Certain airlines cutting fuel surcharges: How air ticket prices are linked to the levy

SINGAPORE - Frequent flyers hoping for months that plummeting oil prices could extend to air travel finally have something to cheer about - some global carriers have started to cut fuel surcharges.

But while the likes of Japan Airlines (JAL), Qatar Airways, Cathay Pacific Airways and Virgin Atlantic have announced reductions, others, including local carriers Singapore Airlines (SIA) and SilkAir, are not following suit.

This, despite speculation that the Benchmark Brent crude oil could fall to as low as US$40 (S$53.30) a barrel - an astonishing six-month slide of more than 60 per cent since it peaked at slightly more than US$115 a barrel last June.

Here is what you need to know about the relationship between the price of jet fuel and air ticket prices.

What is a fuel surcharge?

Carriers first started introducing fuel surcharges, which can be either embedded in the price of an air ticket or tagged on as an additional fee, in the early 2000s when oil prices were on the rise.

But this justification has been criticised as not having much relation to how much fuel actually costs. Instead, it is often used to safeguard a carrier's revenue against fare discounts and taxes.

How much does fuel surchage account for in the price of an air ticket?

The fuel surcharge, which is commonly denoted as YR (or YQ) in the fee breakdown, can potentially make up nearly half the price of an air ticket.

Airlines usually determine its fuel surcharge according to seat class, sectors and whether it is a long haul or a short haul flight.

Why does it still cost so much to fly when even the price of oil at pumps have fallen?

The growing demand for air travel sees no signs of slowing down, but one of the most common reasons for airlines not offering cheaper tickets is the practice of fuel hedging.

This means that airlines are not immediate beneficiaries of the drop in oil prices, and thus cannot pass on cost savings to their passengers.

What exactly is fuel hedging?

In order to ensure that they are not at the mercy of sharp spikes in oil prices, it is popular practice for carriers to "lock in" a guaranteed amount of fuel at a fixed price. SIA, for instance, had hedged 65.3 per cent of its fuel needs at US$116 a barrel for six months till March 2015.

And even though carriers might end up paying more than the current market price for an extended period, it gives the certainty on fuel expenditure. Analysts say the cost of fuel can account for as much as 40 per cent to half of an airline's overall operating costs.

In contrast, US Airways has eschewed hedging since 2008 because of the "volatility of fuel", likening the practice to a form of insurance that can sometimes backfire.

But there is hope that ticket prices could drop across the board in the future with recent reports stating that more airlines are preparing to hedge fuel by taking advantage of current oil prices, as European carriers look to lock in fuel costs into 2016 and beyond. Thai Airways is reportedly planning to hedge 100 per cent of its fuel purchases this year.

Why are some airlines doing away with the fuel surcharge now then?

Both Philippine Airlines (PAL) and Cebu Pacific were forced to comply by the country's Civil Aeronautics Board, which ruled that fuel surcharges could no longer be applied in light of the recent drop in jet fuel prices.

The Philippines also notably ordered 27 foreign airlines, including SIA, to scrap their surcharges for flights to the country effective from Jan 8.

JAL, meanwhile, had applied to the Japanese Ministry of Land, Infrastructure, Transport and Tourism last Dec to lower fuel surcharges in line with new per barrel fuel costs. The changes take effect for tickets issued on or after Feb 1.

Are there rules and regulations requiring airlines to align fuel surcharges with oil prices?

There is no official governing body to regulate how airlines set their fuel surcharges.

However, there have been instances of a country's aviation body stepping in to appeal for a reduction in the levy.

Are there other factors that could lead to an airline increasing or reducing its fuel surcharge?

Supply and demand for seats is usually the biggest factor - airlines have no incentive to lower prices when demand for air travel is high.

Airline costs such as travel taxes and whether it is investing in improvements to its fleet, services or facilities could also play a part.

In a New York Times article last month, the International Air Transport Association's chief economist John Heimlich said that airlines were reinvesting at the highest rate in 13 years as they capitalise on low oil prices to divert resources elsewhere.

Sources: Reuters, The Straits Times, The New York Times, USA Today, ABS-CBN.com, The Economist