The Cost of Fuel Challenges Recovery

Posted: April 23, 2012 in Current Affairs, Economics

US Airways may be about to buy American Airlines, a combination of two ailing commercial carriers that says much about the future of aviation across the globe.  Increases in crude oil prices and highly competitive markets where it is nearly impossible to raise fares enough to cover costs, is driving consolidation that has already touched Delta and Northwest, United and Continental.

While headlines advertise increasing petroleum supplies through new drilling techniques, increased global demand from emerging countries like China and India for fuels to power their economies, keeps supply tight and prices high.  While supply has increased somewhat there are two issues that make these increases hard to be felt.

First, newer extraction techniques are expensive and the costs have to be passed on to the consumer, which makes for more abundant and more expensive liquid fuels across the global economy.  That means no real net gain, especially for airlines, which are constrained in what they can charge.

Second, while supply is up somewhat, demand still far outstrips supply leading the U.S. to continue importing.  In the recent past the U.S. produced 4.95 mbpd (million barrels per day) with demand of 19.5 mbpd.  Today increased drilling and extraction enhancements yield 5.75 mbpd, but while production is marginally improving, the decline in demand brought on by the prolonged economic slump that began in 2008 has done more to move the numbers together than any improvement in extraction techniques.

To net it out, production may be up but it still does not meet demand, and in a healthy economy demand rises.  So there’s little if any good news on the energy front, which helps explain why airlines are merging.

My prediction is that once the mergers are complete we will see a round of fare increases and reduction in service.  First to go will be some of the ultra convenient commuter routes like Boston to New York or to Washington.  There are short haul flights like these all over the map but the cost of seats will soon make alternatives like trains and driving look inviting.

My kids go from Boston to New York all the time for a one-way fee of $15.  There is a certain stigma associated with bus travel but an enterprising transportation company could easily put together service for, say four or five times that fee thus reducing demand from students and producing an environment that business people can embrace.  That would include wireless services but so what?  That technology is already widely available.  And compared with Trains and planes, busses look pretty good from both a cost comparison and a door to door view.

Last point, four dollars appears to be a threshold that the economy doesn’t pass easily.  When liquid fuels like gasoline get to that point the economy goes into slow down mode.  This is not surprising.  It means that we need alternatives to expensive carbon inputs throughout the economy.  It can start with business travel.

So, what did you think?

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