How are low oil prices affecting air fares?

A nearly year-long plunge in oil prices is finally making air travel cheaper, but you may not notice unless you fly a low-cost carrier.

Numbers released by the Bureau of Labor and Statistics this week showed that average airline ticket prices dropped by 5.6% last month, the largest single-month decline in almost two decades.

This is due in large part to falling oil prices, which hit multi-year lows on Friday. Jet fuel, the airlines’ biggest overhead expense, has also tumbled.

Obviously, falling oil is good news for airlines that now have extra cash on hand. What they choose to do with the influx of capital, however, doesn’t always mean savings for the consumer.

Energy Information Administration

Instead of passing on savings, the big carriers posted huge profits in the first and second quarters of this year. United Airlines’ $1.2 billion profit in the second quarter of 2015 was the highest in company history.

In June, the International Air Transport Association (IATA) increased its profit outlook for carriers in North America to $15.7 billion (up from $11.2 billion in 2014).

“Airlines are using this as an opportunity to invest in their business,” said Vinay Bhaskara, a senior business analyst for Airways News. “It’s smart, strategic growth. Given that fuel prices are down, there’s no effect to the bottom line, and the headline profit numbers expand.”

If big airlines aren’t using the windfall to decrease fares, then why do the government’s numbers show a drop? Because lower oil is fueling an expansion among low-cost airlines like Frontier, Southwest and Spirit.

This is huge for budget carriers

“Ultra low-carriers are much bigger than they were a year ago, and especially more than two or three years ago,” said Bhaskara. “With the lower price of fuel, they’ve been emboldened to drop down their base fares even further. Because of that, they’ve been growing at a tremendous rate.”

These low-cost carriers have seen huge increases in market share, and that means competition is increasing.  The Department of Transportation describes this as the “Southwest Effect.”

The big carriers can’t ignore this entirely. Even though most of their revenue comes from first-class tickets and business travelers who won’t see much change in prices, the carriers can also can devote more economy class seats to ultra-cheap fares and compete for some of the low-cost carriers’ customers.

“U.S. airlines have become very good at revenue management, so that their overall fare mix includes more ‘bottom of the barrel’ passengers,” said Bhaskara. “You’re not seeing consistent drop across all tickets sold.”

Prices are likely to keep dropping

Still, there’s good news for consumers who are looking for the cheapest possible flight.

Hopper, an air-fare prediction service, aggregates millions airfares in order to predict price trends. Their “consumer airfare index” predicts prices will keep dropping through at least the rest of the year.

“We’re expecting to see the lowest prices this fall in four years,” said Alex Mozdzanowska, head of research for Hopper. “A lot of this is from the drop in fuel prices being passed on to consumers.”

This article is published in collaboration with Business Insider. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Graham Rapier is an editorial intern at Business Insider and is based in New York. He has previously worked at Inc Magazine and CBS News London.

Image: An EasyJet aircraft comes into landing during sunset at East Midlands airport, central England. REUTERS/Darren Staples