Oil Prices and Airlines Industry in India

The first five years of the 21st century have brought a great deal of turmoil and instability to the global oil market. In November 2001, oil prices stood at under $20 a barrel. By April 2006, they crossed the $75 mark. Many reasons brought to the steep rise in oil prices among them growing demand in developing Asia, lack of sufficient investment, terrorism and political instability in several oil producing countries, fear of military confrontation with Iran and increased hurricane activity in the U.S. This sudden rise in oil prices has already taken a toll on the global economy. The International Monetary Fund suggests that the recent oil price increases were the primary factor behind the decline of global GDP growth by 0.7–0.8 percentage points in 2005–06 relative to 2004. While oil prices impact global economy at large they impose a particular burden on energy intensive industries like the transportation, airline and petrochemical industries. The big question is whether the oil market is suffering a temporary disruption or whether we are at the outset of a new era in which oil output is nearing its peak and will no longer be sufficient to meet global demand.

Governmental and multinational organizations tasked with projecting energy prices are also showing signs of pessimism. In its World Energy Outlook through 2030 the International Energy Agency, raised its long-term forecast for oil prices by as much as one-third and painted a pessimistic picture of the future economy if the industrialized world does not begin to wean itself off oil.

The Energy Information Administration of the U.S. Department of Energy came to a similar conclusion. It projects that oil prices will remain well above $50 a barrel for the next 25 years. This is a sharp shift from its 2005 projection that real oil prices will decline to $31 a barrel by 2025. The reason for the shift is a growing realization that OPEC oil producers are not likely to pump as much as oil as previously projected to meet growing demand. There are those who see an even bleaker future. Goldman Sachs Group predicts that the decline in supply of cheap oil will bring crude prices to $105 a barrel by the end of the decade.

Optimists, on the other hand, point out that some experts have been predicting a scarcity of oil for nearly a century -- and yet the oil keeps coming. They hold that the combination of today's high oil prices and improved extraction techniques means that the break-even point for exploiting harder to extract oil is getting ever closer. June 2005 study by Cambridge Energy Research Associates (CERA) projected that significant oil supply capacity of as much as 16 million barrels per day will be coming on stream by the end of the decade. They also assume that all this anticipated extra supply will drive oil prices back to the mid-$30s. Forecasting future oil prices has always been a tough challenge. The reason is that most of the world’s oil reserves are concentrated in the hands of governments which provide very little access to their field by field reserve data and, even worse, resist privatization of their oil industry and foreign investment in their countries. One thing both pessimists and optimists agree on is that the coming years will bring significant price instability, stemming from the fact that the market lacks sufficient liquidity. Until 2003 the global oil market enjoyed a large amount of spare production capacity: the ability of some producers, primarily Saudi Arabia, to inject extra oil into the market in the event of supply disruption. Due to growth in demand in developing Asia this spare capacity has been eroded from about 5.5mbd in 2002 to less than one million barrels per day today. Little spare capacity means the full burden of sudden shortages or supply disruptions is reflected in current spot prices.

Fuel price increases have a particularly adverse impact on airlines because even in good time fuel costs constitute roughly 10-12% of our operating expense. Every penny increase in the price of jet fuel costs the airline industry $180 million a year. In the absence of pricing power – the ability to pass these costs along in the form of higher airfares – these increases come right off the bottom line.

An even more pernicious aspect of the fuel price increase is the relationship between the economy and air travel. The link between fuel prices and the health of the economy is clear. Three of the major recessions of the past thirty years can, in large measure, be attributed to the steep increases in fuel prices that accompanied the 1973 Middle East oil embargo, the 1980 Iran Crisis, and the1990-91 Gulf War. The airline industry is inextricably tied to the overall economy – even minor recessions result in reduced demand and increased sensitivity to prices for leisure as well as business travelers.
Past fuel spikes and attendant recessions have brought about widespread hardship in the airline industry. As shows, airline profitability suffers as a direct consequence of a weakening economy. During the first Gulf War, almost half of the major airlines filed for protection under Chapter 11 of the Bankruptcy Code, long-standing airlines went out of business, more than 100,000 airline employees lost jobs, and the industry went into a financial tailspin from which it took years to recover.

We all have much at stake – it is not simply a matter of airline finances; it is the national economy. Civil aviation has a profound impact on the U.S. economy. A recently completed analysis performs by DRI-WEFA found that in calendar 2000:
• Civil aviation’s total impact on the U.S. economy amounted to 9 percent of GDP.
• $343 billion and 4.2 million jobs were produced in civil aviation or in industries related to civil aviation such as travel and tourism.
• Combined direct, indirect, and induced economic impact of civil aviation totaled $904 billion and 11.2 million jobs.
Unquestionably, the financial situation of the airlines has had a negative effect on the U.S. economy. Of the jobs lost in the United States since 9/11, fully half – 462,000 jobs according to the Bureau of Labor Statistics – have been in the travel and tourism sector. As airline pain spreads, communities across the country are rapidly affected. Forced contraction in the industry means less service or no service to some communities, increasingly isolating them from the economic mainstream. The adverse impact on consumers and the broader economy is extensive.


