The potential impact of Brexit on Flight Fares

The potential impact of Brexit on Flight Fares

“Higher fares and fewer flights”, “a disaster for tourism”, “Brexit won’t mean more expensive flights for Brits”, these are just a few titles we’ve all seen lately in the press. Some articles even put forward figures, such as a rise of 20% in flight fares, or the cost of a week of holidays increased by £240 on average. Most of those estimates are based on one or two factors, mostly the expected drop of sterling pound and are actually somewhat random.

So what can we expect? We have reviewed all the factors influencing flight fares that will be impacted by a potential Brexit to get a realistic evaluation of the risks.

If the Pound drops as expected, what will be the impact for British travellers?

The biggest fear related to a potential Brexit is a drop of Pound value, especially when compared to Euro. The latest weeks have shown a very high volatility of the Sterling, exposing the markets anxiety. It has lost approx. 10% of it’s value against Euro in the last 6 months. Does this mean a 20% drop immediately following a Brexit? Would that effect be durable? No one on Earth can answer those questions accurately. Uncertainty surrounding the Scottish Independence Referendum in 2014 caused exchange rates to drop and the event we are facing now is much bigger. An even higher volatility of British Pound is more than likely in case of Brexit. A drop of 20% is realistic. Thinking longer term, the likelihood is that real GDP growth would be reduced not just in the second half of 2016 but stretching out to 2019, when Britain’s exit would likely be formalised. Moreover, the current economic situation in the UK (huge current account deficit, which was equivalent to some 7% of GDP in the first quarter of 2016 - a peacetime record - which adds to uncertainty) will not contribute to a faster recovery.

Clearly, the immediate precise impact of Brexit cannot be known. However, the likely direction of the effect seems clear – downwards – and a temporary fall back into recession cannot be ruled out.

How would it affect flight fares?

Direct impact on fares for airlines selling tickets in other currencies

The first obvious effect is a raise of prices for all flights sold in Euros or other currencies. An exchange rate drop of 20% would mean anything we buy in Euros would cost us 20% more.

Risk: High
Term: Short term

Does it mean British airlines would become more competitive?

Not really, as their costs would go up (fuel price, airport taxes).

Indirect impact through fuel price

The fuel price depends directly on crude oil price, traded in US dollars. Any drop in the USD-GBP exchange rate has a direct impact on oil price in the UK, added to market fluctuation. In 2012, airlines expenses for fuel were reaching not less than 35% of their total costs, even more than payrolls. 4 years later, it represents only 15% of all costs, since oil price has decreased by 65% in the same period. The exchange rate is not the biggest factor here, but it still has an impact.

However, this effect might only be noticeable long term, as airlines have hedged their fuel exposure up to a year or so ahead. This is one of the reasons why flight fares have not decreased as fast as oil price, and won’t be impacted by that factor straight away in case of Brexit.

Risk: high
Term: medium term

How would it affect the rest of the British tourism industry?

In total, UK travel and tourism accounts for more than 10% of UK GDP, and directly for some 1.9 million jobs (just under 6% of total employment). Indirectly, it supports as many as 4.2m jobs or 12.7% of total employment.

Tourism would be affected near-term by a Brexit in a number of key ways:

1) Holidays abroad would become more expensive for Britons as a result of weaker sterling, which would raise both the costs of travel itself and the price in pounds of hotels, food and indeed everything bought abroad. The evidence on this seems to be that the initial effects are quite small; but that they build up over time as they affect the structure of the industry.

2) Reductions in the UK’s GDP and people’s real incomes would almost certainly further reduce tourism demand as holidays abroad are very much a “discretionary expenditure.”

3) On the other hand the UK would become a cheaper destination for foreign tourists, almost two-thirds of whom currently come from Europe.

Risk: moderate
Term: medium term

An end to unrestricted access to Europe’s internal aviation market?

