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Thursday
Mar032011

Oil and Water; Jet Fuel and Labor

On June 25, 2008 I blogged asking the question:  Is Oil A Cancer Or A Cure?  At that time, the price of a barrel of oil had not yet reached its apex of $147 per barrel, but was well on its way.  Based on findings by the Air Transport Association’s superb economic analysis team led by chief economist John Heimlich, the U.S. airline industry paid the equivalent of $174.64 per barrel [price of a barrel of oil plus the equivalent cost to refine crude into jet fuel (the crack spread)] on July 11, 2008.  By December 23, 2008 the price of a barrel of West Texas Intermediate had fallen to $30.28 per barrel.  So far in 2011, we’ve seen a similar surge in oil prices, but based on current geopolitical events, I am not expecting another $117 drop in the price of a barrel of oil like we witnessed in 2008.

I’m actually wondering what happens if the wave of Mideast political upheaval washes over Algeria? Or Saudi Arabia? Some economic experts say the price of oil could rocket past the $200 threshold.

In 2011, the industry has paid an average of $89.15 per barrel of crude and another $25.80 in the crack spread for a total cost of “in the wing” jet fuel of nearly $115 per barrel.  Since February 22, 2011 the industry has paid more than the equivalent of $120 per barrel for jet fuel.  On March 1, 2011 the industry paid the equivalent of $132.17 per barrel for jet fuel including the crack spread of $32.54.  For all of 2008, the industry paid the equivalent of $25 per barrel to refine crude into jet fuel.  In the last five days of trading the crack spread paid by the industry is nearly $30 per barrel. 

That’s a lot of numbers, so let me put this in a way that might shock even the most ardent follower of the airline industry: Today’s cost of just refining oil into jet fuel is roughly equal to the total jet fuel price per barrel paid by the industry every year between 1978 and 2001.

1978 – 2001

The mindset of many airline stakeholders - and particularly labor - is based on the period between 1978 and 2001.  Deregulation began in 1978 and 2001 marks the beginning of wholesale industry restructuring. .. which actually should have started 24 years earlier.  To put this period into an oil perspective, over the first 25 years of a deregulated industry, the equivalent per barrel price of jet fuel was $28.93.  Oil was cheap (more than four times cheaper than in 2011) and it was the basis for the industry to grow too big, too fast.   After all, the biggest “uncontrollable cost” was a blip.  There was little change in either the price of a barrel of crude or the crack spread.

Based on analysis at MIT's Airline Data Project, between 1978 and 2001, the industry grew nearly 2.5 times in terms of available seat miles.  Traffic grew faster than capacity.  The great enabler in the growth in addition to the cost of jet fuel was the fact industry yields, or the amount the customer pays per mile, declined by 39% when adjusted for inflation.  Domestic yields fell by an inflation-adjusted 41 percent over the same period.  In other words, cheap seats. The price of an airline ticket was one of the great consumer bargains.  This fact ultimately led the network carriers to refocus their operations on international flying because their high cost structures struggled to conform to the realities of the domestic market economics.

As the industry added capacity, employment grew by nearly 220,000 full-time equivalents.  During the same period, the total cost of an employee to the industry declined by eight percent in real terms.  I can hear it now, ”no way – my salary is significantly less.”  Yes, it is true salary costs when adjusted for inflation have decreased. On the other hand, the cost of pension and benefits paid to airline workers has grown at a rate faster than inflation.  The cost of an employee to a company is not based on salary alone.

Over the 24 year period being discussed here, it is true that employee productivity in terms of available seat miles per employee and enplanements per employee increased 44 percent and 30 percent respectively.  Much of that is again driven by cutthroat competition driving prices downward in order to stimulate demand.  Here is the kicker.  The number of available seat miles produced per dollar spent on labor fell by 42 percent.  Or, labor is producing more output but the cost of that output is increasingly expensive.  This fact alone was unsustainable and the restructuring process was used to address the underlying economics.

Many areas of the income statement were addressed by managements over the period with the most noteworthy being the decision to stop paying legacy commission rates to travel agents.  This action alone saves the industry nearly $6 billion dollars per year although we can also say that the savings are largely competed away in the form of lower fares.  Food and advertising expenses were also reduced.  Each of these cost areas, like labor, is considered controllable costs.  Oil is not.  What the industry did realize over the period was a 30 percent efficiency improvement in the consumption of fuel.

2002 – Today

As 2001 came to a close, unit costs at the network carriers in the face of free falling unit revenue became the story.  US Airways was the first carrier to file for bankruptcy.  United was second.  And American followed with an out of court restructuring.  Each carrier had extremely high overall unit costs relative to the industry as shown by the MIT Airline Data Project.  The ADP also shows the three carriers were out-of-market with respect to unit labor costs relative to the industry.  The network carriers mentioned simply had costs so high, there was no choice but to seek some sort of a consensual restructuring either through bankruptcy or out of court if they were to live and fight another day.  The scary part is, oil was still reasonable during this time. The industry jet fuel price per barrel equivalent as restructuring commenced was $30.07.

While jet fuel prices are uncontrollable, so too is airline pricing, particularly in the U.S. domestic market.  Since 2001, the industry has only increased capacity by 2.5 percent as capacity discipline became the mantra.  Again traffic grew faster than capacity as inflation adjusted yields fell another 12.5 percent.  The nominal level of capacity growth can be attributed to the growth in regional carrier and low cost carrier flying.  Since 2001, mainline carriers have shed nearly 24 percent of their previous domestic capacity with nearly one-third of that capacity removed since the 2008 fuel spike.

Capacity cutting was all that was left in the face of high oil prices.  When carriers delete capacity, they also eliminate jobs.  Since 2001 the industry has shed nearly 155,000 jobs – a period when the jet fuel equivalent price per barrel averaged $73.08.  Labor productivity has improved significantly as the network carriers restructured.  But as I’ve talked about before, the problem with a seniority-based system is that average costs increase as the less expensive employees are the first to be let go.  In 2002, when the restructuring began, the average cost of a full time equivalent airline employee was $74,910.  Today, the average cost of a full-time equivalent employee is $83,869.  More troubling is the benefit and pension package for full- time employees in 2001 cost $11,560.  Today, the cost of that package is $18,195 reflecting seniority as well the country’s inability to reign in medical costs. 

So Here We Sit

The history of pattern bargaining - and resultant expectations - between labor and management was created on a basis of $30 per barrel for jet fuel.  Today, the cost of jet fuel is the equivalent of $132+ per barrel.  Yet labor doesn’t seem to acknowledge the fact that times – and oil prices – have changed.  There are 52 airline cases under the auspices of the National Mediation Board and I will wager few, if any, of the labor negotiating teams consider oil a major factor in a future contract. It’s “management’s problem.”

Well, it’s also labor’s. While the industry has been creative in finding new revenue to address the reality of fuel costs, consumer pass-throughs generally lag behind the rise in the price of fuel. The bigger issue, the one labor has trouble admitting, is the size of the revenue pie is finite.

Oil is uncontrollable and therefore difficult to predict how much of the revenue pie it will consume.  Cost reductions in many areas of the operation have already been largely realized.  And that’s where oil prices become labor’s problem.  Employees – rightfully - want their share of the pie, and they’d like to make-up the concessions of the past.  The problem is the pre-restructuring high water mark, when oil was around $30, is what labor wants to return to. That’s not possible and it’s certainly not sustainable.   