Aviation Industry in India is one of the fastest growing aviation industries in the world. With the liberalization of the Indian aviation sector, aviation industry in India has undergone a rapid transformation. From being primarily a government-owned industry, the Indian aviation industry is now dominated by privately owned full service airlines and low cost carriers. Private airlines account for around 75% share of the domestic aviation market. Earlier air travel was a privilege only a few could afford, but today air travel has become much cheaper and can be afforded by a large number of people.

The origin of Indian civil aviation industry can be traced back to 1912, when the first air flight between Karachi and Delhi was started by the Indian State Air Services in collaboration with the UK based Imperial Airways. It was an extension of London-Karachi flight of the Imperial Airways. In 1932, JRD Tata founded Tata Airline, the first Indian airline. At the time of independence, nine air transport companies were carrying both air cargo and passengers. These were Tata Airlines, Indian National Airways, Air service of India, Deccan Airways, Ambica Airways, Bharat Airways, Orient Airways and Ministry Airways. After partition Orient Airways shifted to Pakistan.

In early 1948, Government of India established a joint sector company, Air India International Ltd in collaboration with Air India (earlier Tata Airline) with a capital of Rs 2 crore and a fleet of three Lockheed constellation aircraft. The inaugural flight of Air India International Ltd took off on June 8, 1948 on the Mumbai-London air route. The Government nationalized nine airline companies vide the Air Corporations Act, 1953. Accordingly it established the Indian Airlines Corporation (IAC) to cater to domestic air travel passengers and Air India International (AI) for international air travel passengers. The assets of the existing airline companies were transferred to these two corporations. This Act ensured that IAC and AI had a monopoly over the Indian skies. A third government-owned airline, Vayudoot, which provided feeder services between smaller cities, was merged with IAC in 1994. These government-owned airlines dominated Indian aviation industry till the mid-1990s.

By 1995, several private airlines had ventured into the aviation business and accounted for more than 10 percent of the domestic air traffic. These included Jet Airways Sahara, NEPC Airlines, East West Airlines, ModiLuft Airlines, Jagsons Airlines, Continental Aviation, and Damania Airways. But only Jet Airways and Sahara managed to survive the competition. Meanwhile, Indian Airlines, which had dominated the Indian air travel industry, began to lose market share to Jet Airways and Sahara. Others players include:

Air India
Air India's is one of the older airlines in India worldwide network today covers 44 destinations by operating services with its own aircraft and through code-shared flights. Important destinations covered by Air India are Bangkok, Jakarta, Kuala Lumpur, Osaka, Singapore, Tokyo, Seoul, Nairobi, Frankfurt, London, Paris, Birmingham, Abu Dhabi, Bahrain, Doha, Dubai, Jeddah, Muscat, Riyadh, Kuwait, Los Angeles, Chicago, Newark, New York, and Toronto.

Air India’s fleet consists of thirty eight aircrafts. These include 12 Boeing 747-400, 1 Boeing 747-400, 2 Boeing 747-300, 19 Airbus 310-300, and 4 Boeing 777-200.

Jet Airways
Jet Airways is one of the premier private airlines in India. Jet Airways operates over 320 flights daily to 43 destinations in India and currently controls about 40% of India's aviation market. Jet Airways became the first private airline of India to fly to international routes. Jet Airways has won many awards in recognition of standards of its service and has also received the ISO 9001:2000 standards certification for its In-flight Services and has set high standards for Airlines in India.

Kingfisher Airlines
Kingfisher Airline is a private airline based in Bangalore, India. The airline is owned by Vijay Malaya. Kingfisher Airlines started its operations on May 9th, 2005 with a fleet of 4 Airbus A320 aircrafts. The airline currently operates on domestic destinations and is one of the most aggressive players among the airlines of India.

Indigo presently has a fleet of four aircrafts and plans to expand its fleet and network in a phased manner. By the end of 2006, Indigo is aiming at 6 aircrafts and 12 cities and has plans to expand its fleet to 15 by December of 2007. Indigo has proposed to serve around 30 Indian cities with a fleet of 40 Airbus A-320s by 2010. Indigo will have fleet of only one type of aircraft, the Airbus A-320 that has a capacity of 180 passengers.

Air Deccan
While some of them like Jet and Sahara survived, others like NEPC, VIF and Eastwest closed down. There were attempts made by the TATAs to start their own airline, but it never really took off. As all the private airlines were also full service carriers, the quality of service was appreciated but they really did not raise any eyebrows.But all this changed with the coming of the India’s first low cost airlines- AIR DECCAN. This truly revolutionized the Indian aviation sector. All of a sudden, for many Indians air travel became a reality

Today, Indian aviation industry is dominated by private airlines and these include low cost carriers such as Deccan Airlines, Go Air, and Spice Jet etc, who have made air travel affordable.

