Qantas Airways Limited (ASX: QAN) faces the prospect of higher oil prices – responsible for much of the airline's recovery over the past few years as we outlined in October this year.
With oil prices plunging from an average of above US$100 a barrel in 2014 to briefly sink below US$30 a barrel earlier this year had seen Qantas save $1.2 billion in fuel expenses in the 2016 financial year.
Brent crude oil is now trading at around US$53.66 a barrel and could continue to head higher after OPEC agreed to production cuts for the first time in eight years at the end of November.
That means a higher fuel bill for airlines, including Qantas and rival Virgin Australia Holdings Ltd (ASX: VAH).
How Qantas CEO Alan Joyce responds to the increased costs is not yet known, but it could include charging extra for in-air entertainment, food and beverages.
The last thing likely to rise will be airline ticket fares – which are at multi-year lows – unless Qantas' competitors also raise their fares. As a commodity item, many travellers opt for the lowest cost airfare or near the lowest cost airfare. If Qantas raises prices and its competitors don't, the airline is likely to lose business and revenue – digging an even bigger hole for the company.
Asian carriers like Cathay Pacific and Singapore Airlines also have the issue that they have much lower margins than their North American peers because competition has pushed down fares. North America has seen waves of consolidation in the airline industry, leaving four main players in American Airlines, Delta Air, Southwest and United Airlines.
Asia has seen several airlines spring up in China alone, as well as several ultra-cheap budget airlines begin flights along with the many traditional national carriers.
Asia Pacific may need to undergo a similar consolidation phase to North America before the remaining airlines can operate profitably and with higher margins.
National airlines, unlike publicly-owned airlines, are less concerned with profitability, so they can keep their airfares low and operate at a loss for an extended period if they have to. That's not the case for airlines like Qantas and to a lesser extent Virgin.
Foolish takeaway
Qantas shares may look cheap at the current price of $3.26 and a P/E ratio of under 7x, but earnings and profits can quickly disappear as costs rise and revenues fall.