I have heard it said many times, "labor is not going to subsidize the price of oil again".  Well, truthfully, labor didn’t the first time. When restructuring began and adjustments to labor costs were realized the price of jet fuel was not the issue.  It was declining revenue.  After much pain inflicted on virtually every stakeholder group over the past decade, $100 per barrel jet fuel is the new reality.  Expectations of returning to the past should be forgotten.  I like to use history, but history is useless in evaluating this industry because the fundamentals that now govern the industry’s structure like oil and the economies of China and Germany and Brazil are new and rapidly evolving.

I had someone say to me the other day that shouldn’t we throw away the past and just start again making this apex the new reality?  The simple answer is yes.

Monday
Dec272010

Time to Look Forward – Not Back

Historically,www.swelblog.com has taken space this time of the year to reflect on the biggest stories of the year. In this column, I want instead to spend more time looking at issues that will be important in 2011.

First, the look back: 2010 began with me taking sides in the battle for JAL and siding with the ultimate victor, American.  We wrote about the National Mediation Board, wondered aloud whether the labor-friendly Obama Administration would permit an airline strike given the fragility of the economy. We challenged Captain John Prater, President of the Air Line Pilots Association, on multiple fronts, offered a favorable perspective of the controversial Chairman and CEO of United Airlines, Glenn Tilton, and looked at mainline pilot scope and the pilot unions’ associated rhetoric. We challenged Southwest to put its money where its mouth was in the proposed slot swap between Delta and US Airways and noted Continental’s contract offer to its pilots that offered Delta wage rates plus $1 per hour. We laid out why we did not like the proposed United – US Airways merger; criticized the tarmac delay rule, pondered the American and jetBlue tie up at New York’s JFK airport; applauded the United and Continental merger and argued that American and US Airways will be fine in a consolidated world – at least for the foreseeable future.  We questioned why the airline industry was losing numerous battles in Washington, the looming threat from carriers in the Middle East,  the price of regulation in terms of what is a public good and lobbed yet another challenge to now ex-Congressman James Oberstar. We also weighed in on the Export-Import Bank; the Southwest – AirTran merger; the national elections; and questioned the need for the number of commercial air service airports in use today. We explained why pilot picketing and other union activity revealed only part of the labor quandary at US carriers, and predicted that foreign ownership restrictions will be the subject of ongoing debate.

Meanwhile, we only touched on airline profitability – a nice change, but noted with caution as three quarters do not make a trend. The airlines are doing what they should be doing in de-leveraging their balance sheets, with consolidation occurring not just in the mainline sector, but beginning to reshape the regional sector as well.  Oil was less of an issue in 2010, with price volatility muted compared to the prior two years. And the revenue picture brightened, particularly coming off a dismal 2009.  Finally we saw pivotal votes rejecting unionization at Delta, although the jury is still out whether labor’s defeat there was due to something unique to Delta or a broader referendum on a union’s ability to improve the lives of dues-paying members

Thanks to all of you who are regular readers and those who check in occasionally, readership was up significantly in 2010 and I hope you continue to read in 2011.

LOOKING FORWARD:

LABOR:  Labor promises to remain a significant story in the coming year.  There is new leadership at the Air Line Pilots Association; the Allied Pilots Association; and the AFA-CWA to name a few.  While it is hard to predict whether things will change at the largest flight attendant union, AFA-CWA, after multiple terms under Patricia Friend, I am confident that changes in leadership will benefit the pilots represented by both ALPA and the APA.  This is not to say that I expect either of the unions to roll over, but believe that there is much to gain for both sides in a constructive dialogue that was too often absent in the previous union administrations. It is safe to say that the terms served by Captains Prater and Hill did more to set the unions back than advance the pilot profession.

The NMB will remain on my watch list.  We could see action sooner rather than later at American, where Larry Gibbons, Director of the Office of Mediation Services, will now oversee the negotiations that have been underway for several years. Will the NMB become even more political as Gibbons sits closer to the board members than do other members of the team he oversees?  Will the Board play a crucial role in facilitating new and joint agreements at Continental – United?  Will the Board side with the unions in determining whether Delta interfered in the IAM and AFA representation elections as the unions allege? Ultimately, the unions will determine how aggressive they need to be to leverage the support of employees at the merged carriers anxious about recent changes in working conditions and how the seniority list is constructed.

It is clear that the industry will be watching as Delta manages one of the least-unionized workforces, particularly as former union members from Northwest are brought into the fold. One might say that the hard work is now done as the votes have been cast and the election is over.  But I say the hard work is just now beginning.  It won’t be that long until another election can be called.  And the difficulty of the task is highlighted by the civil war between the work groups at US Airways that continues into yet another year.  It seems unlikely that the legal issues dividing the merged pilot groups and pilots and management are near resolution. All eyes will be on United CEO Jeff Smisek and Southwest CEO Gary Kelly to see how they manage culture change at their bigger, more complex carriers.

Finally, look for organizing activity to increase at other airlines.  The losses at Delta will make the unions hungry for increased membership and recent changes to federal election law under the Railway Labor Act make it easier for union to win a secret ballot election.  Already unions are targeting jetBlue and SkyWest –where unions lost past elections under the old rules.  If the Delta vote is a referendum on the former Northwest employees not being content with their union, might there not be opportunities for the International Brotherhood of Teamsters to begin raiding select work groups?

FUEL:  As I write, West Texas Intermediate is trading at $91+ per barrel.  As Southwest CEO Gary Kelly, put it, volatility in fuel prices is the industry’s “No. 1 challenge” and “the single biggest threat to aviation.”

The price of oil is sure to be a story in 2011.  Goldman Sachs, the firm that predicted $200 per barrel oil in 2008, is predicting $100 per barrel during the first half of 2011.  Given growing confidence that economic recovery is finally taking hold and the levels of new industrial production activity in the Asia-Pacific region that often drives market oil prices, $100 per barrel seems reasonable. 

Here at Swelblog, we were among the first to suggest that the best thing that happened to the US and global airline industries was oil at $147 per barrel, which more than anything else served as the impetus to reduce capacity from an industry that had grown too big.  If oil prices continue to climb, it will serve as a discipline on any efforts to add marginal capacity to the system, particularly in the domestic market.  And this time around, a Southwest does not enjoy the same hedge book and fuel cost saving potential v. the industry as it had when oil prices surged in the 2004 – 2008 period. 

Should oil continue its rise, we will begin to see further reductions in small community air service.  For many communities, a fuel surcharge on top of what many believe are high fares will test the price elasticity of even the more inelastic customers - who will take to the highway as their first point of access to the air transportation grid.  This would be a healthy outcome for the industry that is still arguably over-connected.  Rising oil prices – along with regulation imposed costs that will come to fruition in 2011 - should be a catalyst for continued consolidation in the regional sector.

If fuel prices rise, the passenger carriers will likely be successful imposing fuel surcharges to fares, just as the cargo carriers were in the past.  Southwest may not charge for bags, but even they will have to consider fuel surcharges this time around.  That is a big differentiator for the US airline industry in 2011.  What makes this tricky is that the US consumer was long conditioned to paying fares based on industry costs of $30 per barrel in-the-wing jet fuel.  The industry has adapted.  At $95 per barrel the industry begins to be tested yet again.

