Oil Prices Effects on the Aviation Industry


The importance of petroleum oil in determining the direction of the world cannot be undermined more so in the new millennium. The 1979 Iran crisis highlighted the role petroleum had on the world economy when a group of religious students surrounded the U.S embassy compound and laid siege of the embassy resulting in the prices of petroleum oil getting to their highest level ever. At the price of one hundred dollars, a barrel the current price of oil has reached unprecedented levels and affected different sectors of the economy. The transport and industrial sectors use up a large percent of the energy demands of the world.

Aviation, shipping, and road transportation enable the movement of goods, raw materials, and personnel. Over ninety percent of transportation is through petroleum-based energy. Air transportation has gone a long way since Kitty Hawk had become the premier means of quick transportation of thousands of people and a massive amount of cargo. The aviation industry is not just about aircraft but encompasses airports and airport management and the network of storage, security, and technical teams that enables the team to work effectively.

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In the recent past as the price of oil in the aviation industry fluctuates as it catapults upwards every sector of the industry is affected by the new circumstances. Aviation fuel takes a huge chunk of the revenue from the industry therefore any effect on it will affect all parts of the industry. Seventy percent of the oil reserves are based in the Middle East, with Saudi Arabia, Iran, and Iraq being the major producers. The volatility in the price of oil has many causes with the major factor being the situation in the Middle East especially Iraq and the perceived effect of this situation.

O.P.E.C (Organization of Oil Producing Countries) cartel has decided to maintain oil prices at high levels while controlling the production of oil among member countries. Airlines are the major users of aviation fuel for their aircraft. The prohibitive cost of setting up an airline has made most airlines be owned by states such as Air France, British Air Ways, and Singapore Airlines. In the recent past, new entrants in the market such as Virgin Atlantic and Ryne Air have taken up a good chunk of the market by using innovative means to cut the cost of fares enabling many people to travel through the so-called low-cost flights.

The expansion of the market in China, India, and South America as economies develop and more individuals have disposable income has put pressure on the demand for more flights and more aircraft and therefore more demand for aviation fuel. It is estimated that each airline’s passengers increase by 10%. The increasing price of oil has resulted in the demand for energy-saving measures on the design of the aircraft and the use of other means of transportation such as high-speed trains for short flights instead of airplanes. Airlines have partnered to share flight routes, passengers, and cargo. The price of oil has also favored oil-producing countries airlines with Emirates Airlines able to provide superior services at a relatively lower cost.

The boom and bust cycle of the airline industry has also affected state-owned airlines. The competition among older established state-subsidized airlines and the new entrants competing under a regime of an uncertain oil market has brought major airlines such as Alitalia and Swiss air to their knees. The government has resulted in protecting their airlines by subsidizing their operations so that they may stay in business. The US government has also invested a lot of money in maintaining a strategic reserve for fuel. For both military and domestic use while seeking partnership with non O.P.E.C affiliated oil producers to keep a lid on the rising oil prices.

The rising oil prices have also prompted governments across the world from E.U countries to the united state to increase or decrease interest rates to control their economies. Prices of petroleum products have been subsidized and taxes lowered so that airlines importers and exporters can have a competitive advantage over their contemporaries. Because of a continuous rise in the prices of petroleum products including aviation fuel, the industry has concentrated its energies towards making changes to variables under their control by shifting to high technology to reduce expenses by increasing efficiency.

Air cargo flights have been concentrated on the carriage of high-value products such as horticultural products, electronics, and computer parts. The effect of carbon emission by aircraft has necessitated the use of large aircraft that use less fuel and certain sufficient cargo to affect the price of energy.

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Oligopolies have also emerged due to the variation and gradual rise in oil prices. Boeing and Airbus have become the only surviving aircraft manufacturers after Lock head and McDonnell Douglas went out of business. High oil prices and the increased demand for products that would conform to present realities and future certainties about the future. The next years have a lot of pressure on the R & D departments of these two corporations to create the very best product, an aircraft that is fuel-efficient, safe and well designed for its intended market.

Globalization of the airline’s service and facilities sector has an eventuality of high oil prices. Big players in the construction of airport infrastructure such as runways and control towers have taken over smaller concerns. The sky is now dominated by less than five major airlines who take the lion’s share of over sixty percent of passenger traffic. The cost of fuel has resulted in more industries that had relocated some of their production to labor-intensive and cheaper regions such as China and India reconsidering the decision to outsource. Motor vehicle, high-end computer parts assembly firms in Europe have opted to invest in central European and eastern European new economies with a highly educated youthful workforce that spent a lot of money in long haul flights.

All major and minor companies have opted to use internet resources to communicate and interact in business. Video conferences have become an important part of doing business across continents and effectively reduced transport costs for companies and organizations.

Specialization to get a competitive advantage by countries and companies is another result of high oil prices. Some items are relatively cheaper to produce or provide services in one country as compared to another. For example, central and South American countries have specialized in producing beef and fruit products for the American market as opposed to African countries that face a prohibitive cost on freight.

Congo on the other hand is an African country that can send a regular cargo of highly valued platinum and cobalt to Europe as do gold and diamond-producing counties. Highly valued passengers such as corporate C.E.O are also affected by the fluctuation in oil prices. It has become the norm for a multinational to have its company fleet of planes and helicopters to fly top management effectively around the various branches of the corporation.

The remaining airlines have now concentrated on cost-cutting measures, replacing people with technology and thus resulted in massive downsizing in virtually all airlines.