Air Deccan is the first airline in India to operate as full low cost carrier. It is a part of Deccan Aviation Private Limited, India's largest private heli-charter company.

Presently, Air Deccan covers 57 destinations in India, which is more than any other airline in India. The success of Air Deccan charged the scenario of the Indian aviation sector. This was the time when shift occurs from luxury and premium segment to low cost airlines. Within a short period of time, a number of low cost airlines have taken steps to take to the skies .Charismatic Chairman of UB Group, Vijay Malaya, launched his own low cost airline under the brand kingfisher.

Though tipped as a low cost airline, Kingfisher is trying to create a segment of its own. The average price of the airfare is slightly above Air Deccan, but way below the full –cost carriers. Kingfisher Airlines seems to be targeting the upper middle class segment, which does not want to travel by first a/c train, but wants to travel by air.

Targeted primarily at the middle-class or train traveler, the question in point is will this concept be feasible for the Indian business traveler? The answer is yes due to varied reasons. Firstly, there is a visible trend both globally as well as on the Indian scene, where corporations are becoming more aggressive in cutting travel expenses and the service gap narrows between big traditional airlines and `discounters.' Secondly, the primary objective of LCC was and remains faster connectivity at a cheaper price - to transport a passenger from point A to B in the shortest possible time at the most affordable price, which means no in-flight services, no cabin crew to welcome you aboard or serve hot towels, no piping hot meals and no posh interiors. Travel experts also point to the fact that employers that never seriously considered low-fare carriers are making it easier book on them.

Other low-cost airlines include Airone and Visa, to be started by former Indian Airlines Pilots, Spice Jet, owned by US-based Royal Holdings limited and Go Air by Nusli wadia of Bombay Dyeing. Modiluft is also reappearing in a new avatar as Royal Airlines .These airlines will definitely increase competition in the discount air travel segment and one can see the prices falling still further. Even if the margins are thin, these airlines are perhaps betting on the potential for air travel in India.

When talking about discount airlines, the international cannot be left out .Air India has recently started Air India express are at least 25% lesser than the full service providers. The flight connects India to destinations in the Middle East and South East Asia. This sector has a large migrant population and it is hoped that this carrier will help his traveler .But Air India Express cannot rest for long, Australian Qantas and other foreign airlines are planning to connect Indian cities with their own discount carriers.
Hence, the Indian civil aviation sector is witnessing an unprecedented growth with a host of private airlines taking to the skies. This has altogether refined the way people in India travel. More and more middle-income class travelers are preferring aircraft to trains. As the prices of airfares drop and increasing number of people travel by air.

Fig 1.
One more factors that caused shift to low cost airlines were airline fares and railway fares were almost same.

Until recently, air travel across India was only for businessmen and women, foreign tourists, and visits home from the country's vast diasporas. Fares were prohibitively expensive and the middle class travelled on the British Raj's most visible legacy: the railways.

But a booming economy, a congested and crumbling train network and the emergence of low-cost carriers have meant a slice of Indian society taking to the skies for the first time. With half-a-dozen airlines planning to launch in the next year, fares have tumbled - and more than a third of the seats will be filled with first-time flyers. Three years ago a return ticket from New Delhi, India's capital, to Mumbai, the country's financial hub, was fixed at 20,000 rupees (£250). Now travelers who book online can get a ticket for 450 rupees. Also, towns which used to be connected only by slow train services or potholed highways have been linked by a series of airstrips unused since the end of the Second World War.

In 24 months, Air Deccan has revolutionized Indian air travel. Last year it carried 1 million passengers, this year that figure will reach 4.4 million. With 35 destinations, the fleet is already stretched and the company has ordered a further 62 aircraft.

Pilots' salaries are also airborne as new airlines try to secure experienced staff. Poaching is commonplace. "The best-paid pilots are working for the newest airline, Spice Jet," said Yajvendra Chaturvedi, a pilot with Air Sahara. "There the take-home pay is 340,000 rupees a month (£4,250). I have had a pay increase of 40% this year because we just don't have enough people with enough experience in India."

In the country's hinterland there has been a scramble to attract airlines to smaller industrial centers, which say businesses will only relocate if there are decent transport links.

