We note that the Isle of Man Office of Fair Trading (OFT) has decided to investigate the prices charged by the Isle of Man Steam Packet Company for Ro-Ro ferry services. The Company will fully co-operate with the OFT investigation but believes that pricing is already sufficiently controlled by provisions contained within the User Agreement between the Company and the Department of Transport. This agreement is a contract which obliges the Steam Packet to provide certain frequency and capacity of services. Significant investment targets must also be met – to date this has exceeded £80m. It also allows government to cap the annual increase in standard passenger fares and freight charges.

Freight prices

We need a certain minimum level of revenue to cover the cost of operating some unprofitable services. Freight prices provide a considerable subsidy to passenger fares and allow for a frequency and diversity of service that could not otherwise be provided. If freight prices were significantly lower, a taxpayer subsidy would be needed to ensure the current level of passenger services continued.

Freight prices are an important factor in the recent Tynwald Select Committee finding that passenger fares are “very competitive”.

Fuel prices

Sharing the cost

Fuel prices have increased at an extraordinary rate in recent years. Travel operators worldwide have struggled to contain price increases to passengers as a result. Many have introduced a fuel surcharge, as we have done, which allows some of the additional cost of fuel to be recouped as a transparent addition to fares. The fuel surcharge mechanism we negotiated with the Department of Transport does not pass on to passengers or freight the full extent of the increase in fuel prices. The table below shows the marine fuel costs incurred by the Company and how much has been recovered by the surcharge.

Year Marine fuel costs paid by Steam Packet Amount recovered by Fuel Surcharge Amount absorbed by Steam Packet Proportion absorbed by Steam Packet
2006 £3.4m £1.8m £1.6m 47%
2007 £4.8m £2.1m £2.7m 56%
2008 £9.4m £3.3m £6.1m 65%

As can clearly be seen, the Company has absorbed a significant and increasing proportion of the rise in fuel costs. Fuel surcharges could have been considerably higher if we had chosen to pass on more or all of these costs to passengers.

Inflation and price increases

The User Agreement recognises that increases in fares can only be limited to Manx RPI less one half of a percent, if costs also rise at a similar rate. The following table shows how fuel prices have risen substantially in excess of Manx RPI.

Sept 1995 Aug 2005 Sept 2008 Feb 2009
6 month average weighted cost of marine fuel (per tonne) £100 £315 £597 £515
What fuel cost would be if increased only by Manx RPI £100 £130 £148 £144*

Fuel is priced in the global market in US Dollars. As has been widely reported, Sterling has weakened significantly in recent months, from a high of more than $2.1 to £1, to a current price of around $1.4 to £1. This weakening of Sterling negates some of the Dollar based fuel cost reduction seen recently.

We could review fuel surcharges on a weekly basis and apply a price increase, or reduction, in line with the real-time movement in the fuel price. However, this would result in fluctuating fares and could mean charging or refunding the surcharge at the time of travel. Passengers would not know the final cost of their fare until the day they travelled.

Incidentally, if we had chosen to do this, fuel surcharges would have increased steadily throughout last summer – as it is they did not rise at all. That is why it is right and fair that these surcharges are still being applied.

Given that the current fuel surcharge agreement does not recover the full additional costs incurred, we were surprised that the Select Committee chose to recommend termination of an agreement which is heavily weighted in favour of passengers and freight and obliges the Company to absorb a significant proportion of additional fuel costs.

Application of the fuel surcharge

The fuel surcharge is reviewed twice a year in March and September. To stabilise fares, it is applied in arrears on the basis of the costs in the previous 6 months. Therefore, there is a time lag before surcharges are raised or reduced. As the price of fuel has fallen, we expect that there will be a decrease in surcharges at the next review in March 2009. Because of the Select Committee recommendation the existing surcharge agreement will end in May. Beyond May higher fuel costs will still need to be recouped either by a new surcharge mechanism or higher fares.

The current fuel surcharge arrangement with Government is intended to provide an element of price stability. The Select Committee recommendation to end it will cause considerable uncertainty for passengers.

An alternative to a fuel surcharge

Unlike other travel operators, we do not have the freedom to change fuel surcharges when fuel costs fluctuate because we have voluntarily submitted to a government controlled surcharge agreement. The cancellation of the current agreement will restore to us the right to impose and/or change surcharges and fares as conditions dictate.

Under the User Agreement, instead of a surcharge, the Steam Packet Company can introduce a permanent increase in prices reflecting the long term increase in fuel prices in excess of inflation. This would allow the company to recover the full cost of fuel above inflationary increases, not just a proportion as is the case with the current surcharge agreement.

If agreement cannot be reached on a new fuel surcharge, the Company may have to permanently increase fares to reflect the real increases in costs already incurred.

Key Points

• Freight prices cannot be considered in isolation as they subsidise the “very competitive” passenger fares.

• The current package of freight and passenger fares enables the provision of a reliable, high frequency service of conventional and fast craft to multiple destinations. This service exceeds the requirements of the User Agreement.

• An enforced reduction in freight fares would result in a reduction of passenger services both in frequency, and very likely, in destinations. It would also limit future investment in fleet and infrastructure. Over the last ten years there has been investment of more than £80million.

• The full impact of rising fuel prices has not been passed on to passengers or freight. The Company has absorbed an increasing amount of rising fuel costs year on year.

• The current fuel surcharge agreement provides an element of price stability and provides the flexibility that avoids permanent price increases as a result of rising fuel costs.

• The fuel surcharge calculation is based on a six-month time lag. While this may be considered unfair for infrequent travellers, for those who travel frequently over the longer term, rises and falls in the fuel surcharge are likely to balance out.

• Real-time application of a surcharge is likely to result in uncertainty of cost of travel.

• The Company is surprised with the Tynwald Select Committee recommendation to cancel the existing surcharge agreement. The Company believes this decision will result in higher costs and uncertainty for passengers.