04.3.2008 « 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.
Reader Comments (13)
Disdain? Naw pious yes but not disdain.
Why don’t you post your 2007 IRS 1040 form here so we can decide if you are worth the money you command.
I’ll give you some homework. Check the fares from two major city pairs for this summer with a Saturday stay. Now ship a 200 pound box on UPS from the same city pairs. For my example on AA DFW-SEA $124 and for the box UPS Next Day Air $891.60. Want to guess what the fare is on Greyhound, $114.00. That’s right for an extra ten bucks you can fly and cut two days off your trip.
No where does it say the citizens of the United States have a Constitutional Right to fly at less than it cost the airline to move that seat. The days of the airline employees subsidizing the passenger’s tickets are over. The whole industry might shrink 10 to 20% but at least Greyhound has their market share back.
Sorry but my “expectations” along with every other airline employee I see on the hotel bus is to be paid a much higher wage then we currently are. If the geniuses in the Ivory Tower can go from $30 to $110 a barrel of oil in five short years then they can tack on an extra $5 or $10 bucks a ticket for my family and me.
I won’t even delve into the lack of leadership these multi-million dollar execs don’t have.
Ok now queue the music and here goes Professor Swelbar on a three hour jaunt down MBA memory lane on market rates, competition, hub-n-spoke operations, etc, etc, etc.
C
Consider yourself spared. No Constitutional Right but competitive reality. As for pious, I thought that chitragupta determined a place in heaven or hell?
Swelbar
Airlines are in a tumultuous predicament at this moment, and unfortunately the outlook is less than optimistic. Labor leaders need to realize this and communicate the facts to their members rather than ratcheting up the "us against them" rhetoric. Given the state of the economy and the rising cost of fuel, if labor continues to place unrealistic and unattainable demands on its parent company, the outcome could prove to be as grim as the fate of ATA.
But I would be all for the us versus them if it could be channeled as the US industry versus the global industry. But there I go again, wishing or claiming hold to my seat as CEO of Air Nirvana.
Thanks for the comment.
...and by the end of April where would ATA and Aloha be if their employees had worked for free? What "unrealistic and unattainable demands" had the employees of ATA and Aloha put on their management?
Come on C
Honestly, if it were not you I would not even respond to this comment. Nothing I have ever written here suggests working for free. And you know that. And you know as well as I that even working for free at either of these two carriers would not have saved either one in the long run.
I will say that I am a bit struck that employees and other stakeholders at each carrier seem to be so surprised by their ultimate demise. What we are seeing is a microcosm of an externality and its effect on a fragmented and hypercompetitive domestic industry. And I do not think we are done, I think we are just getting started.
I know you don't want a thesis but it gets to the heart of your Constitutional Right issue. A fragemented industry is forced to have presence everywhere yet achieves pricing power nowhere. Consumers win.
Consolidating and building global networks begins the process of diversifying airline route portfolios that are too heavily weighted in the US domestic market.
While I am troubled by current events, I also believe that those that survive this transition period will have better days ahead. But you fly and understand weather better than I.
Swelbar
Bill,
Chitragupta speaks of next day air charges on UPS, yet looks at fares for travel months away. Just went to aa.com and looked at airfares for "next day" travel with a "Saturday" stay from DFW-SEA. Just looking at two combinations, one fare was $1185.50 and the other, $1383.00. It seems to me that the person needing to do more homework is the one using a screen name as that of a Hindu god.
Hey Genius,
If you were able to purchase an advance fare for that 200 pound box two months out what would it cost today? Drum roll please, the same cost. So UPS (and FedEx) have realized that they are not going to sell their product at less then what it cost to produce it. Buy it today or buy it in two months this is our cost, take it or leave it. For UPS to move your product in less than 24 hours you will pay $891.60. Walk up fare or advanced fare it doesn’t matter.
Check other city pairs and you will find the same brilliant pricing plans.
