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© 2007-11, William Swelbar.

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Entries in airline issues in 2008 (1)


In Reality, There Was Only One Airline Story in 2008

Oil that is, Black Gold, Texas Tea.

This is the time of the year when many stories will be written on the top happenings in the airline industry in 2008. The economy is certainly an issue as well, but would economic conditions be what they are without the volatility in the price of oil and the transfer of wealth into the hands of a few that occurred as a result of the price rise? The volatility in the price of oil had a significant negative impact on the velocity of the global monetary system’s money supply. After all it is the combination of money in the system and the velocity of that money moving within, and throughout, the system that lies at the heart of the current economic crisis. But I digress……….

While the price of oil is some $110 per barrel off of its high set on July 11, 2008, the average “in the wing price of jet fuel (price of a barrel of crude plus the crack spread, or the cost to refine crude into jet fuel) will be on average $125 in 2008. That compares to “in the wing prices” of $90+ in 2007 and $30 in 2002 when the most recent restructuring began. Simply, it is not just the price of oil that was the story in 2008 but also the volatility in the price of oil. If anyone really believes that today’s price is tomorrow’s reality, then…..we probably do not have a lot to talk about.

I will go to my grave saying that $147 crude was the best thing that has happened to the US airline industry in the last three decades.

If not for the rise in the price of oil: #1

On the first trading day of 2008, crude oil trades at more than $100 per barrel for the first time. Consolidation chatter increased in volume among players in the US airline industry – Delta/United; Delta/Northwest; Continental/United; United/US Airways were just some of the many combinations being discussed. In each case, the price of oil was mentioned as a catalyst for consolidating the industry. Ultimately the only transaction that transpired in 2008 was the merger of Northwest Airlines into Delta Air Lines. United and Continental are working toward an alliance that they have promised to be different.

Consolidation within an industry typically occurs in one of two ways: either through a financial transaction or through financial attrition. Financial attrition has proven to be the more effective method for the airline industry as more bankruptcies have occurred in 2008 than at any time in the global industry’s history. In the US we lost Aloha, ATA, Air Midwest, SkyBus, Gemini Air Cargo, MaxJet and Eos to name some. We have Frontier, Midwest and Sun Country hanging on by their fingernails; any of which if were lost would not cause the US air transportation system to reexamine itself.

If not for the high price of oil and a nuance here or there, these smaller, undercapitalized, geographically limited and less efficient carriers would not have been pushed over the edge or to the brink.

If Not for the Price of Oil: #2

The US industry would not have unbundled its product and decided that ancillary fees should be charged. The first bag fee, the second bag fee, the soft drink fee, the pillow and blanket fee and the aisle or window seat fee all joined the change fee in airline lexicon throughout the course of 2008. Why? Because additional revenues were needed to be generated to offset the high price of oil. In the dark science of airline ticket prices - fares remain harder to increase than fees are to charge.

Southwest Airlines remains a holdout on charging its passengers fees for bags, blankets or sodas. This will continue to be a closely watched story in 2009. The concept of unbundling is proving to be a smart approach for an industry that historically has priced its product below cost with few exceptions. Yes Southwest is differentiating itself from the industry, and time will only prove if their strategy is right. The encouraging aspect is that the remainder of the industry is addressing the concept of cross-subsidization that has described this industry for far too long. Ultimately cross-subsidization means that you will pay the reaper.

If not for the high price of oil, we would not have had fare increases, ala carte pricing, unbundling and ancillary fees to talk about.

If Not for the Price of Oil: #3

The US industry would not have made the difficult decisions to cut capacity to levels not previously imagined. Or stated another way, the US industry would not be challenging the age old belief that you cannot shrink your way to profitability. Or stated another way, the US industry finally began to let the air out of its own “capacity bubble” by removing significant levels of uneconomic flying.

Discipline is not a word that can be used to describe past managers of the US industry. If not for the price of oil, the current group of managers might not have exhibited discipline as they are/have been when it comes to capacity, minimizing fixed costs and pricing either. But they are and it is encouraging that today’s managers recognize that the airline industry emulates other capital-intensive, commodity industries that grew too much in the up cycles and failed to remove uneconomic capacity in the down cycles. Even the low cost sector has been forced from its “growth for growth’s sake” posture.

If not for the high the price of oil, this industry would not have had the will to accept that the capacity bubble needed to be deflated.

