Blog Archives

… Complaining About Airlines

… Airfare

airplaneWith the plummeting price of oil the news is filled with articles about how even though jet fuel is the number one cost that airlines incur (around one quarter to one third of total operating expenses), airfares are not going to go down anytime soon. Airlines tack-on “fuel surcharges” to their ticket prices, which can be especially high for international flights. A few airlines are publicizing that they are decreasing or eliminating their fuel surcharges, but for the most part, they are staying in place for now. Intuitively, this does not make sense. In fact, it does not even seem fair. And to me this illustrates the possible existence of a market failure which ought to be explored and if it is found to exist, eliminated, insofar as it can be.

The market for air travel is an oligopoly – a very cramped one, at that, in the United States, which I have written about before. And this in and of itself lends itself very sticky prices. However, disregarding that reality of the market, I believe that there are other forces at play colluding to keep the price of airfare high through those pesky fuel surcharges, despite the falling price of oil, and commensurately, jet fuel.

Oil_Jet Fuel Price Change

Airlines purchase hedging derivatives, called swaps which are based on the price of oil and/or jet fuel. Basically, they are bets on the future price of the commodity (jet fuel is refined from oil, but other variables, such as refinery capacity, make it so that jet fuel and oil do not move 1:1). If an airline thinks that oil is going to go up, which would increase their costs, they can buy a swap that says that over a certain dollar amount, say $100, the counterparty (such as a bank) would have to pay the difference. Then, if oil moves to $110, the airline would only have to pay $100 and the bank would pitch in the last $10. If, on the other hand, the price of fuel dropped to $90, then the airline would be caught buying fuel at $90 and having to pay an additional $10 to the bank. Other forms of derivatives, such as options, can also be used with similar results.

So, as you can guess, the airlines have purchased a lot of upside protection, so right now they are still paying high prices for jet fuel, based on their derivative contracts, even though prices have plummeted. This is one of the reasons why fuel surcharges still hang over airline tickets. Anyone who has read my blog in the past may be thinking to themselves that this sounds vaguely familiar. In fact, it is very similar to the interest rate swaps debacle that Detroit got itself into.

Right now, Delta and Southwest, who were both lauded a few years ago for wise hedging strategies, are reeling the most from the swing in oil prices. American Airlines, on the other hand, has less derivatives exposure, so it is set to gain more from the drop in the price of oil. Importantly though, even though American Airlines is set to gain, the oligopolistic nature of the market will mean that few of the saving will be passed on to travelers. American can keep its prices high precisely because Delta and Southwest can’t drop prices. The only people who are set to gain are American Airlines shareholders (and the bankers, of course).

The fact of the matter is, for any swap, the two counterparties take contrarian bets. In our case, the airline wins when prices go up, and the bank wins when prices go down. So to be on the other side of the bet, the banks must have seen the potential for oil prices to decline. Rarely do you hear that banks are the ones suffering from being on the wrong side of hedges. Maybe the banks are superior pricing models, or maybe they account for such a large share of international volume that they can influence the price through clandestine means. I don’t know, but it seems that their clients are always the ones taking outsize bets and losing the house. I completely fail to see the wisdom by which everyone espouses the abundant use of derivatives.

And now, with oil so very far off its relatively recent highs, airlines, especially in Europe, are looking to lock in new hedging positions, betting that prices for oil won’t drop below $40/barrel. I think it is only a matter of time before an international airline blows-itself up financially up with a backfiring derivatives strategy. Not only do airlines hedge their jet fuel risk, they engage in foreign exchange hedging, and refineries, which have close financial ties to airlines, hedge as well.

This is part three of a four-part series of posts on the Economics of Oil. Previous posts:

The Economics of Gas Prices

The Economics of International Oil Price Conspiracies

The Economics of Bitcoin Mining

 

Sources:

http://www.reuters.com/article/2014/12/23/us-oil-hedging-airlines-idUSKBN0K10AJ20141223

http://www.indexmundi.com/commodities/?commodity=jet-fuel&commodity=crude-oil

http://en.wikipedia.org/wiki/Fuel_hedging

http://www.cnbc.com/id/102336174#

… Ebola Screening

Sorry that I have not posted in a while. I have been a bit busy and I recently came down with the flu. It is only fitting that this article is about disease. I’ve also got a climate change post in the works. I wanted to post it a few weeks ago when all eyes were on New York, so I guess I’ll just have to post it with a back-date now.

