The First Four Out Are Not the Final Four

Memphis v. Kansas

We awaken this morning anticipating the final game of the 2007-2008 college basketball season. And lest you think I’m drifting off topic here, the geographic locations of each school have some relevance to happenings in the US airline industry. Lawrence, Kansas does not have direct air service; residents are dependent on the highway system to access air transportation. With the airlines’ costs for fuel now nearing an "in the wing" $130 per barrel, Lawrence is simply one among many rural/small communities that have little hope of supporting direct air service.

With fuel prices forcing a re-examination of the entire route structure, there are some analysts who believe Memphis – and some cities like it – can’t justify the air service it receives given the city’s modest scope, scale and contribution to the US air transportation system as a passenger air transportation hub. This is particularly true in light of the renewed merger talks between Northwest and Delta as reported by Justin Baer and Francesco Guerrera of the Financial Times. If negotiations are indeed underway, there will be heavy scrutiny on the deal structure, network structure, labor construct and cost containment strategies. Will the hard questions be addressed or deferred?

The only thing we’ll know for certain by the end of today is the national champion of college basketball. For the US airline industry, we are just beginning the journey down the road to the Final ????????

The First Four Out

The first four US airlines out: Aloha; ATA; Skybus and Champion, which announces out on 5/31. Let’s not forget about Maxjet, which exited the market in December 2007. Even before the Skybus exit, some pundits and analysts were writing that the U.S. would not lose any more airlines. That’s not the bet I’d put money on. But the real question is whether any of these exits from the market will have meaningful impact on the structure of the ailing US domestic market. The answer is no.

What is interesting is that each of these carriers was a niche player with presence only in a relatively contained market space. Aloha in Hawaii. ATA, which was arguably the most confused carrier in determining what it wanted to be when it grew up, was best known for its late-in-the-game code share relationship with Southwest to serve Hawaii. With Champion, the airline’s claim to fame doesn’t go much beyond its business as the non-scheduled carrier of professional sports teams. Skybus, a carrier trying to bring the Ryanair model to the US five years too late, focused its operation in Columbus, OH (yawn). And Maxjet built its model on the transatlantic business class passenger.

A game-changing development? Not in my opinion. A start, perhaps, in addressing certain regionally concentrated capacity – but in no way contributing to a meaningful improvement in US airline results. The saga surrounding Alitalia is much more interesting than anything happening in the US right now. There, the sixth largest carrier in Europe is on the ropes, largely due to labor and politics standing in the way of what everyone knows needs to be done. The media this week actually suggested that the airline needs an exorcist as much as it needs a business plan. In my view, the Alitalia story is a precursor to what could be coming in the US. And when this begins to happen, then it will get truly interesting.

Get ready to put yourself in the same mindset the industry adopted after 9/11. The discussion will be all about liquidity (Clark Kellogg of CBS Sports might call it spurtability), assuming that fuel prices remain at this level. Already, 24/7 Wall Street and The Street.com have written that it is not entirely out of the question that American Airlines will follow the path of the other legacy carriers in filing for bankruptcy, even with $4.5 billion of unrestricted cash in the bank. I’d say it’s a little too soon to make the call, but it sure does underscore a rough and tumble environment out there. As a friend in the industry wrote to me last week: “We do live in interesting times.” In China, that’s considered a curse.

No #16 seed has ever beaten a #1 seed, and at this point all we have lost in the airline tournament is four very low seeds. Hell, we have not even gotten to a meaningful matchup between a power conference team and a mid major. Every year March Madness produces that game and every year a mid major knocks off a power conference team, and when we get there, the tournament gets more interesting.

What makes the NCAA tournament so much more fun to watch than the US airline industry is the fact that there are no barriers to exit and a lot more barriers to entry - you earn your place.

The real airline tournament begins with the next four out of the US market. Enjoy the game.

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.