If Not for the Price of Oil: #4

We would not be seeing the desperate grab for economic leverage by US airline labor as a new negotiating season approaches. We have seen corporate campaigns in the past, but this time we have seen labor reach a new low. Pilots at each American, United and US Airways have all decided in some way, shape or form to play the nuclear card. What is the nuclear card you may ask? It is safety. The use of safety by US labor, particularly pilots, is among the more disgusting tactics employed in decades.

Airlines do not knowingly compromise safety so it should not be hinted at, let alone put in lights. Honestly, competitors are never happy when a catastrophic event occurs at another carrier. In addition, this year’s corporate campaigns by US labor have also been unfurled with the supposition that labor’s fight with their airline companies is also a fight on behalf of customers as well. Surely you jest ALPA, USAPA and APA? Other than safety, air travel consumers and labor have very little in common. Consumers are not standing ready to pay even more for travel just to subsidize the $15 billion in concessions made over the past six years that labor believes they are entitled to be reimbursed.

I am continually drawn to statements by ALPA President John Prater made earlier this year when he suggested that the price of oil would have nothing to do with substantial increases that would be won by airline labor in the subsequent cycle following the industry's restructuring began in 2002. Prater, in a talk in New York earlier this year, warned Wall Street that labor is a fixed cost just like oil. At least Prater got part of it right: labor is a fixed cost. Fixed costs are what the industry must reduce if a sustainable and durable business model is to be found. Fixed costs are being removed and that is why headcount will continue to be reduced.

Another Prater comment I liked: “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." I am really not sure what the hell that means unless there is finally an ability for airlines to be flexible when countering the ebbs and flows of economic cycles and commodity price changes. In my mind, labor flexibility is among the most important issues facing every carrier in their upcoming negotiations. In my calculus, flexibility means durability and that is good for all.

If not for the price of oil, headcount would not have been reduced even further outside of bankruptcy over and above the levels achieved while in bankruptcy. With capacity cuts comes headcount reduction.

Pre-Concluding Thoughts

When we started the 2008 calendar, US consolidation was the talk. Don’t look now, but consolidation in Europe has stolen the headlines here. There is certain to be more M&A activity on the European continent as well as the loss of carriers unable to combat the global economy’s headwinds will continue.

China was the rave as a desired airline marketplace because of its emergence as a global manufacturing powerhouse. How quickly the post-Olympic economic issues are pressuring that country. The globe is now less a consumer of China-produced goods. As a result, China will be slower to develop as a consuming economy. India is worse.

The high price of oil should have been a catalyst to focus the US government on the air traffic infrastructure. Sadly, that was not the case. As I have stated here many times, I just do not get why this is not the penultimate issue where labor and management could join hands and pressure the incoming administration to make it a priority. Management would have to ask for fewer changes to collective bargaining agreements if minutes could be saved on each and every flight. Labor sells time to the airlines; and the airlines sell time to the consumers. This is the only indirect relationship I can conceivably come up with where labor and air travel consumers are joined other than safety - and in this case their interests are far from aligned.

Concluding Thoughts

Because of the high price of oil, hedge contracts will continue to be a story through the first half of 2009. The oil price pinnacle reached in July of 2008 was the absolute best thing to happen to this industry. Managements in the industry were presented with the single-biggest crisis in history. A crisis that promised to ground an industry unless immediate, necessary and legacy-busting actions were taken. The industry has found that new revenue sources could be tapped and fixed costs could still be cut.

The industry has little to cut in terms of costs other than capacity reductions. This is true going forward as well. Balance sheets are stretched thin and not every carrier is yet out of the woods. The airline model can now withstand $90 oil in a mild recession. The question remains: how high an oil price can today’s airline model sustain as we sort through the economic, credit, commodity, trade and geopolitical issues that will confront this industry over the next year?

Next to oil, the largest expense category is labor. So in addition to Oil price volatility; Infrastructure issues; Labor contract negotiations will begin to dominate the headlines in 2009. As an observer of the economics and finances of this industry, I feared for the industry as oil prices marched toward an “in the wing” price of $175 per barrel. I am just as fearful of the speed of the decline in the price of jet fuel.

I hope that we can maintain the same discipline that resulted in many hard decisions. Decisions that arguably have the US industry better positioned to confront the economic headwinds because of the immediate and decisive actions that took place in mid-2008. To revert back to same old ways of doing business - whether it is not charging consumers the "all-in" cost for travel on a going forward basis; ignoring the need to make labor more flexible/productive as the quid for higher pay; or relaxing the need to fix the infrastructure would be such a waste of energies expended since 2002.

We would not be this much closer to finding a sustainable operating model if not for the high price of oil. We really would not.

Happy 2009 to all, Swelbar