Would you buy an airline ticket that could fluctuate in price after purchase? This is the latest innovation that airlines are considering to battle rising oil prices. Variable price tickets could solve the problem, because they would increase in price as the cost of fuel rises. This way, airlines could charge less money initially, but escape loses later if the price of oil keeps climbing. While it's easy to imagine the consumer backlash that would result when airlines start jacking up the prices of already purchased tickets, variable fares could actually make travelers better off.
This morning on CNBC's Squak Box, Bob Crandall, former chairman and CEO of American Airlines, suggested that airlines should begin considering variable fares as an option. He noted that Allegiant Travel, which owns a low-fare leisure airline in Las Vegas, is considering offering this type of ticket. Last week, the Wall Street Journal reported that the company has notified the Department of Transportation that it wants to sell variable price tickets:
Worried about rising oil prices due to unrest in the Arab world, Allegiant said it would continue offering consumers traditional "locked-in" fares that wouldn't fluctuate. But the airline wants permission to add the option of lower fares that could rise or fall by a preset limit, depending on how much fuel costs change between booking and the trip.
For example, let's say you purchase an airline ticket for $300 in March for a trip in July. If the airline determines that its fuel cost has risen by some specified amount, it may charge you more, perhaps an additional $50, to take the flight. In theory, the ticket could also decline in price -- providing the traveler a partial refund -- if oil prices fall.
The motivation for airlines preferring this sort of ticket is pretty obvious: it covers the risk they face by selling tickets in advance if oil prices rise. Of course, this isn't the only way they could escape this risk. They can also purchase financial derivatives that lock-in fuel prices for some specified period of time. That way, whatever tickets they sell over that time period could have prices based on a definite fuel cost.
The Pros of Fluctuating Tickets
A Fair Price for All
In fact, airlines do purchase such derivatives for this purpose. And while they protect airlines from prices rising, they do not protect consumers from prices remaining constant or falling.
To understand why this is a problem, let's go back to the example above. Imagine if the market predicts that oil prices will rise rapidly over the next four months. So to lock-in oil prices, the airline has to pay some premium to reflect this expectation. Let's say the ticket you buy today costs $400 instead of $300. If, in July, oil prices didn't rise by as much as most analysts anticipated, perhaps the ticket only should have cost $350. The airline would still be protected since they overcharged you for the fuel they overpaid for -- the counterparty on the derivative would have made a profit based on the excessive premium the airline paid. The loser in this equation is the traveler who paid $400 for a ticket that should only have cost $350.