Leisure travel now feeling the pinch of soaring oil prices

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Soaring oil prices are beginning to exact a toll on leisure travel, prompting some economists and analysts to downgrade their expectations for the summer vacation season and the remainder of the year.

Last week’s release of the Federal Reserve’s “beige book,” a periodic report on U.S. business conditions, served to reinforce industry concerns. Noting that consumer incomes were being pinched by rising food and energy costs, the Fed reported that “higher energy prices also appeared to damp domestic tourism.”

The Fed found softening tourism activity in New York, Southern California and Hawaii, but reported increased activity at some resorts in the mid-Atlantic region “as families took vacations closer to home.” The Fed did not weigh in on outbound tourism.

So far, corporate travel appears to be more resistant than leisure travel to oil’s impact. And demand for some leisure segments, particularly luxury, appears to be faring better than it is for others.

Although industry forecasters had expected some slowing this year as a result of the soft economy and weak consumer confidence, they now predict that oil prices, which have climbed about 50% in the past six months, have emerged as an additional negative factor.

Airlines remain the most vulnerable industry sector by far, but analysts contend that oil’s effects are beginning to ripple further. For example, a forecast from PricewaterhouseCoopers is predicting a modest reduction in hotel occupancy rates this year as a direct result of rising gas prices.

Analysts contend that oil prices are creating problems for travel in several ways:

• Airline capacity cuts reduce the number of passengers flying.
• Higher airfares lead to lower demand.
• The primary alternative to air, the car, is being constrained by high gas prices.
• Consumer confidence is suppressed as rising energy costs eat into paychecks.   

Although there is hope in some quarters that recent oil spikes are evidence of a bubble that might soon burst, the reality for now is one of significantly higher energy prices. As a result, some economists have begun inserting an “oil factor” into their travel and tourism forecast models, with expected travel demand and hotel occupancy rates linked to changes in oil prices.

Bjorn Hanson, global industry leader at PricewaterhouseCoopers’ Hospitality & Leisure Practice, said that while PWC’s current outlook calls for hotel occupancy to come in at 62.4% this year, “occupancy would have been between 62.8% and 63% were it not for higher gasoline prices.” Last year’s occupancy rate was 63.2%.

Hanson added that room inventory, which has increased more than had been anticipated, is serving as an additional downward force on occupancy rates.

Hanson said he expected oil’s impact to be felt mainly in the leisure market for now, and some leisure segments of travel would be affected more than others. Early indications are that fly-to destinations are being affected, he said, as are longer drive-to destinations. Less affected, he said, are “leisure destinations that are fairly close to population concentrations.”

The luxury segment thus far has felt little impact from higher oil prices, Hanson said, in part because of the continuing influx of international visitors, many of whom stay in higher-priced hotels in gateway cities. Economy hotels, with their heavy reliance on leisure travelers, are being affected more than other chains, he said.

Some economists and analysts who have yet to adjust their industry outlooks as a result of oil’s recent ascent nonetheless are beginning to edge their expectations lower.  

A worsening scenario

The Travel Industry Association several weeks ago forecasted that summer travel would decline by 1.3% (as measured in person-trips) compared with last summer. But Suzanne Cook, senior vice president of research, said that since that forecast was developed, “things have probably gotten a little bit worse a little more quickly than we might have expected.”
 
She noted that although consumers have been able to acclimate quickly to gasoline price spikes in the past, “this run-up was so quick and so strong” that adjusting is proving difficult, especially given the additional factors of softness in the economy and increases in food prices.

Analysts at Smith Travel Research also are wondering if earlier forecasts for leisure travel will hold given crude’s rapid rise.

“It’s probably going to make the summer performance not quite as good as we thought it would be before this most recent ramp-up” in oil prices, said Bobby Bowers, senior vice president of operations.

Bowers, like other observers, predicted that oil’s impact would be uneven. Some markets will continue benefiting from inbound international visitors attracted by the weak dollar, he said, citing New York, Orlando and Miami.

Bowers pointed out that even though rising prices are a big problem for U.S. consumers, most inbound international tourists still find the U.S. to be a bargain because of exchange rates. The perception of low prices even applies to fuel, since Europeans are used to paying far more for gas than Americans are.

Cruise, often associated with providing strong value to middle-income consumers, might prove to be another relative bright spot. The Cruise Lines International Association last week issued an optimistic report on the sector’s prospects. Perhaps not surprisingly, 72% of consumers in CLIA’s survey cited close-to-home ports as a factor that would increase their likelihood to cruise.
 
At the same time, cruise is in something of a “limbo period,” noted Tim Conder, managing director and leisure analyst at Wachovia. He said it would be difficult to assess demand trends until cruise enters its next key booking cycle, which is still some months off.

Though industry analysts and economists expressed concern about the swiftness and scale of oil’s ascent, they nonetheless seemed to agree that the fallout, even for leisure travel, likely would be contained rather than snowballing into all-out rout.

“I don’t think we’re going to see a dramatic falloff,” Cook said. “I think consumers have reserved their valued vacation trip as the last thing that they’ll cut.”

Adam Weissenberg, vice chairman for tourism, hospitality and leisure at Deloitte, concurred. Some consumers likely will stay closer to home for their summer vacations, he said, but “I’m not certain we’ve reached the point yet where someone will cancel a week or a two-week vacation” because of higher fuel prices.

Corporate travel’s early adjustments

Although much of the leisure market is facing a challenging period, it appears that corporate travel will help take up some of the slack. Part of this divergence can be attributed to the discretionary nature of leisure travel, but timing also comes into play. As Hanson noted, corporate travel planners began anticipating rising airfares late last year and made adjustments to their travel policies for 2008 at that time.

Businesses still need to travel in order to remain competitive, said Bill Connors, executive director and chief operating officer of the National Business Travel Association. And though that reality applies to domestic travel, it is especially true when it comes to pursuing opportunities in an ever-expanding international marketplace, he said.

Connors said that rather than reduce travel, most businesses were seeking to cut the costs of trips in order to stay within budget. Any number of things can be done to “turn the valve,” he said, such as trading down to lower-priced hotels or reducing the number of overnight stays.

Connors said that some corporate travel managers might be seeking to renegotiate agreements with suppliers, perhaps by offering carrots in the form of longer-term contracts or consolidating to a smaller number of suppliers.

The direction of oil prices remains a key wildcard for both leisure and corporate travel. But even if the pressure eases, it likely will be some time before the impacts of oil’s recent surge are fully felt. This might be especially true of the airlines.

For example, it will be months before most of the recently announced capacity cuts at American, United and Continental are implemented. And even then, analysts said, airline downsizing currently in the pipeline does not yet fully reflect today’s oil costs.

Given oil’s sharp price moves just over the past few weeks, “one would need to recalibrate the cost structure and the average fares,” said Gabor Kovacs, vice president at the aviation consulting firm Morten Beyer & Agnew.

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