Although India has a fraction of the flights available in the US, the rise in greenhouse emissions is a cause for concern. Rail travel produces two-thirds of the carbon dioxide emitted by planes. The 140-mile trip between Chandigarh, the capital of Punjab, and Delhi, if made by airline, would see 57kg of CO2 sent into the upper atmosphere. The same journey by train produces 38kg.
The following data will give a clear picture of shifting of people from railways to airlines:

Routes Jet Airways Indian Airlines Air Deccan Rail II AC Rail I AC
Hyderabad Bangalore 4700 4705 2375 1211 2286
Mumbai-Goa 3405 3410 2315 1232 2345
Chennai-Banglore 3325 2905 1755 747 1402

Routes Jet Airways Indian Airlines Air Deccan Rail II AC Rail IAC
Hyderabad Banglore 2819 916 1566
Mumbai-Goa 3118 1012 1732
Chennai-Banglore 1816 592 1009

Routes Jet Airways Indian Airlines Air Deccan Rail II AC Rail IAC
Hyderabad Banglore 3749 3675 3603 1026 1716
Mumbai-Goa 3877 3782 3987 1092 1832
Chennai-Banglore 3278 3975 3228 662 1109

The Looming Oil Crisis
The world oil market was characterized by strong demand growth that began in
2003 and continued through 2004 and into 2005. As a result of this growth, and the
resulting high prices, consumers’ budgets were under pressure, the profits of energy
producers were up, and consuming nations again had to face the economic and
political costs of dependence on imported oil.

The Hubbert Peak Theory states, that since oil is a nonrenewable resource, we are slowly going to suck the Earth dry, of its conventional oil. This theory also states that United States' oil production would peak between 1965 and 1970. After these peaks, oil production slowly declines, until there is none left for us to extract. Due to lower quality in oil being extracted from the Earth, oil is becoming increasingly difficult to refine, and is almost using more energy to refine it than the actual production. "The oil- rig count over the last 12 drilling years has reached bottom. This is not because of low oil price. The oil companies are not going to keep rigs employed to drill dry holes. They know it but are unable ... to admit it. The great merger mania is nothing more than a scaling down of a dying industry in recognition that 90% of global conventional oil has already been found." This quote, although outdated clearly states that oil is gradually coming to its depletion.

Crude Oil Prices In The Market
Crude oil prices behave much as any other commodity with wide price swings in times of shortage or surplus. The crude oil price cycle may extend over several years responding to changes in demand as well as OPEC and non-OPEC supply. Reflecting increases in consumer demand for petroleum products, world crude oil demand has been growing at an annualized compound rate slightly in excess of 2 percent in recent years. Demand growth is highest in the developing world, particularly in China and India (each with a population in excess of 1 billion) and to a lesser extent in Africa (0.8 billion) and South America (0.35 billion). Where high demand growth exists it is primarily due to rapidly rising consumer demand for transportation via cars and trucks powered with internal combustion engines.

Trend in Global Oil Prices.
Projections made by the World Bank show that double-digit growth in oil prices is now
set to continue into the third consecutive year. Average crude oil price, which went up by 16.1% in 2003 and by 30.4% in 2004, is projected to increase by 11.4% in 2005 to $ 42 per barrel of crude.

The graph above shows that the oil prices took a dip during the period of 1980-1990 as huge oil reserves were found in Alaska and In some parts of Africa. Due to the Iraq war during the 1991-92 phase there was a rapid increase in the world oil prices. Further sanctions imposed by U.S.A and other countries on the Middle east countries led to further increase in oilprices. World distillation capacity rose 81% from 47,049 TBD in 1970, to 85,304 TBD in 2007. However, distillation capacity increased only 6.7% between 1980 and 2007.(16) It is interesting to note that the EIA reports 2007 distillation capacity of 85,304 TBD, which factoring-in demand growth, is roughly in-line with 2004 consumption of 82,594 TBD (post-2004 consumption data is not available yet.

Change in Prices of Crude Oil through the World
Year Average Crude Oil Prices ($/bbl) Average Crude oil Prices (in Real $ terms at 1980 Price /Barrel)
1980 36.9 36.9
1990 22.9 22.9
2000 28.2 123.4
2001 24.4 106.4
2002 24.9 109
2003 28.9 126.3
2004 37.7 164.9
2005 42 191.9
Table 1

Graph 1

Growth of Global Demand for Oil :
Growth in demand for oil has not always gone by the projections. For instance in 1997
the sharp and unexpected slowdown in Asian economies coincided with an increase in
OPEC production targets and prices fell by more than half between early 1997 and early
1999 (from almost $ 25 to $ 10). In 2004 the International Energy Agency has to revise upwards its estimates for global oil demand by over 3 million barrels per day, one of the largest margins in recent decades.

This was mainly because of the strong demand for oil in China and the United States. China and the United States account from around 44% of the incremental increase in global oil demand between 1995 and 2004.

Growth of Global demand for Oil ( Country Specific)
Country 1995 2000 2005 Share of Incremental Demand % (1995-2005
U.S.A 18 20 20.5 19.9
China 3.3 4.6 6.3 24.3
India 1.7 2.3 2.5 6.5
Dynamic Asia 3.7 4.3 5 9.8
OECD 26.9 27.8 28.8 15.7
ROW 16.2 17.3 19.1 23.7
Total 69.8 76.2 82.2 100

Table 2

Graph 2

India’s crude oil reserves have declined and then improved marginally close to previous
levels in the most recent years. Total crude oil reserves were estimated at 733 million
tons in 2003-04.Total crude oil production in 2003-04 was 33 million tons while imports was as high as90 million tons. The average annual rate of growth of crude oil production in the country over the last 6 years was a negative 0.2%.There was a spurt in import of crude oil in 1999-00 and 2000-01 mainly on account of a very large refinery set up in the private sector(Reliance Petroleum Limited). Imports of crude oil have fluctuated in the 4-10% range over the last few years.

