of the volatility in the marketplace. There (9/11) had very adverse consequences for the U.S. airline were clearly three fuel spikes in this five-year timeframe: in industry. However, fuel prices in this period remained rela- the spring of 2003, in the fall of 2004, and in the period begin- tively stable. Again using nominal dollars, jet fuel sold for an ning in the late summer of 2007 until the summer of 2008. average of 85.8 cents in March 2001 and sold for only 73.5 cents There is a consistent decline in consumption on a year- in November 2001. over-year basis during all three spikes. Obviously the ability of
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8 Exhibit I-2. Annual enplanements forecast the carriers to instantly change their fleets is limited, but they with confidence bands. do have the ability to change their schedules fairly quickly. Not surprisingly, whether they elect to do so or not depends on whether they believe that the price spikes are temporary or are likely to be more long term. Exhibit I-6 focuses on the run-up in fuel prices in 2007 and 2008. The lowest price in this two-year period was in Febru- ary 2007 when the price per gallon was $1.77. From that point onward, the price climbed in an almost uninterrupted fashion reaching a peak in July 2008 at $3.83 per gallon, more than double the value just 16 months earlier. The price then fell precipitously to just over $2.50 in November 2008. Exhibit I-7 shows the pattern of fuel consumption by the carriers during this same time period. Notice, first of all, that Exhibit I-3. Recession periods and real jet fuel price per gallon. 450.0 Real Cents per Gallon (YE June 400.0 350.0 300.0 2009=100) 250.0 200.0 150.0 100.0 50.0 0.0 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Month Recession Months Real Jet Fuel Price Per Gallon (2009=100) Exhibit I-4. Annualized gallons of jet fuel consumed. 20.5 20.0 19.5 19.0 18.5 Gallons (billions) 18.0 17.5 17.0 16.5 16.0 15.5 15.0 14.5 14.0 13.5 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Source: Air Transport Association
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9 Exhibit I-5. Changes in fuel prices and consumption. at every point (except February) consumption is lower in 2008 What is clear in retrospect is that there was a combina- than in 2007. The seasonal pattern of air carrier operations is tion of reduced economic growth and inflationary pressures also apparent in the chart, with summer increases in opera- caused by the fuel spike, which hit aviation both on the tions, seasonal flying during the Easter holidays in March, and demand and supply sides. Carriers faced circumstances where a significant reduction in activity beginning in September. they needed to raise prices to cover increased costs at a time Another factor present in 2008 was the rapidly deteriorat- when there was a significant deceleration in the demand for ing conditions in the credit markets, which also had adverse their services. implications for the macroeconomy. In fact, the fuel spike and Economic theory would suggest that when carriers are faced the economic circumstances may very well have been linked. with both inflationary cost increases and declining demand Higher fuel prices were suppressing aggregate demand even they would reduce operations of their least efficient aircraft while there was turmoil in the credit markets. The longer-term and perhaps downsize across at least some portion of their implications of these circumstances for aviation and for the schedule in order to match capacity to demand. Exhibit I-8 economy at large remain uncertain at this time. shows that with unemployment rising and incomes falling, Exhibit I-6. Average jet fuel price (paid) per gallon in 20072008. 390¢ 370¢ 2007 2008 350¢ 330¢ Price per Gallon 310¢ 290¢ 270¢ 250¢ 230¢ 210¢ 190¢ 170¢ Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Air Transport Association
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10 Exhibit I-7. Gallons of jet fuel consumed in 20072008. 