Your response to the Greyhound fare being ten dollars cheaper then the AA fare seems to be missing.
John Q. Public can ride on a bus that cost less than a million dollars to purchase, doesn’t take two drivers, doesn’t have at least three Flight Attendants to save his ass if it catches on fire or he has a heart attack, isn’t maintained by FAA certified A/P mechanics, burns a lot less fuel and to top it off takes over two days to cover the same distance for ten dollars less!
I guess you are willing to stand in the door with your out stretched wallet and reimburse your passengers ten dollars each for this outrages disservice we have inflicted on them by gouging them for more than Greyhound charges? Not me this Passenger ATM machine is closed.
While I have never considered myself a "genius," I do my research and apply some logic. Now if an individual knows he/she is going to ship a package more than 3 days in advance, let alone months, why in the world would that person choose UPS Next Day Air? If chitragupta would have done the research, he/she would quickly realize the savings that can be generated by using their 3-day service. Additionally, the size of the package changes the price to ship as well but that takes some additional research.
For instance, using the example of a 200 lb. package, I submitted two package sizes. One was a 24"X24"X
24" package and another 24"X36"X
72" [200 lb man?]. For the first example, the price ranged from $938.60 to $553.80. The range of the second one was $1,901.15 to $1,122.73.
As for my previous example, I was merely demonstrating the flawed logic being applied but it would be pointless to attempt to explain it to those who demonstrate little understanding in free market enterprise. Just a thought, but maybe a more prudent approach might be to "stand in the door" and thank passengers for flying on the flight rather than showing contempt for them on this blog, and then use a different approach to formulating contracts rather than the failed approach of APA in recent years.
Hey Genius,
If you were dropping bombs the safest place for me would be sitting on the target.
Your three day air logic is flawed because it takes three days to get there not the four hours if you flew. Why didn’t you add to your comparison the cost to ride on a stage line from DFW to SEA. You feed the horses hay and the drivers nothing but beans. Your CSM will be next to nothing and now you are approaching Swelbar’s Air Nirvana idealism. It would only take six months to get there but it fits your line of reasoning, longer is better for less cost. People fly because they can be there in the same day not three days. To get to your destination in four hours vs. over the two days it takes on Greyhound (or your three days in a 24” cube) should command a premium of more than a lousy ten bucks.
Yes I shipped a 24 inch square box just for just dead weight computations and so I wouldn’t bulk out the plane before it maxed out. I knew UPS would charge more for a coffin size box vs. a 24 inch cube, thanks for helping make my point.
We’ve all seen your “logic” in attempting to form another union to decertify APA. That and it is a sad day when even management has passed you over to be a management lackey. Not wanted by your union and not wanted by management now that is a badge of honor. You have found your blog buddies here on the web but in the cockpit there is nothing but contempt. I’ll take my fellow aviators friendship over worship of a bunch of blog owners any day of the week.
chitragupta,
This is my third attempt at constructing this message because I determined the previous two would do little to move this conversation forward. Frankly, there is nothing to be gained with personal attacks nor to spend time addressing them, so let me try this in a constructive way.
Based on the examples I provided, would you agree that the size of the package, type of delivery [Next day vs. 3-day], and weight determine the delivery cost? Would you also agree that airfares will vary based upon time the reservation is made? Those were the points I was attempting to make which, I believe, showed some weakness to your argument.
If I understand correctly, what you are suggesting is that we [AA] raise airfares. To some extent, would you agree that in 2007 and now 2008 that has and is being done? In speaking with and listening to individuals outside of AA who know more than I do about yield management, would you concur that when the competition fails to match those increases, the net result would very likely be a loss in revenue?
So going forward, what do you believe fare levels should be raised to? If competitors don't match, should we retract those increases? If you believe we shouldn't, then do you believe AA would shrink? Why? Would you agree that with the latest Airline Quality Rating report just out today that the challenge of raising ticket prices with year-over-year deterioration in customer service would be a formidable one?
