Dave thanks for a couple of good points on this - information I was not aware of - just a couple fo comments below:
longer sector lengths use more fuel per seat per trip This is irrelevant in terms of the fuel surcharge - the fare already incorporates a pricing element for fuel so simply having a longer trip does not justify a differential
Sorry this obviously needs more explanation as you have confused two issues here that need to be separated. The first is whether increased fuel prices should be included in the base fare or whether they should be surcharged. This was discussed here (for the benefit of other members)
http://www.frequentflyer.com.au/community/travel-news/fuel-charge-ignites-debate-15644-2.html
The second issue is how much fares (or surcharges) should increase/decrease to cover changes in fuel costs which I will try to give some insight on here.
The first thing to be aware of is that the spot price of oil (and movements thereof) bears little relationship to what airlines pay for jet fuel. This is primarily because of hedging - airlines buy most of their fuel in advance (or more accurately lock in the fuel price well in advance). So for example when oil was at $147 per barrel and all the pundits were predicting $200 it seemed pretty prudent to buy a ton of jet fuel at $100. Note that there is a "Crack" between the price of crude oil and refined products (e.g. jet fuel) which has also been widening over past few years from about $5 to $20 per barrel so $100 fuel = $80 crude. Back to the example the downside is that when oil is back to $40 our generalised airline is still paying $100 until its hedges expire (which is typically a few months). All hedging does is smooth the volatility in oil prices, not protect against high prices for ever and it comes at a cost - think of it like insurance. If you could accurately predict oil prices and consistently make a profit from hedging you should do that rather than run an airline.
The second thing is that in recent history fuel surcharges or fare price rises did not cover the increased cost of fuel (net of hedging) because the market would simply not take it and people will stop flying ("own price elasticity of demand" for students of economics). Let's say that in normal times an airline is making a decent profit on SYD-MEL and SYD-APW and the fuel cost per seat is $50 and $150 respectively reflecting the relative lengths of these routes. Let's say oil prices triple but because of hedging the fuel bill for the airline only (!) doubles. The airline puts on a surcharge of $30 domestically (SYD-MEL) and $100 internationally (SYD-APW). The airline is $20 per SYD-MEL sector worse off (less profit) but $50 in the hole on the longer sector (SYD-APW).
Next let's say that oil prices recede, and after a few months as hedges expire, the cost of fuel to the airline also starts to come down. After a while the actual surcharge (or increased ticket price) if held constant and cost of the fuel may actually meet. At this point the airline has forgone more profit on the longer sector (SYD-APW) than the shorter one (SYD-MEL) for some time. There are two ways (or combinations thereof) the airline can recover this profit. One is to cross-subidise from the more profitable shorter route. The other is to keep the surcharge for a while on longer on the longer sector. As per my previous post these sorts of decisions also have to be made with regard to the different competitive and regulatory environments. But back to my original point that simongr picked up - there are several reasons why surcharges are different for longer sectors than short sectors.
Anyway, hope this has given some insight into the tricky business of how to manage prices (whether fuel surcharge or inclusive prices) in the face of volatility in cost of fuel. Frankly the media has too much fun beating up the airlines about falling spot prices of oil not been reflected in surcharges or ticket prices, than to actually try to educate travellers. Even the journalists who actually understand the issues realise that a beat-up and inflaming public opinion sells more papers than a rational explanation of the situation. Am I just wasting my time here too?
CrazyDave98