The European Union created a single market for aviation in the 1990s; 1992 marked a shift from national air transport markets, with restrictive bilateral agreements between countries to one market for all European airlines operating in the EU. This unified internal market removed restrictions on market access and pricing and established common aviation rules across the EU. It is also generally recognised to have increased competition on intra-EU routes, providing more choice of routes and lowered fares for consumers.

Open access for all European carriers led to the emergence and rapid growth of the low-cost carriers in the 1990s and 2000s, including EasyJet and Ryanair forming a significant proportion of today’s intra-EU market.

While it is difficult to separate impacts of liberalisation from other drivers, between 1992 and
2000, published regular economy air fares decreased by an estimated 5% and published promotional fares by about 30%. Overall, ticket prices fell by more than 15% in real terms.

Will the UK be kicked out of the European aviation market in case of Brexit?

In 2006, the European Commission negotiated a European Common Aviation Area (ECAA) agreement, which aimed to expand the EU’s internal aviation market and integrate South-East European countries and beyond, including Georgia, Israel, and Jordan. Two years after, the EU-US Open Skies agreement entered into force whereby EU airlines can operate flights to the United States from any European airport, regardless of their nationality, and can operate without restrictions on the number of flights, aircraft or routes.

Such an agreement would be negotiated between the UK and Europe without a doubt in case of Brexit.

1) If the UK negotiated continued access to the Single Market following Brexit, e.g. as part of the European Economic Area (EEA), aviation would likely remain much the same. Norway is currently part of the single market for aviation and is also a signatory to ECAA, its airlines operate in a similar way to the UK’s.

2) Should the UK opt out of the Single Market it could apply to join ECAA with status much as other non-EU, non-EEA members. The UK would have to agree to EU aviation laws, to which UK airlines currently adhere. The UK would also be expected to continue close cooperation with the EU. Regardless, members of ECAA would have to agree to the UK’s application, which would most likely be the case.

Given that London is a preeminent international hub, and a key destination for dozens of European airlines, it is likely that a bilateral ECAA application would be granted, but even if the UK were able to join ECAA, access could be restricted such that UK airlines could fly between the UK and EU airports, but could no longer fly between two destinations in continental Europe.

What are the potential consequences of those scenarios?

1) UK carriers might opt to set up a separate EU-based firm, which would involve changing airlines’ structures. Restructurings are seldom costless, including in terms of job losses.

2) As for a UK-US Open Skies agreement, the UK could sign up to the EU-US agreement in the same manner as Norway. But if it chose to negotiate a bilateral agreement with the US, this could be complex as it could necessitate 30-odd agreements, i.e. UK-US, UK-France, UK-Germany, so that (as now) French and German airlines could fly from London Heathrow to anywhere in the US.

3) If the UK had to negotiate bilateral agreements for all international routes, each could take months to negotiate even if the drafting would likely only take weeks individually. Such agreements could also prove difficult for the UK: in recent years the bilateral negotiation team has been scaled back as the larger agreements e.g. US Open Skies were handled at the EU level.

Risk: high
Term: short-med term

How would it affect airlines and flight fares?

Uncertainty on continental flights or in-UK flights for both side

There is no doubt UK and Europe will find an agreement beneficial for both parties, but in that process (which could take months, if not years), some important factors could be lost. Today if you fly from London to Berlin through Frankfort with British Airways, you will most likely stay on the same airline for both flights. In the case of Brexit, the possibility for British airlines to compete freely on inner Europe continental flights should no longer be taken for granted.

This has a number of structural consequences as airlines have a particular setup and agreements with all major airports, infrastructures that might need to be scaled down on certain destination with less inner-Europe flights.

The indirect effects Brexit would have on the aviation sector

There are a number of forecasts available in many economic fields to evaluate a probable impact of Brexit but in the case of aviation effects of shocks on prices cannot be inferred from studies of other industries. Airfare models of aviation, and of the determination of prices in particular, are notoriously complex, the result of the particularly diverse and international nature of the industry and the wide range of factors that influence air fares, which include:

1)  Operating costs

2) Seat capacity

3) Load factors

4) Flight frequency

5) Origin/destination market share

6) Origin/destination market concentration

7) Population and income per capita

8) Levels of tourism and business activity

9) Whether the airport is a hub

10) Airlines’ slot control

11) Period of the year, week, day

Therefore, legal and regulations issues are not the sole concerns in terms of air fare volatility. Beyond flight fares, other changes are to be expected.