WASHINGTON:   the Air Transport Association has a new leader in Nicholas E. Calio, a former Citicorp executive with keen bipartisan skills. Calio becomes the new President and CEO of the industry’s trade group on January 1, 2011, hoping to turn the airline industry fortunes after some trying legislative and regulatory losses in 2010.  With new costs and operating constraints posed by rigid new tarmac delay rules, increased passenger compensation for overbooking, a new push to have a total cost of trip (fare and fees) made known to the purchaser, proposed constraints on regional carriers,  changes at the NMB, investigative actions by the FAA, the rejection of the slot swaps between US Airways and Delta, and the loss on appeal of the right of airports to implement congestion pricing, airlines are hoping for kinder, gentler treatment in Washington in the new year.

In a recent media release, the ATA said it was pleased with the recommendations of Secretary LaHood’s Future of Aviation Advisory Committee.  I am assuming this will prove to be a blueprint agenda for Calio and his team at ATA.

And with Oberstar now gone from the House Transportation and Infrastructure Committee, new Chairman John Mica (R-FL) has an opportunity to make some headway on relevant and important issues that threatened to make US aviation a second-tier player in the global industry under the misguided direction of the former chairman.

I am encouraged by the leadership changes taking place in the industry and hope that we can finally have a discussion on issues with a mindset on positioning the industry within the global sphere.

CONCLUDING THOUGHTS

The industry’s work is far from done.  Progress on consolidation, cutting capacity, new technologies and efficiencies, and re-balancing labor costs have dramatically improved the cost structure in the industry, just as anti-trust immunity, open skies agreements and global partnerships have improved revenue opportunities for US carriers. But work must continue on alternative fuels and reducing the impact of aviation on the environment and ensuring that the airline industry is not paying more than its fair share of the tax burden.

There are still barriers to better operations on the labor front as well. Union leaders need to decide once and for all how to address the split between mainline and regional flying all the while securing/maintaining some form of scope protection their members expect.  A good start would be to stop the charade that this is a 76-seat issue.  The mainline does not want that flying because they will not accept the rates necessary to do the flying.  Once again, labor did much to create the problem, now it is time that they figure out how best to fix it.

Finally, it is time to stop playing politics with the FAA Authorization bill and put together a clean bill to address the aviation infrastructure.  Let’s get rid of the pet projects loaded into a bill that should be designed for efficiency.  And airlines and airports need to figure out how to work together.  The debate should not be about an increase in the PFC but the extent to which the industry has a say in how the money is spent.  Just as airlines need to be positioning themselves to succeed in a global industry, airports that add little to no value to the airline map of tomorrow should not be spending precious money building out an infrastructure that may not be used.

Let’s hope that in 2011, we can stop living in the past and look toward a strong future for the US airline industry. We have to get our impediments fixed at home to prepare for the next upcoming competitive battle for advantage in the global market.  For some this next competitive battle will be much tougher to win.

Happy New Year. 

Thursday
Feb182010

Patience and Perseverance: Tilton Walks It Like He Talks It

There is no way to describe United Airline leader Glenn Tilton other than resilient.  He is disliked internally by organized labor and questioned externally by nearly everyone who has an eye on this industry.  He has taken his role as the industry spokesperson seriously, perhaps more seriously than anyone before him.  We listen intently to Giovanni Bisignani, the CEO of IATA.  But we do not listen enough to Tilton. Why? Because Tilton’s is a message of change not cluttered by this industry’s history, and some people don’t like the message.

Tilton was quoted shortly after United ended a three year stay in bankruptcy: “If I were able to draw a visual image of the beginning (of bankruptcy) to today, it would be one continuous experience of knocking down internal and external barriers.”  In his role as chief spokesperson for the US airline industry as Chairman of the Board of the Air Transport Association, Tilton waxes philosophical about the barriers that impede the industry’s natural evolution.

I have a long history at United and knew the “old company” well.  United epitomized all that was wrong with the US airline industry prior to its bankruptcy in December of 2002.  One of Tilton’s predecessors as CEO, Stephen Wolf, did some very good things along the way that provided United with its global roots.  But even Wolf did little to address the company’s bloated cost structure and a management bureaucracy that often resulted in paralysis.  For every cubicle in Elk Grove Village, one could find at least one silo. 

Tilton cares less about the history of United than its future.  His history lesson was a short one – whatever structure in place when he arrived in 2002 did not work and therefore needed to be changed.  If Tilton was wed to preserving United’s legacy, then he likely would not have taken the same course in fundamentally reshaping the company. He would not have taken on the pilot union, ALPA, over its actions to disrupt United’s operations – winning an airtight legal victory for management that ranks among the most significant victories in decades.  Rather he would have permitted bad behavior – or paid the pilots to stop behaving badly - just as prior administrations had done. 

Today United is a lot smaller, with a mainline operation 30 percent smaller than it was 10 years ago.  For this, Tilton takes a lot of heat.  As the pilots union watches its ranks diminish, ALPA constantly reminds Tilton that an airline cannot shrink its way to profitability.  This may have been true in United’s past, but on Tilton’s watch growth will only occur if it is profitable growth.  It is hard to envision a day when United will again have 12,000 pilot equivalents on the payroll.

Tilton and others recognize that the industry is still too big.  In the most read Swelblog article to date, Montie Brewer makes a clear case that the industry’s capacity-lead business model is the number one reason why the airline industry will never be profitable over a sustainable period.  Also weighing in on the subject is Professor Rigas Doganis who writes about over capacity in Airline Business.  According to Doganis, the airline industry is inherently unstable and airlines have only themselves to blame for the constant state of oversupply and the downward pressure on fares that result.

Doganis goes on to discuss how airlines are “spasmodically” profitable, quoting Tilton on the fact that the industry has "systematically failed to earn its cost of capital."  This is a fact that has long bothered the former oilman.  In a recent speech to the Wings Club in New York, Tilton raised the industry’s continuing and daunting challenge: “How to navigate to sustainable profitability in light of our financial instability.”

In London he made the point again and differently:  “Volatility and losses have been the norm for this industry, as has our systemic failure to earn our cost of capital and achieve any level of consistent financial resilience. The industry has lost nearly $50 billion worldwide since 2000 and a staggering $11 billion last year alone.”

Tilton at United – From Hands On to Chief Strategist

One can be sure that when Tilton arrived at United in September 2002, he had little idea just how bad things were.  But he would soon find out.  Three months after his arrival in Elk Grove Village, United landed in a downtown Chicago courtroom for more than three years as the company restructured itself.  There were mistakes along the way.  There was some bad luck along the way particularly as it pertained to rising values in the aircraft market.  There was the decision to terminate employee defined benefit plans, which among other things permanently damaged Tilton’s reputation in the labor ranks, but enabled the airline to get the exit capital it needed to start anew.

As United exited bankruptcy protection in February 2006, oil prices were on the rise.  The company restructured itself around $55 per barrel oil – a price that was fast becoming a memory and a bad assumption in the company’s plan of reorganization.  Company performance – operational, financial or otherwise – was nowhere near expectations set based on an entity that had spent three years fixing itself.  For either right or wrong reasons, Tilton kept many of United’s legacy management team around to complete the bankruptcy process.  What he belatedly came to appreciate is that leadership at the company had to change – and change it did.

