Air Canada 2012 Annual Report Download - page 69

2012 Management’s Discussion and Analysis
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Fuel Costs
Fuel costs constituted the largest percentage of the total operating costs of Air Canada in 2012. Fuel prices fluctuate widely
depending on many factors including international market conditions, geopolitical events, jet fuel refining costs and the
Canada/U.S. dollar exchange rate. Air Canada cannot accurately predict fuel prices. Since approximately 2007, fuel prices have
significantly increased and fluctuated near or at historically high levels. Should fuel prices fluctuate significantly or increase
significantly above current levels, fuel costs could have a material adverse effect on Air Canada, its business, results from
operations and financial condition. Due to the competitive nature of the airline industry, Air Canada may not be able to pass
on increases in fuel prices to its customers by increasing its fares. Based on 2012 volumes, management estimates that a
US$1 per barrel movement in the average price of West Texas Intermediate (“WTI”) crude oil would have resulted in an
approximate $25 million change in 2012 fuel expense for Air Canada (excluding any impact of fuel surcharges, foreign
exchange rates and fuel hedging), assuming flying capacity remained unchanged and that refining spreads between WTI crude
oil and jet fuel as well as foreign exchange rates remained constant.
Foreign Exchange
Air Canada’s financial results are sensitive to the fluctuating value of the Canadian dollar. In particular, Air Canada has a
significant annual net outflow of U.S. dollars and is affected by fluctuations in the U.S./Canada dollar exchange rate.
Management estimates that during 2012, a $0.01 strengthening of the Canadian dollar versus the U.S. dollar (i.e., $1.01 to
$1.00 per U.S. dollar) would have had an estimated $33 million favourable impact on operating income and a $54 million
favourable impact on pre-tax income. Conversely, a corresponding opposite change in the exchange rate would have had the
corresponding opposite effect. Air Canada incurs significant expenses in U.S. dollars for items such as fuel, aircraft rental and
maintenance charges, interest payments, debt servicing and computerized reservations system fees, while a substantial
portion of its revenues are generated in Canadian dollars. A significant deterioration of the Canadian dollar relative to the U.S.
dollar would increase the costs of Air Canada relative to its U.S. competitors and could have a material adverse effect on Air
Canada, its business, results from operations and financial condition. In addition, Air Canada may be unable to appropriately
hedge the risks associated with fluctuations in exchange rates.
Competition
North America
Air Canada operates within a highly competitive industry. Over the past few years, several carriers have entered or announced
their intention to enter or expand into the domestic (including regional), the U.S. transborder and international markets in
which Air Canada operates.
Canadian low-cost and other carriers have entered and/or expanded or announced their intention to compete in many of Air
Canada’s key domestic (including regional) markets and, along with some U.S. carriers have also entered and/or expanded
their operations in the U.S. transborder and leisure-oriented markets. Carriers against which Air Canada competes, including
U.S. carriers, may undergo (and some have undergone) substantial reorganizations (including by way of merger with or
acquisition by another carrier), creating reduced levels of indebtedness and lower operating costs and may therefore be in a
position to more effectively compete with Air Canada.
The proximity of several American airports in cities close to the Canadian border (such as Plattsburgh, Buffalo and Bellingham)
has also presented an additional challenge for Air Canada. Higher taxes, charges and fees for passengers departing from
Canada travelling to the U.S. has redirected appreciable passenger traffic away from Canadian airports. Low-cost carriers
based in the U.S. have and may continue to increase their capacity at these airports and attract Canadian-originating, price-
sensitive, leisure customers.
International
Air Canada is also facing increasing competition in international markets as carriers increase their international capacity, both
by expansion and by shifting existing domestic capacity to international operations to avoid low-cost domestic competition.
Given Canada’s diverse, sustained immigration levels and multicultural population, Canadian gateways such as Toronto,
Montreal, and Vancouver are deemed attractive by international carriers. Alone for 2012, foreign carriers such as Air Algerie,
Air China, British Airways, Egyptair, Korean Airlines, Lufthansa, Philippines Airlines, Saudi Arabian Airlines, and Turkish Airlines
have entered or announced their intention to enter or expand their operations into Canada.
Increased competition in the domestic, transborder or international markets could have a material adverse effect on Air
Canada, its business, results from operations and financial condition.