Two aspects of the Ebola case in Dallas bother me a lot. The first is that the patient went to the hospital with symptoms, told the hospital he had recently been in West Africa, and nevertheless he was turned away. I can’t know for sure, but I assume that the patient is uninsured, and the admitting nurse, who is instructed to turn away patients who are unlikely to be able to pay their hospital bills, simply saw the hospital’s finances as a greater danger than Ebola.

o-EBOLA-570

Because of this episode, the White House is considering establishing States-side Ebola screening in airports. However, people seem to be at a miss on how to implement this. They say that there are just too many airports and too few West African passengers. That’s the second aspect that bothers me a lot. It is fairly easy to identify which airports have the highest rate of passengers coming from Liberia, Guinea, and Sierra Leone. Here’s how:

I assume that the FAA has a database of all passengers coming and going from the US. If not Homeland Security, the airlines, or probably the NSA does. Gather this data and discard all trips that do not originate in West Africa. Then count up all the trips by the airport that they terminate in and convert this into a percentage. And there you have a crude estimate of the most likely entry points for Ebola into the United States of America. I’m assuming that JFK will be high on the list. Maybe Chicago, LA or San Francisco, and maybe Dallas and Miami will be high on the list as well.

Now that will only cover some of the possible passengers who could carry the virus. People could travel to an infected country on a different ticket, and then later come back to the United States. For instance, last year my friend went to West Africa for work, and on the way home he spent a few days in London. I assume that his Africa-London ticket and his London-US tickets were different.  These would be harder to track because I don’t know if there is reliable data available on these trips. Maybe Homeland Security, the NSA, the FBI, or the CIA tracks these trips, but I think it would be difficult for even an economist at the CDC with security clearance to obtain this information. However, on landing cards for the US you are asked, “Countries Visited on this trip prior to US arrival.” Of course these are not digital, but it is possible that Homeland Security has some stats they can share. I won’t dive into how to process these stats, since we have no idea what form they could take.

Landing Card

Lastly, another way to capture the elusive passengers who visited West Africa on non-US terminal tickets is through a random sampling method. First, collect a list of all possible one-stop destinations from Liberia, Guinea, and Sierra Leone. I think that one stop is reasonable. There are very few non-stop flights from West Africa in general, but I think that two-stop flights may be casting the net a bit too wide. From this list, eliminate any flights that terminate in the US (those are already covered by the supposed-FAA data) and any flights that do not terminate in an airport with flights direct to the United States. From the FAA data, randomly select passengers departing from these airports to see what airports they are arriving to in the US. The random sampling could even be weighted, giving higher preference to more likely airports, such as those in Europe, and lower preference to less convenient flights, such as East Asia. Simply add this sampled data to the FAA-obtained data and you have a more complete, albeit less-than-perfect, picture.

The last obstacle is time-frame. Peoples’ flight patterns and behaviors have changed since many airlines have cancelled flights to West Africa. So this data should probably only be collected over a six month period or so. Otherwise we would be setting up screening centers in airports that are no longer seeing passengers coming from West Africa.

If these data are properly parsed and analyzed, the government would have a list of the most likely ports of entry for Ebola. With this information they could set up screening centers in a cost effective manner that interrupts and inconveniences air travel as little as possible.

… Ebola

I first had the idea for this article about a year ago when MERS was popping up, but I didn’t write it. Then a few months ago, when Ebola was just beginning to rear its head, I resurrected the idea, but I didn’t follow through. I wish I had written this earlier, but nonetheless, I’m taking her home this time.

From a public health point of view, 2014 has seen an alarming number of epidemics spreading around the world. MERS is emanating from Arabia and infecting travelers worldwide. One of the most feared diseases of modern times, Ebola, is experiencing its worst outbreak in history. And the infamous Plague has appeared in Colorado and China, alarming public health workers. That’s not to mention the spread of Chikungunya (chik-en-gun-ye) in the US and Latin America, and terrifying protocol breaches at infectious disease laboratories in the US. In addition to the devastating human impact that the spread of infectious disease has, there are also acute economic impacts that are interesting to explore.

o-EBOLA-570

The last time that there was an epidemic of worldwide proportions was 2003, when SARS ripped across Asia and spread to others regions of the world, including Canada. The epicenter of the epidemic was Hong Kong. Due to fear of the virus spreading, people tended to avoid the public sphere. As a result, consumption plummeted. Certain retail establishment, such as restaurants and movie theaters, saw traffic decline by more than 50% during the spring of 2003. Overall, Hong Kong retail sales were 6.1% down year-over-year in March, and a whopping 15.2% in April, before fully recovering by July. In addition, travel and tourism were severely stunted during the outbreak and for a period following it. In total, Hong Kong saw 63% fewer visitors during the outbreak, and during the height of the scare air traffic fell by 77%. SARS eventually infected 8,422 people, resulting in 916 deaths. This equates to a mortality rate of 10.9%. Most remarkably, due to the public health response to the virus, all victims were identified and isolated, and SARS has been completely eradicated from the human race. There has not been a single reported case since the outbreak in 2003 was contained. It is the only disease in the history of the world that humans have achieved 100% eradication.

