Fuel and airfares: the story behind falling oil prices

There’s a lot of confusion these days over falling oil prices, “crack spreads”, fuel and currency surcharges, foreign exchange and airfares. You’re seeing lower gasoline prices and you’re wondering whether you’re going to see lower airfares, too.

It’s a fair question. To answer it, we need to start at the beginning. We also want you know the full story.

Jet fuel — WestJet’s largest single expenditure — is a distillate of crude oil and it costs money to turn a barrel of oil into a barrel of jet fuel. That cost is known as the “crack spread” and nowadays it adds about another $20 to the price of crude.

On top of that, jet fuel is sold in U.S. dollars and like all Canadians, WestJet is feeling the pain from our sliding Canadian dollar. As I write this, it costs roughly 1.16 Canadian dollars to buy one U.S. dollar, so before we even order our jet fuel you have to add another 16 per cent on top of that crack spread. And while we’re on the subject of foreign exchange, we also buy our aircraft, vacation packages and other goods and services in U.S. dollars, so we’re getting hit pretty hard by foreign exchange in general.

Yet, unlike some of our competitors, we have no fuel surcharge and no currency surcharge. To put things in perspective, fuel makes up roughly one-third of our expenditures and for the first nine months of this year (Q1 through Q3 of 2014), we spent nearly $850 million to carry some 15 million guests to more than 90 destinations in 20 countries. (By the way, we encourage you to check the fine print when you’re booking with other airlines or vacation tour operators. The pricing may look good but are you being charged extra fees for fuel and currency?)

So, if oil has fallen nearly 50 per cent in the past six months, isn’t WestJet saving money? Yes, we are, but nowhere near as much as you might think. In 2013, we paid an average of 91 cents per litre (CAD) for jet fuel for the full year. And although 2014 isn’t quite over (and we won’t have final numbers until we report our Q4 and year-end financial results next spring), we expect our full-year average price for jet fuel this year to be in the same range.

Furthermore, at least 40 per cent of any savings realized from lower oil have been erased by an increase in refining costs and a weak Canadian dollar. And the rest of those savings is being used to help ensure we’re here for the long haul, providing much-needed competition and continuing to keep fares as low as possible for Canadian travellers.

It is also important to note that when we fill our vehicles at the pump, we use that fuel as soon as we start the car. In the airline business, reservations made today can be for a flight up to 11 months from now, and we don’t have a crystal ball that tells us what the price of fuel will be this coming spring, let alone almost a year from now. So, we must be very careful about making pricing adjustments so as to remain competitive while ensuring we’re also being responsible on behalf of our shareholders.

That said, we took decisive action on fares this year. We minimized fare increases and in fact, reduced fares on six million seats. Today, one-third of our seats are less expensive than they were one year ago. We are Canada’s low-fare leader and will aggressively defend that position.

So, will you see further reductions in WestJet fares? It depends on multiple factors including the price of a barrel of oil, the refining costs to produce jet fuel, foreign exchange, competitive forces, supply and demand and the overall state of the economy – all of which may change on a daily basis.

Take just one of those factors, for example. In July of 2007, oil sat at around $85 a barrel. One year later, it rocketed to $144. Seven months after that, it fell all the way to $44. This year, oil peaked at $107.65 at the beginning of August and today it’s below $56. If we adjusted pricing up and down to reflect such radical changes, our guests would think we’d lost our minds. Instead, we smooth out our pricing to avoid such peaks and valleys and we ensure we are always competitive relative to the market.

Nobody knows for sure how much further oil will fall, when it will turn around or how high it will go the next time it goes on a run. Nor does anyone know how much the foreign exchange gap will widen in the months to come. We’re living in uncertain economic times, with an equally uncertain forecast.

It’s no wonder we’re keeping a close watch on the skies.