Trends in growth of crude oil reserves, production and imports (%)
Year Crude oil reserves Crude oil Production Net Crude oil Imports
1998-99 -4.1 -3.4 15.4
1999-00 -7.8 -2.4 45.2
2000-01 6.5 1.5 28.2
2001-02 4.1 -2.4 6.2
2002-03 1.1 3.2 4.2
2003-04 -0.9 1.0 10.3

Table 3

Graph 3

Estimates of demand elasticity of oil are very sensitive to the assumption made. Long run demand elasticity is generally higher than short run elasticity. As indicated in table below the long run elasticity of demand are very wide and vary between OECD countries and developing countries.

Developing countries have lower price elasticity and higher income elasticity, particularly the fast growing economies this is because oil is a necessary commodity and there is no good substitutes for it. As per the income elasticity is concerned, as the incomes of consumer increases he/ she moves from one income group to a higher income group and gets a car or a vehicle for himself and as a result the per capita oil consumption increases.
There is also evidence that oil demand may become less sensitive to income levels as
Income elasticity in the post 1986 period have been lower than those for a longer period.

Price Elasticity and Income Elasticity Of Different Countries
Country Thousand barrels daily per 10000 people in 2006 Thousand barrels daily per 10000 people in 2004 Purchasing Power Parity (per US Dollar) of 2006 Purchasing Power Parity (per US Dollar) of 2004 Per Capita GDP(US Dollars at international prices ∆q/∆p ∆q/∆i Price elasticity (∆q/∆p) *(p/q) Income Elasticity (∆q/∆i) *(i/q)
New Zealand: 0.374 0.354 2.478 2.3541 12169 0.10 0.16 0.1817 1.0695
0.347 0.312 0.5813 0.5638 2671 0.18 2.00 0.3608 3.3504
Canada: 0.672 0.598 0.4544 0.4362 630 0.38 4.07 0.3980 2.7520
0.348 0.325 2.3 2.231 2371 0.12 0.33 0.2276 2.2030
0.073 0.052 0.8603 0.8324 980 0.11 0.75 1.2989 8.8703
0.326 0.304 1.9467 1.9173 630 0.11 0.75 0.23277 4.4684
0.318 0.295 0.4904 0.4682 2344 0.12 1.04 0.25077 1.5977
0.385 0.358 0.2742 0.265974 3446 0.14 3.28 0.24258 2.3376
0.136 0.098 0.5739 0.5648 1684 0.20 4.18 1.24720 17.621
0.308 0.276 2.545 2.472 11256 0.17 0.44 0.37292 3.6221
0.228 0.203 4.69 4.432 10204 0.13 0.10 0.39611 1.9932
Korea, South:
0.469 0.392 3.761 3.543 1342 0.40 0.35 0.63180 2.8324
0.024 0.014 6.075 5.864 830 0.05 0.05 2.29747 11.996
0.018 0.007 0.7241 0.683 6740 0.06 0.27 5.05444 10.766

Table 4

Graph 4

Problems Facing the Global Oil Industry:

Growing Demand:
The main consumers of oil will continue to be the advanced economies; the U.S,OECD Europe, and Japan together consume about half of global annual oil output. But during the course of the coming two decades, the developing Asian countries are projected to grow at a rate several times faster than those of the industrialized world. China’s GDP growth is expected to grow at nearly 6% per year, compared with 1.7% for Japan, 2.2% for Europe, and 2.9% for North America.8 When it comes to oil, rapid economic growth in China and India,together a third of humanity, has caused in recent years what can be viewed as a demand shock. China’s automobile market demonstrates the degree of the challenge humanity is facing. In 1994, there were 9.4 million vehicles on the road in China. In 2004, there were 28 million vehicles. In 2020, the Chinese government predicts, there will be 140 million. Barring a policy shift, most of these cars will operate primarily on petroleum products. As a result of its growth, China became in 1993 a net oil importer and since then its oil consumption has grown by leaps and bounds. China recently surpassed Japan as the No. 2 oil consumer behind the U.S. Its demand for oil is projected to grow at a rate of 500,000 barrels per year in comparison to U.S. demand growth of approximately
200,000 barrels per year.

Constrained supply:
The projected increase in world oil demand would require in the next 25 years an increment to world production capability of close to 40 mbd relative to today’s level. This figure only represents the net addition. The gross addition will have to be far higher as it includes the need to replace depleted oil which today stands on 5%. To meet 2010 requirements of some 94 mbd entails a net new capacity of 8mbd plus replaced depletion of 22mbd. This adds up to a total of 30mbd of new oil not currently available, equivalent to the total amount of oil currently produced by OPEC.