United mainline is much smaller today than it was the day it emerged from bankruptcy.  Tilton oversaw its downsizing in bankruptcy and continued the work as oil prices climbed.  But he also recognized that he was not the guy to handle the day to day operations. Like any good restructuring guy, Tilton knew to hand over the operation of the company to others on the executive team, particularly  John Tague, Kathryn Mikells and Pete McDonald.

And the plan seems to be finally working.  United is starting to produce some good results.  There might be a lesson here for others in the industry, including the consideration of whether CEOs should delegate the day-to-day functions and concentrate on their role as the company’s chief strategist.  Just as pivotal, in United’s case at least, was Tilton’s decision to focus on tearing down the barriers to change – something all industry CEOs should consider in improving the financial prospects for a once proud industry relegated to underperformance, in part by the stakeholders who benefit from its inefficiency.

Tilton and Government

In one way or another, Tilton delivers the message that “no matter how well United or any U.S. carrier transforms its business, none of us will be as strong as we should be - much less in a position to compete in the emerging global aviation industry - if there's no change to the regulatory environment in which we operate.” Without a coherent U.S. aviation policy that “reverses the bias against airline size and removes the barriers that prevent us from constructive consolidation, U.S. carriers will be unable to compete on a global scale and we risk being marginalized,” Tilton said.

Among the questions for the industry, as Tilton outlined in a talk to the UK Aviation club, is what motivates the protectionists’ view of the industry.  “What is it that they are “protecting? A chronically underperforming industry?” he asked.

Concluding Thoughts

For what it’s worth, I focus on Tilton not because of his work at United but because of the message he delivers and its relevance to the rest of the industry.

As I predicted in my last post, February 2010 has been a significant month for airline news – some of it good and some of it bad like government’s call for slot divestitures in the USAirways – Delta slot swap.  It appears likely that oneworld will get permission to compete on an equal footing with the STAR and SkyTeam alliances.  This is the necessary next step to ensure inter-alliance competition as we think and talk about the industry’s structure going forward.   Tilton is a huge proponent of alliances who quickly recognized that one airline cannot be everything to everybody and that network scope and scale can be economically garnered through partnerships that leverage each member airline’s strengths.

Tilton also remains a proponent of consolidation.  His voice is growing increasingly louder on the subject of cross-border mergers and the flow of capital based his belief that the US and the European Union should move forward on Phase II of a transatlantic agreement and pave the way to permitting cross border commercial activity in the airline industry.  As Tilton noted in his UK speech, “capital is global and doesn't have sovereign inhibitions."

Like him or not, Tilton rarely shies away from stating his views, even at the risk of ruffling some stakeholder’s feathers.  For Tilton, too many people focus on the past rather than the future and what needs removed in order that the industry can continue to evolve. That evolution may continue to prove painful for some in the industry as Open Skies and re-shaped alliances bring new competition all the while presenting new opportunities for agile and nimble operators.

Tilton’s role, like that of the Anderson, Arpey, Smisek , Parker and other airline CEOs, is to serve as agents of that change and find a way to balance the demands and interests of labor, shareholders and other stakeholders that depend on a robust, profitable industry.

 

Note:  I hold stock and options in Hawaiian Holdings, Inc. as a result of my Board position.  I also hold stock in United Airlines accumulated at various points in time since the company emerged from bankruptcy.

Tuesday
Jul282009

Propagating Harm: Senators Boxer and Snowe; and Kate Hanni

The festering issue of whether to enact a Passenger Bill of Rights is on its most aggressive track, both publicly and in Congress. Last week the Senate Commerce Committee approved its version of the FAA Reauthorization Bill. Tucked inside was the Boxer-Snowe amendment, which resurrects the Airline Passenger Bill of Rights nearly two years after it first reared its ugly head on Capitol Hill.

Among other things, the Boxer-Snowe version requires airlines to let passengers off of an aircraft that is delayed on the tarmac for three hours or more.

I ask, is this really a cause for Congress? Is this “issue” worthy of all the angst we see in articles like in the USA Today, which is to my eye drafted to drum up controversy replete with anecdotes and devoid of the relationship to the sheer number of flights consumers enjoy.

It is anecdotal and emotion driven by a populist appeal that seems to be driving this debate. With the airline industry already in fierce competition for customers and revenue, my bet is that the industry is more than capable of addressing this issue on its own as evidenced in the recent focus on operational results. But Congress too often seeks a legislative solution where the private sector should prevail, as we’ve seen before and will unfortunately see again. And in these cases, it is clear that the law of unintended consequences is alive and well.

At MIT, I am fortunate to work with learned academics and industry experts who produce a volume of impressive research on airline operations and performance and schedule recovery. Among it is some interesting data that shows airline schedule planning may actually propagate the kind of air travel delays that has some in Congress pushing bills that very likely will add to, and not ameliorate the problem.

Professor Amy Cohn of the University of Michigan is a Sloan Industry Studies Fellow researching the passenger airline industry. Her research illustrates that plans that look good on paper often do not perform well in practice. Cohn argues that, with the complex nature of airline networks, a little “slack” built into the schedule actually improves performance – but offsets the benefits of system optimization. Much good work has been done to make this capital and labor intensive industry as efficient as it can be, particularly given the many variables that affect performance – from a crew member calling in sick, to a mechanical problem, to a geopolitical event, or to the weather.

Consumer Benefits of Airline Schedules Have Been Significant

Schedule planning has provided a wide range of benefits – primarily for consumers. Over the past 20 years, passengers have seen connecting times fall significantly – which is particularly important to those who do not live in hub cities and face a combination of flights to get to their desired destinations. This opaque airline practice has resulted in more productive time for the airline passenger. It has helped to make airlines significantly more efficient because time saved on the ground translates into money saved for the airline. These cost savings have also been passed along to consumers in the form of lower fares

In addition, schedule optimization has permitted added frequencies to non-stop destinations, providing consumers a wider array of departure times and, in some instances, a wider choice in carriers and hubs.

All Anecdotes, Few Facts and Little Analysis

Federal legislation like the Passenger Bill of Rights proposal could significantly undo the progress the airline industry has made. And the real shame is that the legislation borne of one unfortunate delay and an angry but media darling passenger activist named Kate Hanni is the product of anecdotal, and often unsubstantiated evidence rather than serious analysis. Anecdotes produce sensationalist stories like the one in the USA Today. But real research tells a different story. According to the Air Transport Association and the US Bureau of Transportation Statistics, all but one of the airline efficiency metrics are at their best levels since 2000, including flight cancellations as a percent of domestic departures, on- time arrival rates, mishandled bags, customer complaints, and taxi-out times in excess of three hours.

So why the focus on an arbitrary three hour time limit? Why not two hours? Why not three hours and 17 minutes? As it is, the legislation now in Congress is designed to affect no more than .014 (1q’09 according to ATA) percent of domestic passengers. Of that small subset of passengers, who, if anyone will actually benefit from the legislation? Well that depends on how many of those passengers would rather wait a little while more in hopes of getting clearance to take off, and how many would prefer to return to the gate and call it a night and risk the ultimate arrival. Now I will add that in order to wait out a delay, there is a rightful expectation of a fully functioning aircraft and onboard amenities that allow a bearable experience.

Who Wins?

