President of American Airlines Says Your Ticket Prices Are Going to Go Up. Don’t Be So Sure.

American Airlines President Robert Isom told employees in a Dallas Fort-Worth question and answer forum on Friday that everyone should expect higher airfares because “in the long run higher fuel prices are passed on [to customers] through higher prices.”

American has consistently said they believe airfares rise with fuel. If fuel gets more expensive they’ll take in more revenue. And that’s one reason they don’t hedge fuel costs, when fuel cots go up is precisely when they’re best able to handle the increased expense.

Copyright vanbeets / 123RF Stock Photo

However here’s the problem American may be facing:

  • American is increasing capacity by adding seats to planes across their domestic fleet. They’re going from 150 seats on a Boeing 737 before US Airways took over to 172 seats in the latest retrofit. This is called “Project Oasis” to cram in additional seats, reduce legroom in first class even, shrink the lavatories and put in larger overhead bins. Soon the bins will be the only place on the plane
    many passengers will actually fit.
  • At the same time they’ll have more seats to sell, there may be less demand. There are people far wiser about such things than I am but there’s seems a good chance of recession starting in the next 12-18 months. We’re already in the midst of one of the longest post-World War II expansions in US history and the Federal Reserve is raising interest rates (increasing short term rates but with less effect on long term, the yield curve is flattening but has not yet inverted).
  • American’s costs will be higher (fuel), revenue may fall off through reduced demand. They’re going to have more seats precisely when they don’t need those seats. But the excess capacity could hold down fares.

Boeing 737 MAX Economy

Airfare prices aren’t set based on the average cost to fly a plane. The average cost to fly a plane sets the boundaries for how much capacity is offered, and prices are a function of passenger demand. Indeed no industry is more adept at charging different prices to different customers than airlines, segmenting passengers based on willingness to pay. It’s not as though customers overall are somehow willing to pay more to travel than they pay today and airlines aren’t charging more.

Indeed it’s the ultra low cost carriers setting the lowest prices for the most part, with the large legacies matching. That’s the entire point of the rise of Basic Economy fares, charging what the ultra low cost carriers do for tickets but segmenting customers so those who will pay more do. (Isom makes the point that fuel is a higher percentage of total costs for an ultra low cost carrier than for American, because everyone more or less pays the same for fuel while Spirit’s and Frontier’s other costs are lower.)

Rising fuel prices mean that certain routes become unprofitable. So airlines cut back on their flying, taking capacity out of the marketplace. They are less likely to experiment with new routes. They don’t compete as aggressively with each other introducing more capacity into competitor airline hubs. And fewer seats drive up prices. That’s the mechanism by which prices rise when fuel costs rise. At least that’s the expectation.

However United’s President Scott Kirby says there’s little benefit to reduced flying since they’re already paying for the planes and in many cases fully committed to pay for employee time too. So will United cut capacity?

Probably not enough to offset capacity growth at American that comes simply by virtue of more seats on the same existing planes.

Each of the large legacies will still compete with the ultra low cost carriers on the basis of price. They’ll still compete aggressively on price to fill their marginal seats. And American’s densification program, Project Oasis, means there will be more seats on each flight to sell. So will higher fuel costs lead to higher prices as American believes?