Will the price of jet fuel go stratospheric?

Comparison of air fares and HSR fares used in the patronage demand forecasting modelling (one-way). NOTE: The clue to understanding this graph is the blue curve is business fares and the grey one is non-business fares

Ultimately, the bottom line in discussions about the warrant for High Speed Rail (HSR) always seems to come down to proponents’ certainty that the price of jet fuel will go stratospheric.

HSR won’t save time, won’t reduce fares, won’t increase economic activity, won’t promote decentralisation and is an extraordinarily expensive way to reduce carbon emissions – but if at the end of the day the cost of jet fuel means flying becomes ridiculously expensive, then, the argument goes, HSR is the only way of filling the breach.

There are a number of points to consider about this sort of scenario.

One is that while fuel is a significant part of the cost of flying, it’s not the whole story. At present, fuel comprises around a third of airline operating expenses, up from about 15% ten years ago. So a doubling in fuel costs will have a big impact, but it isn’t going to double fares – that would require fuel to quadruple in price (and other costs to remain constant).

Airlines could respond to higher fuel prices by finding ways to reduce their consumption of jet fuel. Aviation expert Ben Sandilands reckons “by 2036….jet fuel is realistically predicted to be at least 50% derived from algal or biological fuel substitutes….”. Others like Robert Merkel are not as convinced of the prospects for biofuels on the scale required. There’re plenty of “out there” proposals for alternative fuels and technologies (e.g. here and here) but they all look pretty speculative.

I don’t think alternative fuels have much potential at this stage but there’re better prospects in using jet fuel more efficiently. Although commercial jet aircraft speeds haven’t increased a lot over the last 40 years, the Aviation Green Paper says modern aircraft are 70% more fuel-efficient than they were in the late 1960s.

The current average fuel consumption of the world’s jet aircraft fleet is around 5 litres per 100 Revenue Passenger Kilometres (RPK), but this will improve as larger, more modern aircraft come into service. For example, a fully laden A380 consumes 3 litres per RPK and the new Boeing Dreamliner is claimed to be even better. Of course this is a mature technology so it’s unlikely historical efficiency gains can be carried forward at the same rate.

However not all experts expect fuel prices to go sky high. The Federal Government’s new High Speed Rail Study – Phase One report assumes both air and HSR fares will reduce by three per cent in real terms by 2015 and remain constant thereafter. Road vehicle operating costs on the other hand are assumed to increase in real terms by eight per cent to 2036 and by a further four per cent to 2056. None of this suggests the apocalypse is nigh.

There’s very little in the report elaborating on these assumptions but it’s as well to remember that the peak oil hypothesis does not mean an immediate end to oil production. Rather, as John Quiggin says, it means a gradual decline over 100 years or more (international oil production has been stable for the last seven years).

But what matters most according to Professor Quiggin is that the peak in world consumption took place back in 1980, when it was 5.3 barrels per person per year:

Since then, consumption has dropped to 4.4 barrels per person per year. Given the growth of demand in Asia, consumption per person in the countries that were already rich in 1980 has fallen much faster. Meanwhile living standards have risen substantially, unconstrained by declining consumption per person of oil, and of energy more generally.

It could be that improvements in the efficiency with which oil is used in other applications – like road transport and manufacturing – where there are better substitutes available or greater scope for efficiency improvements, will leave enough “room” for jet fuel prices to remain within tolerable limits. This would of course be determined at an international level, but as a guide to developed countries, note that the aviation sector accounts for only 11% of all petroleum-based fuels used in Australia.

Even if air fares were to go stupid, Government could subsidise them directly for much less than it would cost to build HSR. Assuming operating costs are fully covered by fares, the capital cost of the proposed east coast HSR network is circa $130 billion (i.e. $108 billion, plus 15% procurement costs, etc) and is estimated to carry 54 million passengers a year in 2036. Assuming a real discount rate of 7%, the capital cost of HSR represents a subsidy from Australian taxpayers to HSR travellers of around $170 per trip. If the average trip is 250 km (three quarters of trips are by regional residents), the subsidy would be around 67 cents per kilometre. That’s sizeable – the excise tax on petrol for motor vehicles is around 3.5 cents per kilometre.

There’s also another way of looking at this. Various costs rise (and fall) over time, there’s nothing new about that (I’ve just looked at my latest electricity bill!). People make adjustments, they adapt. If the cost of flying rises, people will travel less. Non-business travellers will tend to stay closer to home, perhaps driving their hybrid or micro car to a local destination rather than flying to somewhere more distant. Business travellers will cough up whatever it takes to fly if the trip is important enough (how else will they get overseas?) but they too will prioritise and forego marginal trips, possibly relying more on electronic communications instead. There would have to be a very, very good reason why any industry or group should get a subsidy to offset the impact of higher oil prices, whether that subsidy is direct or via infrastructure like HSR.

Of course there’s doubtless some conceivable level of oil price where the cost to productivity would be so extraordinarily high it would be worth spending public money on either subsidising air travel directly or constructing High Speed Rail (although there might still be better alternative investments). Nobody knows what that level is although I suspect it’s a long way north of the current price. For the moment, I take some comfort from the view of the HSR experts who reckon air fares will remain much the same in real terms for the next 25 to 45 years.

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