The benefits of aviation sector liberalisation jeopardised

The benefits which successive rounds of market liberalisation have given to passengers and the aviation industry are generally reckoned to be considerable. Equally clear is that these benefits did not happen all at once – they materialised slowly and progressively through the 1990s and 2000s. Liberalisation spawned the birth and subsequent development of a pan-European network of low-cost air travel, which involved amongst other things the development of new routes, the reorientation and development of many regional European airports, and the purchase (and thereafter maintenance) of new fleets of aircraft. The pace at which all of this took place was determined in important part by the expansion of facilities and other tourist infrastructure (both at origin and destination) extending to hotels, restaurants, car hire, transport links, etc., in regions that often had hitherto not figured prominently as tourist destinations.

Thus in summary, what was involved following EU airline deregulation was nothing less than a fundamental transformation of the structure and landscape of the European tourism industry.

A Brexit, with associated reduced ease of airline access, would produce adverse results in similarly progressive fashion, but also similarly inexorably. We have analyzed immediate effects, such as a rise in the (sterling) cost of fuel, if, as most economists expect, sterling were to continue to depreciate in the event of a Brexit. Other effects would come through more gradually. Economic evidence suggests that the price of most products is determined importantly by, in addition to input costs, competition, economies of scale, and technological progress. The aviation industry is no exception: modern fuel-efficient aircraft, high load factors, elevated daily utilisation rates, and competition on routes, have all served to lower prices. At the same time, and but for the interruption following the 2008/09 Global Financial Crisis, growth in most of the economies in Europe has raised real incomes and thereby people’s capacity to pay for holidays abroad. In the event of a Brexit, many of these processes would be checked or perhaps even reversed.

A tourism sector widely hit with long term effects on aviation

Currencies exchange rates is not the only factor that would affect tourism over the long term.

The EU recognises that tourism is a powerful way to create jobs and boost wealth in peripheral, relatively poor, regions. The European Regional Development Fund contributes to projects that improve the infrastructure and tourism appeal in locations such as the Highlands and Islands of Scotland, Northern Ireland and rural Wales. Britain is a large contributor to Europe, but it also benefits from a number of programs, and would lose these infrastructure funds.

Some, perhaps surprising, suggestive evidence from recent surveys is that Brexit is in itself likely to discourage tourists from travelling to the UK, and not just from Europe but from the US too.

And we can go further on indirect impact. EU citizens who live in Britain have kith and kin; at present more than a quarter of inbound arrivals are classed as visiting friends and relations. Although such visitors spend less on average than ‘pure’ tourists, they still leave behind around £5bn a year in payment for accommodation, etc., along with the associated tax contribution. If the number of foreigners working in Britain were to fall, then it is reasonable to expect a commensurate decline in tourism revenues. People from overseas working in the UK (and their families) sustain a significant number of flights to and from Britain. If some air links were to end, the number of tourists coming to the UK would likely fall (and the choice for British travellers keen to go abroad would also shrink).

In a nutshell, the perspective of an exit from Europe bring huge uncertainty and risks for unclear rewards. No one can present precise figures, first signals of volatility and drop in currency exchange rate which results in a globally negative perception by most financial and industrial sectors.

Of course, regulations and bilateral agreements with European partners will be adapted to this new situation as the UK is too big a partner to ignore. Heathrow airport is a major European hub and will continue to be.

But over the short term, in the process of an exit, it is very likely that airlines and therefore travellers will experience negative effects.

On a longer term it is more difficult to predict, but tourism industry analysts are very pessimistic. If the sector is affected over a long term it will have consequences on airline activities, number of flights and ultimately flight fares for British people.