Ebola, on the other hand, has a much higher mortality rate. In some previous outbreaks it has reached 90%. So far in 2014 it has not infected as many people as the SARS outbreak, probably because the West African countries it is spreading through are less densely populated and have fewer interconnected socio-economic communities than East Asia. However, it is taking serious tolls on the under-developed economies. Consumption, like in Hong Kong, China, Singapore, Taiwan, and Canada, during SARS, has plummeted. Even though the virus is not spread through the air, no one wants to risk catching the disease from an infected person at the market. Plus mines, which are one of the economic engines of growth in Africa, are shuttering to prevent the spread of the disease through workers. And globally, prices for agricultural commodities such as cocoa and palm oil are increasing in anticipation of an under-productive harvest in West Africa. Lastly, foreign airlines are cancelling flights to the three infected countries – Sierra Leone, Guinea, and Liberia. And the latest news from West Africa now has the disease spreading into Senegal as well, although it seems to be contained in Nigeria.

These short-term impacts fail to mention the more dire impact on human capital. With the loss of life there is an immense loss of economic productivity for years to come. In addition, this Ebola outbreak is acutely affecting health care workers who are caring for patients. Health care workers, especially doctors, are extremely productive members of economic communities, and the affected countries will have to reinvest millions in medical education for years to come to recuperate the losses they are experiencing as their best doctors and nurses succumb. In addition, with attention being placed on Ebola, other virulent diseases are being neglected, so mortality rates are rising generally across West Africa, further sapping human capital.

The last time there was a widespread, nearly uncontrollable worldwide pandemic was 1918, when Spanish Influenza spread across the entire world and killed 40 million people worldwide, including 0.8% of the population of the United States of America. Evidence from the pandemic is hard to come by, but the main effect, similar to SARS, was a vast reduction in retail sales – the face to face interactions that often drive economic activity. However, globalization had not swept the world by 1918. Commercial air travel did not exist, and World War I was still being fought, severely limiting international travel and economic cooperation. If another global pandemic were to arise, the economic effects could be far more severe.

Although there has never been an international pandemic during the era of globalization of international air travel, we can use the experience of the 2010 eruption of Eyjafjallajökull (EH-ya-fi-AHT-la-yo-coot) on Iceland. Due to the emission of ash particles into the atmosphere, air travel across Europe was all but shut down for a week in 2010, stranding millions, stunting professional services-based economic activity, and shuttering the tourism industry for a short time. In the UK alone, 456.5 GBP was shaved off of GDP, an equivalent of 0.02% of annual GDP. This translates to more than 10,000 jobs. The impact was much larger on the airline and hospitality industries (British losses exceeded 700 million GBP), but domestic consumption, in the form of retail sales, was not affected. In fact, the stranded customers likely boosted retail sales by having to eat and sleep for an extra week.e25_23048757

If an infectious epidemic were to spread globally, forcing governments to close borders and ground air travel, the British and European volcanic experience could be magnified hundreds-fold. Tourism and business travel would evaporate. Plus, most forms of human economic interaction, mainly shopping and entertainment would dry up before our eyes. Shops would close, lay-offs would be massive, and most effected economies would dive head-first into recession, if not depression. Interestingly, cyber commerce may experience a boon, with consumers preferring to shop from the safety of their home computers. That is, as long as telecommunications were still properly functioning and not suffering from the loss of workers, and delivery services, such as FedEx, UPS, and the US Postal Service, were still carrying out package deliveries.

I truly hope that the current Ebola outbreak in West Africa is contained and eradicated, because the pain that victims and their families are suffering must be awful and the fear that the populations are living in absolutely stifling. And I also hope that societies around the world take this as an opportunity to optimize their public health initiatives, if only to prevent undue harm to economies, developing and developed, from epidemics and pandemics.

Sources:

http://www.hiebs.hku.hk/working_paper_updates/pdf/wp1084.pdf

http://www.bloomberg.com/news/2014-08-21/ebola-sickens-economies-of-west-africa.html

http://www.stlouisfed.org/community_development/assets/pdf/pandemic_flu_report.pdf

http://www.visitbritain.org/Images/Volcano%20Economic%20Impact%20Study%20-%20Oxford%20Economics_tcm29-15226.pdf

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