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Analysis & Opinion
04.09.08 The Sky Is The Limit
By Sergei Balashov

Russia is home to some of the world’s longest domestic flights, with a trip from Moscow to Petropavlovsk-Kamchatsky or to Vladivostok stretching over 4,000 miles. The prices for domestic flights are just as enormous. While it currently costs a little over $400 to fly from New York to Seattle and back, a roundtrip ticket from Moscow to Krasnoyarsk, a route roughly 300 miles shorter, costs $200 or more on average. Economy class tickets for longer routes, such as from Moscow to Vladivostok, start at $700, and run as high as $1,400 to get to Russia’s easternmost region of Chukotka.

Airlines are putting the blame on skyrocketing jet fuel prices, which have jumped over 40 percent this year alone to reach over $1,200 per ton. Russia is the world’s second largest producer of oil, the primary ingredient used for making jet fuel. This fact raised legitimate questions over the reasons behind such high prices, yet there was no serious debate on the subject until a Russian airline alliance found itself on the brink of bankruptcy.

AirUnion, composed of KrasAir, Domodedovo Airlines, Omskavia, Samara Airlines and Sibaviatrans, became Russia’s first airline alliance when it was set up in 2005 by these five air companies, three of them partially or fully controlled by the government. The alliance had to halt its scheduled flights due to fuel supply cutoffs by fuel filling stations after its debt amounted to over $1 billion.

“The prices themselves weren’t the problem,” said the Director for Marketing and Development of the Kortes Information Center Pavel Strokov. “Coordination between the airlines and the jet fuel market is nonexistent. They expect to get a three months notice about a hike in jet fuel prices so they can adjust the ticket prices to cover these costs. It doesn’t happen and we don’t have hedging mechanisms to insure these risks.”

“They don’t ask not to hike the prices, they just want to know about it,” added Strokov.

High fuel prices alone are not seen as the reason behind AirUnion’s demise. Despite having been kept in the dark about the price increases, the company had to have enough operating funds to pay off its debts and keep the flights on schedule.

“This airline alliance has been having problems for two years now,” said Evgeny Ostrovsky, General Director of the Airport Fuel Supply Trading House, AirUnion’s largest creditor. “The high fuel prices are just an excuse, the situation is really tough but if we look at other companies in the market they’re still flying and dealing with it.”

The government took steps to provide fuel for the troubled airline by ordering the state reserve to supply AirUnion with 24,000 tons of fuel, which should suffice to keep the airline running for now.

But AirUnion’s problems have had a positive effect by bringing to light the situation in the Russian jet fuel market. High prices and a lack of coordination were just two of the problems uncovered. A monopoly on the jet fuel market has apparently been exposed, but one that appeared not due to a lack of jet fuel producing companies, but because of the lack of government regulation—the reason behind the almost uncontrolled growth of jet fuel prices.
“The market is so monopolized that it’s becoming manipulated,” said Ostrovsky.

This monopoly exists on two levels, as the wholesale market is controlled by a handful of oil companies: LUKoil, Gazpromneft, Surgutneftegaz, Rosneft and TNK-BP. The retail business is dominated by fuel filling companies. “In the civilized world, their business is storing fuel and filling, and here they resell fuel,” Ostrovsky said.

To make things even harder for domestic customers, export has been a priority in this market. “Outside markets are seen as a guaranteed outlet area,” said Strokov. “Producers were thinking: if I can get it out of the country and if you want me to sell it over here, you have to make it profitable for me.”

As a result, airlines have had to deal with ever-growing fuel prices, while the end customers are the ones to shoulder most of the burden. Strong demand for flights creates the room needed for substantial increases in fuel prices, making the ticket prices as high as they currently are.

“If five years ago, the jet fuel costs made for 25 percent of the ticket prices, today its share has grown to more than a half,” said Ostrovsky.

Russian airlines’ operating expenses are substantially higher than those of their foreign counterparts. According to Ostrovsky, in lieu of the growing oil prices, the operating expenses of foreign airlines increased from 14 percent five years ago to the current 34 percent, while in Russia, this number has grown from 25 to 40 percent depending on the airline to over 60 to 80 percent. “Jet fuel makes for the bulk of these costs,” he said.

Even before the AirUnion crisis unfolded, Prime Minister Vladimir Putin strongly encouraged the Federal Antimonopoly Service to look into the situation in the jet fuel market and review the activities of the oil companies and filling stations. The aim was to break the monopoly of the latter and to strip them of the right to resell fuel. “If we set aside AirUnion’s problems, every airline is in the risk group today,” said Strokov.

“This monopoly poses a major threat, the consequences of which will be very serious,” said Ostrovsky. “If this keeps going on for a while longer, everything will start to collapse.”

Ostrovsky sees setting up a commodity exchange to sell jet fuel produced by oil companies as an efficient tool to keep prices reasonable. The Antimonopoly Service has already started investigating five jet fuel producing oil companies. Some results have already been achieved, as fuel prices in Moscow have gone down by about $150 to $1,040 per ton.

Some of the airlines have already reacted to this decline. In early September, Transaero announced that it was lowering its prices by an average of three percent for domestic flights and 1.5 percent for international flights. The airline stated that lower jet fuel price was the sole reason behind this move.

“Maybe AirUnion’s trouble will actually be helpful, it will prod the government to set the rules for the market,” said Strokov. But until then, affordable domestic flights remain a rather distant possibility.
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