The truth is, you can’t legislate smooth travel conditions. Weather is a reality and weather causes delays. And yes, delays add to the angst of travel and wets the appetites of those in the media that thrive on the travails of travel. In those cases of severe weather and flight irregularities, some fliers may be happy just to wait out the delay if it means getting to their destination. A return to the terminal, after all, just adds to the chaos for later flights as the airline struggles to get crews on planes and passengers on their way. And the issues propagate. Imagine the mood on a plane queued to take off following a weather delay if the pilot suddenly announces that they are headed back to the terminal because Congress says they have to. Whose “rights” does that protect?

What Does This Have to Do With Reauthorization?

Of the .014 percent, or the .01 percent of domestic departures during the first quarter of 2009, of domestic passengers impacted by tarmac delays greater than three hours, shouldn’t we also be asking how many of those delays could possibly be laid at the feet of Congress and the government because they did not keep their promise of upgrading the air traffic control system? That’s a legislative solution that would benefit all airline passengers, every community and the industry itself. Whereas the USA Today article was largely sensationalistic with its statistical story and included vignettes about crying babies and the like, at least the reporter talked to an airline and a knowledgeable consultant about the old and inefficient air traffic control system.

The USA Today article rightly makes this case. "Because of the antiquated air-traffic-control system in which we — and every airline — operate, we're restricted as to the operational improvements we can make," Bryan Baldwin, spokesman for JetBlue Airways, told the newspaper

Aviation consultant Michael Boyd said airline CEOs "should form a conga line" to the FAA and demand the country's air-traffic system be modernized. That could increase airspace capacity and reduce the number of waiting planes.

That alone would do far more to reduce congestion and delay than would a phony and likely counterproductive passenger “bill of rights.”

Don’t get me wrong. The airlines deserve some blame here. We would not be facing the prospect of such a ludicrous proposal if the airlines did not fail their passengers and fail them more than once. But remember, they do operate nearly seven million flights per year - significantly more than when competition was born. Their failures pale in comparison. Passengers could, and have, experience serious repercussions from a prolonged wait on the tarmac – whether from lack of food, water, medicine or simply the need to get off the plane and attend to personal matters. But that is an issue that can be solved with a directive, a renewed focus on customer service and basic human comforts, not a piece of legislation that certainly will result in unintended consequences. Airlines and airports are making progress on that front and addressing delays that they can control. But last I checked, weather was not among them.

This issue needs study – a very detailed study – and it sure as hell is not the 2008 ARC study - on the issues . There is a solid foundation of scholarly work to build on and adapt that work to this particular issue. Those that perform the study need to understand how airline operations work and then determine how an airline can best address the anecdotes (outlier events) given the unique constraints placed on airlines, airports and the air traffic system each and every day as there is no one size fits all solution that seems to be called for in the ill advised Boxer-Snowe legislation.

The real issue is in the root cause of airline delays, and the answer will be found to incubate in the air traffic control system. The FAA reauthorization bill comes around only once every so many years. Is Congress going to use this opportunity to pass a meaningless “protection” for a few passengers, or take a bold step and do what it takes to build a better air traffic control system for the good of all?

I thought the administration was going to take parochial interests out of legislation. This legislation should be about funding the FAA in order to modernize the air traffic system and increase its safety – not tarmac delays; not propping up a non-essential Essential Air Service program; and certainly not about anti-trust immunity.

More to come on these issues.

 

The next post will examine the baseline of pay and productivity issues the airlines face as labor seeks to return compensation lost from past negotiations.

Wednesday
Sep102008

Horton Says American Means It

Last month, in a blog post Begging ……. The Questions, I wondered aloud if the US industry, that had announced capacity cuts in July as crude touched $147 per barrel and jet fuel approached $180 per barrel "in the wing", would rollback their capacity cutting plans as oil prices have dropped nearly $40 per barrel since.

At least in Ft. Worth, announced capacity cuts will be actual capacity cuts. Tom Horton, American’s CFO said the domestic capacity cuts are permanent in an interview with the Associated Press. Horton touches on two important cost benefits that will be realized by the decisions his company is taking: 1) the fleet being retired is not efficient from a fuel consumption perspective; and 2) older aircraft require much greater expenditures to maintain.

American Airlines has been aggressive in its capacity planning and has been joined by United and others. Airports around the air transportation system will certainly point to the fact that oil has dropped significantly in the past two months. But we cannot lose sight of the fact that the price of crude oil is only part of the equation; remember the crack spread or the cost to refine crude oil into jet fuel.

The industry is still paying roughly a $140 per barrel equivalent for jet fuel. On average, the industry spent the equivalent of $90.93 per barrel for jet fuel in 2007. It is the difficult management actions that are being undertaken like capacity reductions, ancillary fees and additional employee dislocations that are giving Wall Street some hope that the industry just might be profitable in 2009. But, that all depends on the actual condition of the economy doesn’t it? And I am not sure we can even get an accurate temperature read today.

A Demand Prism?

Let’s not lose sight of the important guidance the cargo side of the business gives to the passenger business despite the fact that they are very different business models. It was the cargo sector that first warned of a slowing economy earlier in the year and the effects it saw on its business outlook. The cargo business addresses more traffic that is demanded on a just-in-time basis and as a result is less price-sensitive. The cargo business is a more leading indicator of things to come. The passenger business sells a significant level of its product well ahead of the actual delivery and tends to be more price-sensitive for a majority of its demand.

Last night, William Greene of Morgan Stanley wrote a piece on Federal Express. It was entitled: Weak Guidance Highlights Cyclical Pressures. And I quote: "Cyclical headwinds clearly a challenge for earnings. As we noted when we downgraded FDX shares back in late July, we struggle to find a compelling reason to own parcel stocks. Although lower fuel prices have pushed off some of our secular concerns about a permanent modal shift, a global slowdown is undermining one of the few remaining areas of strength – international. Moreover, air fuel surcharges are still high from a historical perspective and domestic volumes remain under pressure."

A couple of things in closing. Oil is down but still 50 percent higher after the fall than the average price paid in 2007. And, passenger airlines now face the reality of economic forces and the actual health of consumer’s pocketbooks as the peak travel season just completed was sold in February and March of this year. Fuel coming down is good for all of us, but its fickle nature should not be ignored. Nor should it suggest that the hard decisions made by the industry earlier in the year to park capacity are no longer necessary.

Interesting too is Greene’s assessment that international markets might be weakening. Does the cargo sector offer a prism for the passenger side of the business? I think so and you do not have to read aviation news from around the world everyday to reach that conclusion.

I must say I am amazed that I have not read any uneducated and uniformed reporting to date that suggests that the capacity cuts are not needed given the fall in crude oil prices – but I am sure that I will. Maybe even one written in 2002?

More to come.

Monday
Aug182008

Begging ……. The Questions

I don’t know about you, but the Air Transport Association’s prediction of a 6 percent slump in Labor Day travel caught me a little off guard. Sure I did expect a decline, but not on that order of magnitude. Demand is impacted by both price and service. Moreover, we will not begin to feel the reductions in service until after Labor Day. Is this a sign of things to come and why most of the US’s largest carriers are targeting capacity reductions in the 10-13 percent zip code?

If this is the case, can we as an industry not lose sight of some very fundamental and important issues during this slowdown as we have in the past?

1. Immediately after 9/11, somehow we all forgot that the nation’s air traffic system was a national embarrassment and remains so. What should be transparent in its role everyday was made a daily headline. When capacity was being reduced and demand slowed, there was an opportunity to continue work to address this fundamental issue. This is not about slot auctions and other band-aid approaches; it is high-time that we address what is fundamental to the efficiency of the nation’s commercial airline industry that impacts nearly every cost center. Embedded inefficiencies that burn more fuel can no longer be ignored - let alone tolerated.