All this begs for a rapid increase in new supply. In the past decade non-OPEC suppliers, despite the fact they account for under a third of the world total reserves, provided additional supply far above their relative share. They were able to do so primarily because they pump at an unregulated pace and are not subject to production quotas. But it is not clear whether non-OPEC production is sustainable. Exploration, development, and production costs in non-OPEC countries are much higher than in OPEC countries and the reserve-to-production ratio -- an indicator of how long proven reserves would last at current production rates -- is far smaller than OPEC’s. Exxon Mobil Corporation has estimated that
non-OPEC production--this includes Russia and West Africa--will peak within a decade.10 At that point, there will be little easily recoverable oil left outside of the Middle East. This means that over the next two decades the call on OPEC will be significant, requiring that it more than double its output. It is very unlikely that OPEC members would be able to step to the plate with such huge quantities of oil. The Saudis claim they could raise output from 9.5mbd today to 12.5mbd by 2009 and to this end they are planning to increase the number of their drilling rigs from 55 in 2004 to 110 in 2006 but it is not clear how successful they will be insustaining such level of production.

Factors affecting Oil Prices:

Few years ago air travel was a dream for an average middle class income group. Middle class income group constitute for the major portion of the population in India. They preferred railways to airlines due to sky high prices charged by the airlines. But all this changed with the launch of the India`s first low cost airlines. The airfares were of low cost carriers were affordable to the fast growing middle class income group.

India witnessed record 9.4% GDP growth in FY07, and has continued the strong growth by recording 9.3% growth in Q1FY08, characterized mainly by strong performance in industry and service sectors. Explosive growth in wages during this period has led to significantly higher disposable income, bringing about a distinct change in the lifestyle of the middle and upper class population, which essentially is the target market of the aviation sector.

We have studied the effect of Crude oil price increase in the budget line of the consumer. Let us first analyse the time series graph of the Crude Oil Price .

Crude Oil Price (2005-2008)
Year $/Barrel
2005 54.99
2006 62.11
2007 66.40
2008 110.94

Table 5

Graph 5

The crude oil price in the above graph clearly depicts the increase in the price of the oil over the period of time. The price of the crude oil in the year 2008 is almost twice that of the year 2005.This lead to the tremendous increase in the price of the Air Turbine Fuel in India.

Monthly Average Crude Oil Prices for the Year 2008
Month $/barrel
January 08 86.20
February 08 87.92
March 08 97.46
April 08 104.31
May 08 117.40
June 08 137.34
July 08 135.62
August 08 116.82
September 08
(as on 5.09.08) 115.46

Table 6

Graph 6

In the year 2008 there has been huge fluctuation in the Crude Oil Price which in turn has increased the Aviation Turbine Fuel in India. Aviation fuel in India has tripled over the past three years and now is the most expensive in the world—80% higher than in most countries, including the U.S. and Britain. That is in large part because of high federal and state government levies, including 15% oil marketing charges charged by India's state-run oil companies. Indian carriers and foreign airlines that refuel in India must buy oil from Indian Oil, Hindustan Petroleum, and Bharat Petroleum. Indian government allows the oil companies to charge the airlines higher prices to make up for the fuel subsidies that the state-owned oil players are forced to offer the public for cooking oil, gasoline, and diesel. As a result, fuel accounts for nearly 50% of the operational costs of the Indian airlines, compared to a global average of 23%.

ATF PRICE IN INDIA (Rs/Kl)-Indian Oil Corporation
Month\Year 2005 2006 2007 2008
January 26464.03 35065.47 39013.31 47045.16
February 26535.07 36214.67 35078.99 46233.36
March 26414.03 35957.79 35740.85 48655.23
April 31388.03 36863.63 37364.45 55191.58
May 33889.24 41027.79 38690.39 60468.28
June 30644.44 41784.90 37973.30 68626.89
July 32550.75 42731.31 39062.46 71630.53
August 33145.64 43826.43 40388.40 73673.56
September 35687.99 45529.95 39441.30 61834.81
October 37417.95 41703.79 41105.49
November 36714.91 38323.79 42796.74
December 32564.27 37363.88 49061.13

Standard Deviation 3868.15 3481.86 3656.38 11320.47
Average 31951.36 39699.45 39643.07 59262.16
Percentage Change 24% -0.14% 49%
Max. for the year 37417.95 45529.95 49061.13 73673.56
Min. for the year 26414.03 35065.47 35078.99 46233.36
Range 11003.92 10464.48 13982.14 27440.2

From the table 7 the following observations are made
1. The average price of ATF in the year 2006 & 2006 is almost the same.
2. The percentage increase in the ATF in the 2008 is nearly 50% compared to 2007.
3.High fluctuations in the price of the ATF in 2008 is observed by high standard deviation value
For that year.
4.Year 2008 accounts for the maximum increase in ATF which is observed by the range.
5.The difference in the maximum ATF for the year 2007 & 2008 is Rs.24,612/Kl

Graph 7

The following are the comparison of railway and airfares for the year 2005,2007 and 2008.