No doubt, it is in everyone's best interest to have an industry operate at a profit and every effort should be made to generate revenue sufficient to create that environment. That being said, let's push the envelope to raising ticket prices but also understand that the free market must be considered. As pilots, let’s do everything within our power to assure customer satisfaction. I also believe there are ways to generate competitive costs while providing real value to pilots. I believe the Southwest pilot contract is an example of that. That is the template I believe the new pilot contract at AA should utilize. One of the major stumbling blocks, however, is the lack of leadership on the part of AA executives and I think I can safely say that we find ourselves in agreement there. We face significant challenges but after what we did following 9/11 and given this Nation’s history, no challenge is insurmountable and a bright future can be achieved.
Respectfully,
Carmen Villani
Hey Genius,
You don’t know much about the UPS system do ya. While you were out there doing Mach 2 defending the country I (among other things) was a Freight Dog. I don’t have time to school you on the UPS or FedEx system but that 24 inch cube you just stuffed yourself into for the next three days most likely won’t see any device operated on Jet A. With fuel costing what it does the overnight freight companies now ship a lot of their packages on trucks.
That Next Day Air package you’re shipping from DFW to AUS guess what it most likely goes by? You got it, a truck. That Three Day Select package once again truck or train and most likely NOT air. Watch a freight train out west and count the UPS trailers on the back.
Only when you get into long haul Next Day Air or Second Day Air will your package see the inside of a plane. Most of the Second Day Air packages are move during the daytime operation for UPS and anything beyond Second Day Air, most likely truck.
So once again you have dragged a useless idea into this discussion. Is that 24 inch cube you are shipping yourself in for the next three days is it going to be move on a $100 million B767 with two fuel lines that look like fire hoses or a $75,000 Freighliner with a fuel line that looks like a pencil? Will your opulent cube be moved by a driver who has a GED certificate and a CDL License issued by the state or two guys with college degrees and FAA license? The truck will it be worked on by mechanics from Bubba’s Diesel School or mechanics with FAA certificates in their wallets?
Your argument using UPS Three Day Select isn’t germane to this discussion when you are comparing shipping a 200 pound box (smaller is cheaper) overnight and moving a person on a plane. One is self-loading freight and the other is cargo. Both have a huge and expensive infrastructure to get them safely to their final destination in the least amount of time possible and not your 72 hours.
Once again UPS and FedEx have taken the corporate policy of we are in this to make a profit and we will not price our product at less then it cost to produce it unlike the airline industry. As I said before, Walk up fare or Advanced Fare the price to ship that cube is the same. No matter when you book it we will still make a profit, i.e. RLC’s “Value Pricing?”
Sorry but if Swebar’s super smart fellow MBAs can’t sharpen their pencils to RESTORE my pay to its previous level by raising their ticket prices then there isn’t much to discuss. They have adapted very well from $30 barrel oil to $110 barrel oil now they need to learn how to adapt on paying the employees. We will be out on front for a year or so but DA, UA, NW etc will catch up given time.
Maybe we need to go back to the three flights a day for some city pairs. Does the DFW/OMA city pair need five flights a day at some chump change fare or would it be better to go back to the old breakfast, lunch and supper flights of the old? Yea we would down size but at least we would be making money.
Until there is corporate genocide on the top floor this contract isn’t moving anywhere but to a job action. Arpey & Co. will have to take their millions and move on before this airline can return to it’s once grander. Everyone seems have forgotten this is the same airline, with the same employees, flying the same equipment, in the same weather to the same cities as when Bob Crandall was here and it was called “The On Time Machine.” The only thing that has changed is the leadership.
Well it was at least worth a try. I can sum up much of chitragupta's commentary with his following statement: "I’ll take my fellow aviators friendship over worship of a bunch of blog owners any day of the week." This coming from an individual who refuses to identify himself by name and takes on the screen name that of a Hindu god.