Written by Hasan Zengin
Before February 24, when Russia unexpectedly started its invasion of Ukraine, very few thought that a full-scale war between two large countries could be waged in the year 2021. This expectation was strengthened not only by the fact that the many international organizations and treaties guarantee international order and sovereignty, but also by the extent to which our world, businesses, and economies have become globalized. Without exaggeration, the smallest economic failure in one of the bigger economies in the world could very well create a global economic downturn, affecting even the least open countries in the world. Indeed, after the abrupt start of the war, many businesses around the world were not ready for its implications. From international businesses that have large operations in Russia to industries that are very dependent on oil prices and to industries such as defense industries that suddenly became more important, many actors in the markets are being affected for the better or the worse. One key industry that is affected greatly is the airline industry, and it is important to understand what they are doing to make their operations run.
AIRLINE INDUSTRY IN CONTEXT
Since the start of the pandemic two years ago, airlines companies have been in an unprecedented situation. With a dramatic decline in airline passengers and halting flights, airline companies were incurring big losses. Airlines have to plan ahead as they often hedge themselves against the risk of fluctuations in oil prices by buying (or selling) crude oil options in the derivative markets. With the day-to-day changing conditions amidst the pandemic, however, they had a hard time making good predictions. In addition to all this, airlines in some countries had to run empty flights for the right to keep their airport slots per agreements (Sillers). More than 100,000 “ghost flights” are expected to fly this winter, and the CEO of Lufthansa, the German National Airline, said that they are expecting to run 18,000 unnecessary flights this winter (Sillers). So, how does the war in Ukraine affect such a fragile industry? The most direct consequence of the war is the rising oil prices, as Russia produces 12% of the world’s oil. On March 8, the United States government banned the imports of Russian oil, liquefied natural gas, and many other international companies stopped buying Russian oil. With global sanctions against Russia and many oil companies stopping purchases of Russian oil, the global oil supply fell. One week after the start of the war in Ukraine, this change in prices was reflected in the stock market: the stocks of airline companies fell with the rising oil prices. On March 8, the price of oil reached its peak of $123 per barrel, which corresponds to the crash in airline stocks. Crude oil prices were in a decline until March 16, which later went up due to uncertainty about whether the EU will ban Russian oil imports. Since then, the disagreements among the EU members decreased the likelihood of such a ban. Nevertheless, oil prices are still high compared to before the war, and the already-tight profit margins of airline companies contracted. The fluctuating prices also make future price predictions less reliable, which complicated things even more for airline companies.
Although this was yet another example of why we should decrease our dependence on oil and, ideally, use more alternative energy sources, many economists agree that we need a short-term solution to the shortage. Similarly, the CEO of Tesla and one of the pioneers of electric cars, Elon Musk, tweeted on March 4 that he “hate[s] to say it, but we need to increase oil & gas output immediately. Extraordinary times demand extraordinary measures.” Unfortunately, U.S. energy companies “have been expanding a little more slowly than in previous cycles when oil prices were also high,” (Rampell), and the best solution right now seems to be compensating for the decrease in supply by potentially working together with OPEC (Organization of the Petroleum Exporting Countries) members such as Saudi Arabia or Venezuela, for which Biden administration has already started holding meetings.
CHANGING AIR TRAFFIC ROUTES
Another major consequence of the war for the airline industry is the changing air traffic routes. First, the European Union banned all Russian airlines (all Russian-owned and operated planes) from flying in its airspace (Euronews). Canada and the United States shortly imposed a similar ban, which was followed by Russian retaliation (Euronews). Maps on the internet that track international flight routes show the weird routes different airlines have to follow to comply with the bans. Russian airlines can’t fly to the US, and the only planes over Russian airspace belong to countries such as China or the United Arab Emirates, which did not reciprocally impose a ban on Russia. Those airlines who now can’t fly over Russia, are facing yet another challenge: lengthened journey times that not only multiply the effect of rising oil prices but also increase labor and maintenance costs—especially for air freight (Cherney et al. ). Lufthansa’s cargo division had to cancel its flights to some Asian cities including Hong Kong and Beijing until the end of March—they are still working on solutions to resume profitable transportation (Cherney et al.). Similarly, a London-based airline company, Virgin Atlantic Airways Ltd. suspended their London-to-Shanghai airline freight service until they figure out an alternative (Cherney et al.).