Year 2005
Routes\Operators Jet Airways Indian Airlines Air Deccan Rail II AC Rail I AC
Hyderabad Banglore 4700 4705 2375 1211 2286
Mumbai-Goa 3405 3410 2315 1232 2345
Chennai-Banglore 3325 2905 1755 747 1402

Year 2007
Routes\Operators Jet Airways Indian Airlines Air Deccan Rail II AC Rail IAC
Hyderabad Banglore - - 2819 916 1566
Mumbai-Goa - - 3117 1012 1732
Chennai-Banglore - - 1816 592 1009

Year 2008
Routes\Operators Jet Airways Indian Airlines Air Deccan Rail II AC Rail IAC
Hyderabad Banglore 3749 3675 3603 1026 1716
Mumbai-Goa 3877 3782 3987 1092 1832
Chennai-Banglore 3278 3975 3228 662 1109

Table 8

Graph 8

Input: 2005 2007 2008
I= 13899 16514 18000
Px= 2286 1566 1716
Py= 2375 2500 3603
Output: 2005 2007 2008
Px/Py 1 1 0
I/Py 6 7 5
I/Px 6 11 10

The following are the assumptions for the budget line.
1. The average income of an individual per annum is Rs.3.0 lacs in the year 2008.
2. The average expenditure spent on transportation by an individual is Rs.18000p.a in the year 2008.
3. The budget of Rs.18,000 in the year 2005 is discounted at the rate of 9% for the year 2005 & 2007.

We are considering first class air-conditioned coach railway fare with low cost airline Air Deccan fare.
Then I - the budget allocated by an individual for his travel.
Px –Price of Railway I Class
Py –Price of Economic Class Low Cost Carrier

In the year 2005,for the budget of Rs.13,899 and considering the ticket price for railway & airline as Rs.2286 & Rs.2375 respectively the consumer can choose between either of the two since the prices are almost the same. But considering the comfort level and duration of the journey, there are more possibilities for the consumer to travel by plane.

In the year 2007, Our honourable railways minister has considerably decreased the rail fares to compete with the Low cost carriers of India. For the budget of Rs.16514 and considering the ticket price for railway & airline as Rs.1566 & Rs.2500 respectively the consumer prefers to travel more by train than by plane.

In the year 2008,for the budget of Rs.18,000 and considering the ticket price for railway & airline as Rs.1716 & Rs.3603 respectively the difference in the price of tickets is large so the consumer is shifted towards rail from air travel.

From the above analysis we found that over the period of time from the year 2005 to 2008 the cost of air travel has considerably increased and would enforce the airline to move back to its position as premium segment. The principle factor behind this retro trend is the rising price of aviation turbine fuel (ATF) .Due to increase in crude oil price the ATF price increases throughout the world. But what
distinguishes India from the rest of the world is the crippling sales tax state governments levy on ATF.
Fuel cost
The overriding challenge for the entire aviation industry which is not really in their hands is the price of oil .The increase in aviation fuel has resulted in an increase in prices of airfares around the world. The price of fuel is a key determinant in the competitive world of aviation and perhaps the least the airlines can hope for is a decrease in the price of fuel.
Infrastructure Issues: to cater to the explosive growth
This is one of the important challenge before an airline industry .If there are around 400 airports in India, only about 60 are used and they are not up to international standards. The growth of the discount airlines depends on the availability of the infrastructure in small towns. The ministry of civil aviation expects a requirement of Rs.40,000 cr to develop the infrastructure at airports and as all of it cannot come through the budgetary route, the government must give incentives to encourage participation.
Airport Charges are stupidly high for a very poor service
Low cost airlines require low cost airports which have less landing fees. Though asking for alternative airports in a city is too much, at least the airports should have low cost terminals where people can walk up to airport. Though the government is constructing these low-cost terminals at the Greenfield Hyderabad and Bangalore airports, other airports will not have these facility
Immediate and major challenge: Scarcity of Manpower
India is known around the world for abundance of manpower and India exports quality human capital year after year to run the engine of the developed world .Perhaps it’s an irony that India is falling short of people required for the aviation industry. There is shortage of captains , pilots, air hostesses, cabin, crew, engineers and ground staff.
Poaching due shortage of skilled manpower: 2006-2007 faced over 15 pilots & engineers poached from DKN alone - burning issue. While the training period in the case of air hostesses and ground staff is less, it takes a lot more time to train pilots and captains. What is worse that even trainers have been poached by the airlines to work as a pilots. This has caused a serious dearth of trainer. Though some of the airlines seem to sign a no poaching of pilots agreement and also recruit foreign pilots, all these moves are short term in nature. What is required is proper recognized pilot training institutes. Seeing the glut in the supply some of the airlines themselves are thinking of starting their own pilot training institutes.
Other challenges includes:
Huge waste of fuel in air & at tarmac due traffic congestio (especially at DEL, BOM)