2. Just because the price of oil has come down off of its July 11, 2008 high, does not mean that the network surgery planned for the fall and winter should become an elective surgery. Rather it is mandatory surgery that has been put off too long. I share Bill Greene’s [Morgan Stanley’s airline equity analyst] concern that the oil price drops will somehow cause some airlines to vacate the announced capacity reduction intentions.

3. The US airline industry has been forced to address multiple macroeconomic issues throughout its deregulated history. This time, can we put the customer at the top of the list and make air travel a value proposition again? It is not just about price and now is the time to demonstrate that fact and begin the process of affecting consumer attitudes and expectations – in the right direction. Simply, make them feel that they are getting more for more, not less for more.

4. In keeping with that theme, can we please recognize that the air travel experience begins and ends at an airport. We talk ad nauseum about airline alliances. Shouldn’t there be an unstated airline-airport alliance? If airlines are going to reduce service, then the service at the remaining airports should match the product that the airline(s) serving that airport market are trying to sell. It will increasingly be in the best interest of both the airline and the airport to make the customer experience the very best it can be otherwise accept the fact that the customer will access the air transportation system via the highway and fly another airline.

5. Whereas I understand the need to be judicious with cash and liquidity, non-existent non-aircraft capital expenditures by the US industry need to exist again. Honestly, if there was going to be foreign capital employed in any of the transactions being considered, it was my fervent hope that the capital would have been dedicated to upgrading the product. If the industry is to justify higher prices, then we really need to invest in the product. Sitting in a ratty airport holding area to board a flight with coke for sale and no movie to watch just does not seem to be the long-term solution.

As demand slows, it is a perfect time to assess the passenger experience from beginning to end. Different approaches and processes can be tried in a less-taxed environment. Airlines could even begin the process of differentiating their product from another. Maybe we could even begin to recognize the difference of services and amenities in a STAR alliance-dominated airport from a SkyTeam-dominated airport from a oneworld-dominated airport from a Southwest-dominated airport.

I do not pretend to have all of the answers because I do not. But I do believe in the adage that says where there are problems, there are opportunities. In the past, opportunities have been missed. This time, any opportunities missed may result in something significant being lost. No matter what we do, it all comes back to the fundamentals. The fundamental product this industry sells is the seat that carries an air travel consumer from A to B.

So, I guess I am begging that we address the fundamentals while facing the problems at hand - and there are many and my short list is not intended to be exhaustive. But, without customers there is no industry - or at least one that we can all be proud of.

Tuesday
Jul152008

Speculation, Consternation and Regurgitation

First, the regurgitation. In writing this blog, I am often amazed at which posts receive the most attention and the posts that do not. The one post that continues to amaze me in its interest by readers around the world is the piece I wrote in March of this year entitled: Invoking the Force Majeure Clause: Oil Taking Its Toll.

In that post, my primary intent was to challenge the contracts between the mainline carriers and their respective regional partners. Some took it that I was taking a swipe at labor contracts and implied that was the sole reason I wrote the piece. It is the contracts between the mainline and regional partners that are beginning to receive a lot of attention. I will say that I am happy to see significant cuts being undertaken by those carriers that makeup the regional sector of the US industry as they largely received a free ride as the industry restructured post-9/11.

Consternation

Just what to do at Midwest? This is a most difficult decision for labor as well as the private equity in the deal. What is true for Midwest is that it fits the mold of those carriers that have liquidated thus far. Labor is being asked to give amounts similar to what their legacy brethren gave during the bankruptcy period relative to their current payroll. This really does seem to be a tired attempt by restructuring firm, Seabury, to employ the same tactics that it tried at America West, US Airways, Northwest and Air Canada with moderate success. But those carriers possessed some scale before the cuts ultimately won and Midwest does not.

If Midwest does file for Chapter 11 protection, can the company prove that its labor rates are non-competitive and therefore require immediate relief to implement a successful plan of reorganization. I am just not sure that they can as the labor bill at Midwest is just simply not big enough to offset the increase in the price of fuel. Can Midwest cut back to a skeleton of its current self and find a profitable core that can survive oil’s assault on the meek? From what I can tell, it is going to take a hell of lot more than trying to trot out the same old playbook that was used when oil was $30-40 per barrel.

Seabury’s tactics lack for creativity in an environment that is entirely different. Unlike the prior restructuring period, labor is not the only issue at Midwest. In fact labor may be only a very small issue, if an issue at all. I will let you draw your own conclusions based on the analysis of US carriers just completed by MIT’s Airline Data Project by assessing stage length adjusted labor unit costs and stage length adjusted non-labor unit costs.

Can Spirit be far behind?

I am of the view that this period’s force majeure will be liquidation.

Speculation

It has been interesting to see how various organizations, writers, bloggers and keen observers have come down on ATA’s campaign to rid the markets of possible rampant speculation when it comes to oil prices. For one who firmly believes in markets over the long term, there is some trepidation regarding which side is right as both sides make very compelling arguments regarding their views.

But I do not believe that ATA and the industry is suggesting that speculation is the sole cause of the rise in the price of oil. I do not believe that ATA and the industry discount the enabling issues surrounding demand; I do not believe that ATA and industry discount supply issues or infrastructure issues; nor do I believe that ATA and the industry discount that certain world economies and organizations that produce oil have every incentive to do very little as it is simply not in their best interest.

A friend, Frank Gretz of Shields and Company in New York writes a weekly letter to his clients entitled: Equities Perspective. I am fortunate to get to read Frank each week and I found his comments this week on commodity stocks and oil most interesting.

“When it comes to the Commodity stocks, and Oil especially, even the likes of Warren Buffett tell us that prices are being driven by demand, not speculation. Certainly, the demand is there, but so too it would seem the speculation. From a demand standpoint, China has accounted for roughly 80% of the world’s incremental oil consumption over the past couple of years, a time during which the commodity climbed from $50 a barrel. Clearly there is something to the idea of “China-driven commodity demand.” But similarly, back in 2000 there was a real demand for Cisco’s routers and, more recently, a real demand for housing – the poor immigrants and all. But we all know that there was plenty of speculation in Cisco at $84 and no money down housing, and the same seems true now of commodities. An environment of negative real interest rates is particularly conducive to the speculation we have seen in different sectors of the economy and asset markets – NASDAQ in 2000, housing in 2006 and commodities now. Of course no one complained when speculation was driving up the NASDAQ stocks or the price of their house, but when the price of food and gas goes up, we’ll have none of that speculation.”

Just like consolidation activity was never going to be the only answer to the airline industry’s ills, defusing speculation is not the only answer to the steep, upward trajectory of the price of oil. But it just may be a part of the problem that leads to focused action on other aspects of the energy issue as well, like: alternative sources of energy; increasing supply by considering actions previously thought as taboo; better understanding the demand for oil; make a priority of addressing infrastructure needs in order that supply might better match demand.

I do not even pretend to know of the necessary solutions here. But I am confident that there are many forces at work and if highlighting one might lead to progress on other fronts, then it is an approach worth taking. But I sure wish we did not have to ask Congress for their help as I fear that the ask might bring into play a less than desired outcome. On that note ………

Tuesday
Jun172008

10 Airline Issues That Have My Attention

Note: at 634pm I made some minor edits to the orginal post. Immediately after posting, a personal issue arose that required immediate attention. I apologize.