The emergence of the Jumbo jet by Boeing has enabled more passengers to be carried in a single plane, the 747. This plane has dominated the airspace enabling cheaper long-haul and domestic flights. The A 380 by Airbus that carries up to 555 passengers is now the biggest planet in the sky with the commissioning of the first plane to Singapore airlines. More orders for the A380 and the smaller four-engine A330 as well as the Boeing 747 identify the shift towards bigger planes that carry more people and more air cargo relative to the among of fuel oil used.

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Another change in the aircraft industry is the shift towards faster planes on long-haul flights. Boeing’s smaller plane, the Sonic Cruiser travels at 95% of the speed of the sound but uses up less fuel than the 747 which gives us a preview of the future direction of the aviation industry. Billions of dollars are being spent on R & D that will open the key to an alternative to petroleum as the sole source of fuel. Boeing and airbus technicians have spent many man-hours on finding Aerodynamic and energy-saving solutions to the problem.

Price and How It Affects the Industry

While the recent reduction in the value of the dollar has led to an increase in the cost of production of airbus products, it has not undermined faith in the steady value of the euro. The cost of constructing the 380 orders has gone up because most aircraft’s component manufacturers are in the U.S or trade-in U.S dollars. This has been regarded as a temporary setback for airbus and recent events where companies have shifted to conduct their operation in Euros. The corporation has also taken the initiative to negotiate with airlines on terms of sales, discounts and allowances. Due to competition from its sole rival Boeing, Airbus initiated cost cutting measures when it became one single corporate entity in 1997.

The manufacturing process was streamlined and a lot of more processes in all departments from administration to the sharp floor to create a leaner organization that reduce the cost of production and therefore increasing the profit ratio. An aircraft in general has an expensive price tag and for this reason the corporation has negotiated several contracts with the government and their national carriers to provide aircraft to be paid for on installment basis at this time when many aircraft have reached the lifespan of twenty years or more and airlines need to have new fleets.

The Paris air show is the Oscars of the aviation industry. With all key players in the aerospace, aircraft manufacturer and space research came to display and market their products. Buying government, purchasing airlines and military experts arrive from all over the world to see the new trends. This is where the airbus A380 was unveiled and it made world headlines as viewers marveled at the technological feat of creating the aircraft.

Paris show is also the place where deals to make orders for aircraft are revealed. Before that there’s a lot of competition to bag the most orders. Airbus has steadily achieved equal status with Boeing in purchasing the product. The most important sales force for the corporation are the R & D department., for it is here that after may years of finding out what customers and air passengers want that the next generation of aircrafts will be built (Armstrong G. & Kotler P. , 2007)..

In partnering with universities and other research institutions and participating in seminars, meetings conducted by the world organizations such as the united nations and the E.U , the profile of the corporation among its target market of government and airways personnel and enables synergy and networking. Global warming and carbon emission is the hot topic in this millennium and it has become extremely important for every international company to highlight its green credentials. Airbus had a decade ago invested a lot of R &D resources towards energy saving devices in its components.

Currently every partner company has to follow guidelines as carbon emissions to be 10% above world standards by 2010. These measures are meant to promote a favorable image among the public and non-governmental organizations such as Green Peace. The message that the corporation and the aviation industry portrays is quality, economy, value and performance.

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Price Elasticity of Supply and Demand

The importance of oil in the price elasticity of supply and demand in the aviation industry cannot be ignored. The supply and demand for oil products is inelastic, this is because the product has few substitutes. Although alternative energy is available as substitute we have not managed to cover the aviation industry. if the aviation industry does not get oil products, they do not have any options of a product to use. This is inelasticity of price. From both the point of view of a lay man aand a professional economist it is inelastic. Currently the price elasticity of supply and demand for oil products is high. The price elasticity of oil products looks as follows. Even with increase in the prices of oil the demand for aviation services will remain perfectly inelastic.

The price remains inelastic because of the nature of all services. Q will swift to the right if anew player comes to the industry while will swift to the left if a company leaves the industry.

Wage Inequality

There is wages inequality in the same market for the same services if supply and demand are not balanced. If the bargaining power of the parties in the labor market is in balanced then you expect wages inequality to be inadequate. To fight wages inequality there is the government intervention through the setting of minimum wage legislation. They also do through arbitrating in cases where there is a deadlock. Lastly the gover4nment can control wages through an income policy (i) if prices are to be stable, controlled inflation and cost of production in various industries.(ii) the effect of continuous increment in prices as a result of wages this will assist in controlling the balance of payment.

Monitory and Fiscal Policies

Monetary policy is the integral part of economic policy of a country. It involves setting of monitoring and credit conditions so as ,to achieve desired goals in terms of inflation and economic growth. If borrowing becomes more expensive some consumers may borrow less and have less to spend this with slow economic activities. The effectiveness of monetary policy depends on the relationship between credit conditions and ultimate objectives of the policy that is controlling the level of inflation and the rate of economic growth.

When the interest rates go up businesses will limit price increases to maintain demand for their products leaving wage earners in precarious position.

Fiscal policy is used in regulating economic activities using macro economic s items in the economy. Through the budget, the government regulates activities or developments in the economy. Just imagine the borrowing a government makes from the market in financing her activities.

References

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Kotler, P. (2005) Principles of Marketing. New York.Melbourne Press.

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Staw, B., Sandelands, L. & Dutton, J. (1983). Threat-rigidity effects in organizational behavior: A multilevel analysis. Administrative Science Quarterly, 26, 501-525.

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