• Rationalize taxes on ATF for domestic airlines / sales tax on fuel:
• Fringe Benefit Tax: Fringe Benefits such as free/ concessional passages to employees & their family, expenses for crew, hotel accommodation to pax due delays & canx, expenses on catering & in-flight, etc included in the tax
• Service Tax / Handling Fee: 10.2 service tax fee on landing, airport & air navigation fees should be removed.
• Sales Tax on ATF for Jets: Unfair discrimination in fuel sales tax between Turboprops and Regional Jets. Jets are charged higher sales tax for their fuel needs compared to Turboprops.

1. Increase in oil prices would enforce airline travel to return back to its positioning as luxury segment.

From the analysis of the budget line and the data collected, we found that over the period of time from the year 2005 to 2008 the cost of air travel has considerably increased. The main factor for this trend is the rising price of aviation turbine fuel (ATF) .Due to increase in crude oil price the ATF price increases throughout the world.
But what distinguishes India from the rest of the world is the crippling sales tax state governments’ levy on ATF. Moreover there are very less subsidies provided to the oil sector companies from the government, as a result of which the cost of ATF in India is 75-80% more compared to other developing nations. As a result the air fares have increased once more and the so called Low Cost Airlines are operating at a higher cost than before.
The low cost airline players are running at a huge loss and so to survive in the long run, they have to increase the price of air tickets. Thus airlines will return back to the days when it was a luxury segment.

Thus we can say that our first hypothesis is proved.

2. Acquisition of small time players in the airline industry is inevitable.

From the data collected we found that the growing demand and the constrained supply of oil throughout the world has led to the increase in operating cost for most of the players in the industry.
Reduced air fares alone are not enough to cater to the increase in the demand of air travel. It is also important to cater from geographical point of view The infrastructure constraints in different cities mean having different aircraft for different geographies. Geographical inclusivity also meant increasing complexities by way of inventory management, logistics and maintenance.

When airlines add aircraft and routes it affects the cash flow and the profitability in the short run because any new route takes six months to one year to become profitable. It is also a socioeconomic reality that for any new service or product, it takes some time for a consumer shift to happen.
In addition to the above issues there were few other issues of infrastructure constraints, increasing fuel prices, wage inflation and excess capacity because of a whole lot of new players who came in to the aviation industry. On the other end large scale operators get good economies of scale. Non-metros can be covered by the available resources with the small time players.

Large Scale operators are able to offset the increase in ATF price by their well established infrastructure and business model thereby reducing their operational cost .Therefore on a long run acquisition of small time players in the airline industry is inevitable.

3. Upgrading to cutting edge fuel efficient engine would offset the impact of increase in oil prices

Several sources have documented the diminishing discovery of new petroleum sources and the ever increasing global demand, Fig. 1.

Some sources claim we have already reached a point where half of the world’s crude oil has been consumed, while others indicate mid-century, Fig. 2. In any regard, mitigation options must be implemented many years, perhaps decades, in advance of the actual peak oil event to assure a smooth transition to alternate fuels.

Current aircraft have experienced dramatic improvements in fuel efficiency since the introduction of commercial jet aircraft in the 1960s. Next-generation aircraft will see another 15-20 percent improvement in fuel efficiency, making air travel one of the most efficient means of transportation. However, air travel growth is predicted to continue at five percent per year and the future rate of gains in fuel efficiency will thus be outpaced by the projected growth in air traffic. So the aircraft industry will still require an increasing amount of fuel.
As a consequence, the aviation industry is interested in alternate energy sources and alternate fuels in particular. The key issues center on finding a sustainable source of fuel for the future that will keep the fuel costs at a reasonable level. In addition, potential alternate fuels should exhibit environmental benefits, by providing airline operators with potential CO2 Credits.

Other alternatives that mitigate the impact of oil prices are synthetic fuels, fuel cells etc.
This proves our hypothesis that cutting edge fuel will mitigate the impact of impact in oil prices.

4. Increase in oil prices has an adverse effect on the employment opportunities in the airline industry.

One of the worst hit is GoAir, India's youngest low-cost airline set up by Jeh Wadia, scion of a textile conglomerate Bombay Dyeing. GoAir, which has been trying to sell off a 26% stake in the airline for some time now, is cutting 10% of jobs, paring short-haul flights, and putting expansion plans on the back burner.
This is collected from the survey which we collected from the Go-Air site. So based on this facts we can say that our hypothesis is correct.
Thus the increase in oil prices may have an adverse effect on the employment opportunities in the airlines industry.

After doing this project we can conclude that oil prices have affected the Aviation Industry. Based on our methodology, all the hypothesis have been proved true.

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