But before we go there I will share my favorite headline of the week gone by: Congress, get off your gas, and drill!

1. Crandall

It is interesting to me that Gordon Bethune has gone quiet for the most part and has now been replaced by Crandall. The entire industry recognizes what Crandall recognizes and that there is little obvious cost cutting that remains other than capacity cuts and that the revenue line must become the focus for the industry. The interesting note to all of Crandall's suggestions for some form of reregulation is how US airline labor generally, and American Airlines' labor specifically, are hanging on his words of late. Is it Crandall the leader or the suggestion of reregulating the industry? Crandall the leader would not be handing out big increases in compensation in this fuel environment; yet Crandall the re-regulator is the silver bullet that would enable the industry to charge enough for an airline ticket to offer a return of the concessions and still employ all 400,000+ people that remain in the industry?

2. IATA Annual General Meeting

Mark Pilling of Airline Business writes Airline bosses call for strict capacity discipline following IATA’s Annual General Meeting last week in Istanbul. This piece is good reporting on the differing levels of cuts being considered around the globe. With the US undertaking the most aggressive actions: Europe is now beginning the process of how to react; the Asia-Pacific carriers are exiting some routes but redeploying capacity to other more promising routes; and the Middle East is continuing on their aggressive growth path. Is the industry serious about capacity discipline this time and will we really put capacity down as a reaction to outside forces and inherent inefficiencies? Or is this just a time out?

3. Labor PR and of Course Fuel Does Not Matter

I did not think I would see ALPA take a page out of APA’s tired play book, but they have. On Sunday night, the following appeared: labor Relations Darken at Hawaiian Airlines. But my favorite story in this topic area was written last week as Continental pilots picket for higher pay, benefits. I have no issue regarding a union’s right to picket. But I do have an issue with yet another irresponsible statement from a labor leader. In the Continental story, Captain John Prater, President of ALPA is quoted as saying: “Don't try to use the price of gas," said Prater. "The industry is unstable, and the only way to add labor stability is through a solid contract." What does that mean? Of course the price of gas will have absolutely nothing to do with the outcomes of negotiated agreements John [emphasis added]. With so many things happening in the interesting Hawaii market, I only wish I could write on some of them.

4. European Carriers

Over the last few months, stories have been appearing that suggest the underlying fundamentals in the European market are weakening. Austrian Airlines has suggested the carrier will seek a strategic partner. We all know of the woes at Alitalia. Among the Big 3 in Europe, British Airways has been warning of turbulence ahead for the carrier in the face of high oil prices and the carrier’s exposure to the weakening US market. And now there are even rumblings from Lufthansa and Air France/KLM. For each of those two carriers the revenue synergies have been captured through their acquisitions. Now there will be a renewed focus on costs. Finally, the US is not alone.

5. Asian Carriers

For me, things were starting to get interesting in this critical world region immediately following Singapore’s earnings announcement in February that was less than stellar. Then Cathay Pacific suggested it would begin to curb capacity growth. Then Qantas. Each of these carriers has a place on the list of global elite airlines and are not immune from the environment either. AFP reports that Oil costs will push some Asian airlines under: analysts. Thinking about it, this region’s airlines carry passengers long distances and we know that the price of fuel and long-haul flying are not in concert today in all markets. In the article it is suggested that the region’s airlines are not close to doing enough and that SARS-like capacity actions should be considered in some cases. With or without high oil prices though, this region is certain to lose airlines along the way given its early stages of development.

6. Boeing and Airbus – A Couple of Things

Julie Johnnson of the Chicago Tribune writes that Foreign carriers' woes could hurt jetmakers. I have heard that some deliveries will be deferred. Certainly today’s issues will only prolong the needed replacement programs for the US industry, except for Southwest, Continental, AirTran and others. The manufacturers and lessors cite the fact that aircraft can be quickly placed into another carrier’s portfolio if positions or newer generation aircraft come available. But we still have not felt the full effects of the economy’s headwinds in my judgment.

At the same time the manufacturers are doing the industry no favors by perpetually delaying the delivery of the new generation aircraft that promise significant efficiencies and fuel savings. I found it most interesting in Continental’s announcement last week that it would park its older aircraft but continue to take delivery of new aircraft. This will be a story to watch.

7. Liquidity and US Airline Equities

Bill Greene, Morgan Stanley’s airline analyst, published another very good piece of research today where he continued to write on his tipping point theme. He writes: Too soon to begin buying US airlines, in our view. "As we’ve written in the past, we believe that amid the current macro backdrop, airlines will not become attractive investments until the industry reaches a Tipping Point - when extremely bearish fundamentals trigger broad, acute financial distress and restructuring that leads to significant capacity reductions (beyond current announcements); thus, serving as a very bullish catalyst for shares in surviving airlines. After updating our estimates for $130/bbl oil, it appears that a Tipping Point catalyst is more a question of when rather than if."

In Greene’s liquidity analysis of his tipping point theory, some very interesting findings are expressed. I have written often of liquidity concerns and that this period’s focus will remain firmly on the balance sheet and the cash flow statement. Yes we are in a cash burn scenario yet again. As Greene analyzes the airlines he covers, he points to the steeply downward sloping liquidity positions for each of the carriers assuming $3.81 jet fuel and taking into account all fixed obligations between now and the end of 2009.

Through 2009, he ranks the US airlines he covers from worst to best in terms of liquidity: US Airways, and a need to raise $1.5 billion to maintain a liquidity balance equal to 10 percent of last 12 month revenues; American, and a need to raise $2.6 billion to maintain a liquidity balance equal to 10 percent of last 12 month revenues; Northwest, and a need to raise $856 million to maintain a liquidity balance equal to 10 percent of last 12 month revenues; Continental, and a need to raise $260 million to maintain a liquidity balance equal to 10 percent of last 12 month revenues; United, and a need to raise $290 million to maintain a liquidity balance equal to 10 percent of last 12 month revenues; Delta with no need to raise cash; and jetBlue, with no need to raise cash.

8. Continental's Announcement of Capacity Cuts

Last week, Continental described in detail its planned capacity reductions. Can we learn anything from their list as we look toward the detailed cut announcements to be unfurled by United, American, Delta, US Airways and others as we approach fall? Markets with leisure attributes that demonstrate little to no hope of being able to charge for the full cost of fuel, let alone all other expenses associated with carrying a passenger from A to B will either be eliminated or cut back significantly. Long-haul regional jet flying will be scrutinized, and reduced, as Continental cut a number of these city pairs. City pair routings of a highly seasonal nature might be totally eliminated during the shoulder season. And while much has been made of the shift to international flying, Continental certainly demonstrated that underperforming international markets will be cut as well. Finally, the elimination of service to certain cities that offer little hope of ever being profitable were dropped from their network map. Distinct patterns will develop as other carriers make their announcements.

