Why doesn't cheaper jet fuel mean lower airfares?

Airlines estimate they will save up to $20 billion this year in jet fuel costs, but passengers are unlikely to see cheaper airfares.

Travelers might expect price relief in the skies equal to what they are seeing on the roads, especially since U.S. domestic oil output is the highest in 30 years. But several factors besides fuel—the biggest flight expense—make airfare a tricky calculation.

First, many airlines’ flights are staying full at current prices—with a record average 85 percent of available seats selling easily. Americans, it seems, are willing to pay what the market asks at levels that have increased 5 percent in one year and 31 percent over the last five years, according to government figures.

Travelers assume ticket prices are based mainly on fuel costs because that used to be true, said Robert Mann, a former airline executive who now consults for the industry. A decade ago, an airline might cut fares to sell tickets and raise needed cash by filling seats that would otherwise fly empty. But recent mergers have left four big airlines in control of about 80 percent of the U.S. flight market: United, Southwest, Delta, and American.

“Right now the airlines have a great balance of supply and demand,” said Jim Corridore, an airlines analyst for S&P Capital IQ.

Second, airlines will use their fuel savings windfall as a means of paying down debt and blessing shareholders, not reducing fares. Companies tend to buy back their own shares in flush times to increase the value of remaining stock, something Delta Airlines CEO Richard Anderson said Tuesday his company plans to do. As for passengers, Anderson touted the idea of shopping around: “The marketplace is incredibly competitive, and there are always differences in fares.”

And the third factor that influences ticket prices is future expectations. Airline know oil prices are unstable and could easily trend upwards. Oil prices have peaked and troughed quite a bit since the summer of 2008, when the per-barrel price was almost $100 more than it is now. The expectation is that oil will not stay this cheap for long, though some oil analysts believe continued booming levels of production will keep prices from climbing too fast.

To protect their budgets against fuel price spikes, most airlines buy contracts known as hedges. But if oil prices actually plummet, the hedge can lose a lot of its value. For example, Delta reported this week a fuel bill of $342 million less for the fourth quarter than it did the previous year. But it also had a $712 million loss—due to $1.2 billion in lost value of its future fuel-hedging contracts. The company still expects to save $2 billion on fuel this year, even with its hedging losses.

A question buzzing in the industry now is whether cheaper oil might actually lead to higher airfares. Though it may seem absurd, analysts wonder if consumers who are saving money on gasoline and heating bills will spend that extra cash on travel, driving new demand. Moody’s Investors Service even predicts travel demand will rise by 5 percent this year.

The Associated Press contributed to this report.