Options considered by airlines typically include a longer route below Russia; however, as previously mentioned, this comes with its associated costs. To reduce the costs, one solution they are weighing on is to decrease the amount of cargo each plane carries, which would decrease the fuel they need. Although this sounds viable, it is probably easier said than done as reduced cargo capacity would also mean less revenue for airlines. Furthermore, all this could work if airlines could get the necessary legal permissions from the countries and airports that will be on the new routes. This could create yet another major supply chain challenge around the world as companies relying on air freight won’t be able to transport their goods and resources without paying more. Surely, the war’s impact on oil can easily spread even to industries that aren’t immediately dependent on oil or oil-based energy.
A DIFFERENT POINT OF VIEW: RUSSIA
Russian airline companies are even in more trouble. Airbus and Boeing, the biggest two aerospace companies, halted the supply of aircraft parts to Russian airlines (Topham). Unexpectedly, China has also announced that it will not supply aircraft parts to Russia either (Goodman). A considerable number of planes in the Russian fleet are leased by foreigners and are registered in Bermuda as the country does not have income, corporate, or capital gain taxes. Also, many lessors believe that the Bermudian legal system is more reliable than the Russian. However, recently, the Bermuda Civil Aviation Authority “suspend[ed] permits for Russian-operated planes over safety oversight concerns” (Sharma and Freed). Russia approximately has 1000 planes in its fleet, and almost one-third of them are registered in Bermuda (Sharma and Freed). Legally, none of those planes can be operated right now because of the lack of permits. The Russian government, however, has started to register those planes to the Russian legal system, allowing them to continue being operated and bypass safety checks (Sharma and Freed). Most of these planes are now only operated domestically. European plane lessors to Russia were required by the EU to cancel their contracts by the end of March. They complied with this requirement; however, they now face yet another problem: will they be able to get their planes back?
THE END?
Despite all these major challenges, this crisis will certainly not be the end of the global airline industry. Airlines companies have proven their effectiveness in adjusting to changes, especially during the height of the pandemic. However, it is important to realize that companies involved in the industry are under great pressure to find ways to continue making profits in very unfamiliar circumstances.
Sources
“All the Countries Affected by Ukraine Travel Bans and Sanctions So Far.” Euronews, 2 Mar. 2022, https://www.euronews.com/travel/2022/02/24/ukraine-travel-all-the-airlines-and-countries-that-have-been-affected-so-far.
Cherney, Mike, et al. “Airlines Scramble for Routes around Russia as Flight Bans Intensify.” The Wall Street Journal, Dow Jones & Company, 2 Mar. 2022, https://www.wsj.com/articles/amid-ukraine-war-airlines-plot-detours-around-russia-as-flight-bans-intensify-11646232786.
Goodman, David. “Russia Says China Refuses to Supply Aircraft Parts after Sanctions.” Reuters, Thomson Reuters, 10 Mar. 2022, https://www.reuters.com/business/aerospace-defense/russia-says-china-refuses-supply-aircraft-parts-after-sanctions-2022-03-10/.
Rampell, Catherine. “Opinion | Both Parties Neglect to Propose a Solution That Might Actually Lower Gas Prices.” The Washington Post, WP Company, 21 Mar. 2022, https://www.washingtonpost.com/opinions/2022/03/21/high-gas-prices-us-politics-blame-and-solutions/.
Sharma, Akriti, and Jamie Freed. “Bermuda Suspends Permits for Russian-Operated Planes over Safety Oversight Concerns.” Edited by Daniel Wallis et al., Reuters, Thomson Reuters, 13 Mar. 2022, https://www.reuters.com/business/aerospace-defense/bermuda-revokes-licences-russian-operated-planes-over-safety-concerns-2022-03-13/.
Sillers, Paul. “Why the Sky Is Still Full of Empty ‘Ghost’ Flights.” CNN, Cable News Network, 12 Feb. 2022, https://www.cnn.com/travel/article/ghost-flights-pandemic-greenpeace-cmd/index.html.
Topham, Gwyn. “Airbus and Boeing to Halt Supply of Aircraft Parts to Russian Airlines.” The Guardian, Guardian News and Media, 2 Mar. 2022, https://www.theguardian.com/business/2022/mar/02/airbus-and-boeing-to-halt-supply-of-aircraft-parts-to-russian-airlines.