9. The Mixed LCC Bag

Samer A Majali from Royal Jordanian was named the new Chairman of IATA. In an interview where he discussed issues confronting the global airline industry, he stated that fuel prices to hit budget airlines the hardest. In the US we have witnessed this very issue. We have seen ATA liquidate; Skybus liquidate; Frontier file for Chapter 11 reorganization and still searching for capital; and just recently Sprit announced that it will begin to cut capacity and headcount. This is not a very good time to be a "bottom fisher". AirTran and jetBlue have each sold aircraft and/or delivery positions to bolster liquidity. A question to ask: what will Southwest do when it has to run an airline instead of a trading desk? Will Southwest become the savior for big leisure-oriented markets like Las Vegas and Orlando and will these will be the markets that “fuel their growth”? Southwest is the one that scares me on the capacity discipline issue.

10. Those Frothy Commodity Markets

Today, the Air Transport Association called on Congress for U.S. curbs on oil speculators. I just get nervous when this industry calls on Congress for anything as it seems to be an invitation for layering on more favors that tend to make this industry even more inefficient than it is. But I do understand the need to investigate anything and everything that could help in the jet fuel area.

Finally and based on my previous post, the world’s best golfer was crowned yesterday. Only issue is - he had already been identified.

Thursday
Apr032008

Fuel Up, Forecasts Down and Labor at American Airlines Drills a Dry Hole

Crude Oil/Jet Fuel 101

There will be a time down the road when we will all stop talking about the high price of oil and thus the high cost of jet fuel and the resultant impact on the US and global airline industry’s ability to sustain profitability. But that time is not now.

I will put the impact of fuel costs in some historical perspective. During the second quarter of 2000, the industry paid 1.25 cents per available seat mile (ASM) for fuel and 3.50 cents per ASM for labor. By the fourth quarter of 2007, the industry was spending 3.50 cents per ASM for fuel and 3.00 cents per ASM for labor. At 1 billion plus available seat miles flown in 2007, you can do the math.

John Heimlich, the Chief Economist of the Air Transport Association, keeps us up to date on ATA’s website, http://www.airlines.org/, on energy/fuel issues facing the US airline industry. For serious industry watchers, if you don’t have a link to John’s work on your list of favorites then I suggest that you add it now.

It Is More than the Price of Crude

On the site, Mr. Heimlich regularly updates the presentation entitled: “Coping With Sky-High Jet Fuel Prices” in which he points out very clearly that the price of crude oil is only part of the cost for the airline industry. Heimlich reminds that the industry pays a premium, known as the “crack spread,” which is the difference between the cost of a barrel of crude oil and what the industry pays for crude oil refined into jet fuel. Until, hurricanes Katrina and Rita, the industry historically paid a crack spread price of $5 per barrel. In his initial forecast for 2008, Mr. Heimlich forecasts a crack spread price of $25 per barrel.

That $25 of crack spread forecast for 2008 is roughly equivalent to the cost of a barrel of crude in each 2001 and 2002. Simply stated, at a cost of $110 per barrel crude oil, the industry would pay an all in, or “in the wing,” cost per barrel of as much as $135. According to Heimlich, just last week the New York Harbor price of jet fuel topped $145 per barrel, including a crack spread nearing $35 per barrel.

So the pain the average driver feels at the pump is even worse for the airline industry. Heimlich points out the difference in his analysis comparing gasoline to jet fuel. Whereas the difference between the two was $2 per barrel in July 2007, today jet fuel is $29 per barrel more expensive than gasoline. Even with the many industry efforts to improve fuel efficiency, Heimlich forecasts that airlines will pay in excess of $55 billion for fuel in 2008 -- more than $14 billion more than the industry paid in 2007, without consuming so much as a single gallon more.

Many believe that raising fares will fix all. Yes, fares have increased some. But Heimlich shows that, all told, fares for the first two months of 2008 are 2.4 percent less than the average fares for the same two months in 2000. Over the same period, fuel costs have risen 198 percent.

Revised Forecast

As Heimlich was updating his fuel analysis, Brian Pearce, Chief Economist for the International Air Transport Association, was revising his 2008 global forecast – for the second or third time. Mr. Pearce’s initial outlook, issued early last year, predicted that the global airline industry would see a profit of nearly $10 billion in 2008. In September 2007, Pearce revised his profit forecast downward from $9.6 billion to $7.8 billion, citing both fuel costs and the beginnings of the credit crisis.

Only a few months later, in December of 2007, IATA revised its global forecast down yet again. But that revision caught many by surprise based on its sheer magnitude: in less than a year’s time, the IATA forecast a global airline profit of $5.0 billion – a 36 percent reduction from the previous forecast. Now, only yesterday, Pearce again revised his outlook downward by another 10 percent to $4.5 billion in his report “Stagflation Threatens The Outlook.” It is worth a complete read, but his first three points are powerful:

Our previous forecast in December projected a downturn in traffic and profitability for the airline industry this year. Since then the situation in the US economy has deteriorated and jet fuel prices have risen sharply. Stagflation has returned, a damaging combination of forces to which the airline industry is highly exposed over the year ahead.

The uncertainties facing us are far greater than usual. If central banks fail to reverse the credit crunch the outlook, particularly for the US industry, could be far worse. Our next forecast in June will be able to take a clearer view on the extent of the economic difficulties. In this forecast we have taken a conservative approach to cutting our profits forecast. We now project net profits of just $4.5 billion this year.

US consumer confidence slumped in March to levels consistent with a serious recession. The bursting of the housing market bubble leading to falling house prices and sub-prime mortgage defaults has led to a deepening crisis in the financial sector. The resulting credit crunch is now damaging the wider economy.

Now Let’s Turn to American Airlines’ Labor Issues . . . Yet Again

At this point, AA is in negotiations with all three of its unions, so it’s no longer only the Allied Pilots Association attracting news coverage. This week, it was Transport Workers Union, which represents maintenance, ramp and other workers. Yesterday, Trebor Banstetter of the Ft. Worth Star-Telegram reports on his blog that the union placed John Conley, Air Transport Division Director, on administrative leave. This questionable decision apparently stems from a comment Mr. Conley made at an aviation conference in which he suggested that the meteoric rise in the cost of fuel might impact the negotiating outcome in contract talks between the TWU and American.

I have met Mr. Conley and have listened to him in other public forums. I have always been struck by his thoughtful approach, his knowledge of the industry, and the care he shows for the people he represents. In this case, he simply stated the obvious. The reaction by TWU International President Jim Little is unfortunate, but it is likely one we will see more of.

Tracking the news and managing the expectations of the workers they represent is what union leaders do, or should do. But that has not been the case of late in the airline industry, where zealots and ideologues have set completely unrealistic expectations in their rhetoric surrounding contract talks. The TWU’s overheated reaction to Conley’s comments may have more to do with an ongoing campaign by a rival union, AMFA, to organize AA’s M&E shop. But if that’s the case, workers will face the unappealing choice between one union that attempts to silence one of its key officers for speaking the facts, or another that did a less-than-respectable job in representing its members at Northwest and United.

It has been said in the comment section on this blog a couple of times that I have a disdain for airline employees. As a former airline employee (and union steward) myself, nothing could be further from the truth. But I don’t have much patience for union leadership that overpromises and thus sets unrealistic expectations for members when the industry is under enormous financial and competitive pressure. Actions like this are precisely why I believe that this will be the toughest period in labor history since deregulation.

Since posting this piece this morning, I note that Holly Hegeman of Planebuzz.com wrote on the subject of John Conley’s demotion last evening. It is well worth a read.

Watch Alitalia as it is a precursor. In the US, we are witnessing happenings at Aloha and ATA. And we are still on the A’s.