1,800 1,750 2007 2008 1,700 1,650 Gallons (millions) 1,600 1,550 1,500 1,450 1,400 1,350 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Air Transport Association domestic seat offers per day nationwide (a key measure of air costs that are relatively low relative to their peers would fare services) did indeed fall by 7.9 percent in 2009. better in adverse economic circumstances than more expen- However, a carrier's ability to undertake a downsizing strat- sive aircraft. This hypothesis is consistent with a downward- egy would be constrained by the logistics of its own schedule sloping trend line like the one shown in the exhibit, with more as well as its financial circumstances. In some cases, carriers aircraft being removed from the fleet as aircraft become less may be forced to operate the aircraft they are best able to and less efficient (evidence of a positive premium to the aver- afford, rather than the aircraft that make the most economic age among their group). sense for their route systems. To analyze this behavior, a small Exhibit I-10 provides some additional evidence for the eco- database was developed showing the characteristics of individ- nomic hypothesis described above. Here, older aircraft are ual aircraft in U.S. carrier fleets as of the first quarter of 2008. more likely to be retired from the fleet (primarily because they As noted previously, it is expected that airlines would tend to are less efficient than newer aircraft). reduce operations of their least efficient aircraft and would Finally, Exhibit I-11 shows that a substantial percentage of remove at least some of them from their fleets in reaction to the fleet retired in 2008 was attributable to airlines that ceased the circumstance in which they found themselves in 2008. operations during the most recent fuel spike. In total, these Exhibit I-9 provides some confirmation of this hypothesis defunct air carriers, all of which are relatively small, accounted by relating the relative cost per seat to the percentage of the for approximately 20 percent of the fleet reduction. (The fleet changed in 2008. One would expect that aircraft with carriers stopping services in 2008 were MaxJet, Aloha, ATA, Exhibit I-8. Jet fuel prices and recession drive unprecedented withdrawal of domestic air service. Jet Fuel as a Percentage of Revenue Domestic Seat Offers Recession
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11 Exhibit I-9. Percentage reduction in fleet vs. relative group average seat cost (2008). Note: WB = Widebody, NB = Narrowbody, RJ = Regional Jet Exhibit I-10. Change in domestic fleet vs. year aircraft type introduced. Note: WB = Widebody, NB = Narrowbody, RJ = Regional Jet Exhibit I-11. Change in fleets due to carriers ceasing operations (2008).
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12 Exhibit I-12. Fuel cost as a percentage of revenue per available seat mile. 60% Fuel Cost as a Percentage of RASM 50% 40% 30% 20% 10% 0% 89 90 91 92 93 94 02 03 04 05 06 07 08 95 96 97 98 99 00 01 09 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q 1Q Quarters Recession Fuel Cost as a Percentage of RASM Moving Three-Year Average SkyBus, EOS, Champion, Avidwest, Vintageprops, and Gemini ing prominent rapid increases in the share of airline revenue Air Cargo.) accounted for by fuel. This illustrates the difficulty carriers may In total, U.S. carriers reduced the number of aircraft in their have in accommodating rapid changes in fuel prices, given the fleet by about 8 percent during 2008. The charts in this section fixed nature of their scheduled networks. suggest that, in general, the carriers attempted to retire the Short-term volatility, however, is not the whole story. Also least efficient aircraft, subject to the logistical and financial shown in the exhibit is a three-year moving average over the constraints they faced in their schedules and lease obligations, same time period for jet fuel prices as a percentage of RASM. respectively. Over the entire analysis period, the moving three-year average Another way to view the impact of fuel price spikes is to con- stayed below 20 percent until the first quarter of 2006. From sider the extent to which carriers are able to pass jet fuel prices that period forward there was a rapid increase, with the moving forward to consumers. This issue is taken up in Exhibit I-12, average peaking at 34 percent. which shows fuel prices as a percentage of revenue per avail- An important question for this work effort was the extent to able seat mile (RASM) over the analysis period from the first which the instability in fuel prices and the secular rise in real fuel quarter of 1989 through the first quarter of 2009. The effects prices over time have affected air services in the United States. of the fuel spike are even more apparent in this chart with the Exhibit I-13 begins to address this question for the domestic 1991 recession and the recession that started in late 2007 show- U.S. system. Found in this chart are percentage changes in Exhibit I-13. Seat offers vs. fuel as a percentage of revenue per available seat mile. 20.0% 40.0% Fuel Cost as a Percentage of RASM 15.0% 35.0% Percentage Change in Seat Offers 30.0% 10.0% 25.0% 5.0% 20.0% 0.0% 15.0% 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 -5.0% 10.0% -10.0% 5.0% -15.0% 0.0% Recession Domestic Change in Seat Offers Fuel Cost as a Percent of RASM