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 ………

Not Time For “Hush Money”

The Status Quo Is the Issue; Not Firing CEOs

Today I received a comment from Carmen on my latest blog post. Carmen is a frequent reader here, student of the industry and a person that is not afraid to say and write what he believes. Even if it means that he is not the first person other pilots seek out in the crew room when he checks in for his trip. He suggests that invoking force majeure might incite a revolution – and I paraphrase.

Carmen is not a current member of his union and his philosophical differences with his union have been written here and on multiple blog sites that cover the industry. Carmen, like others, point to the lack of a people element in the US airline business today is what stands in the way of a successful and sustainable industry when contrasted to the industry we know that perpetually teeters on the edge.

I Said I Would Not Acknowledge

Regarding Carmen’s comments, I responded in a pretty matter of fact tone. After responding, I started thinking back to Bob Reed's piece in Business week last week entitled: It's Time for United's CEO to Go; UAL should keep United Airlines in Chicago—but send Glenn Tilton, its deal-hungry CEO, packing. OK, for those that know me, you know that I have an affinity for Tilton. Do I agree with everything that has been done at United under his watch? No, I do not. Where I absolutely agree with Mr. Tilton is that the status quo does not work for any stakeholder group. Period.

So Mr. Reed, my question to you: are you singling out Tilton or are you joining hands with certain industry stakeholders that are looking for any leverage to maintain the status quo and perpetuate the self-imposed gridlock toward change which afflicts the US industry? It seems to me that any question you asked in your article could have been asked of Richard Anderson at Delta, Doug Steenland at Northwest, Doug Parker at US Airways and yes, even Larry Kellner at Continental. And I am going to include Gerard Arpey of American and I will discuss that later.

And Mr. Reed, I am sure glad you mentioned Continental and its transformation. From my read, about the only thing in your article that comes close to even describing the competitive reality that faces this industry each and every day is the fact that Continental survived the “controversial and oft-despised” Frank Lorenzo era. And I quote further: “the airline survived his tenure (along with two bankruptcies) and eventually morphed into one of the country's most successful large carriers. Now Continental is enjoying solid financial returns, improved customer satisfaction, and stronger employee relations. What's more, its CEO doesn't want to merge and is even ordering new planes”.

Pretty bold statement on the intentions of Continental’s current CEO who has done anything but rule out merger efforts should other carriers in the industry decide to join hands. Then again, it is hard to talk about joining hands when you are encumbered by a golden share that also serves as golden handcuffs. And even bolder to insinuate that other airline CEOs would not want to achieve the same thing that took Continental 10 years to begin fully realizing. And for that matter, that type of success is what CEOs want to be paid for. But the type of transformation that continues at Continental is more akin to a marathon than a sprint.

Where This Whole Post Started

Like today, the industry then was engaged in a shakeout and survival of the fittest when Continental began its transformation. For any Continental, PEOPLExpress, Frontier, New York Air, Texas International (see comment section) and Eastern (did I leave any carrier out?) employee of the time there are plenty of horror stories. But 20+ years later, we continue to witness the legacy carrier that first underwent necessary quadruple bypass surgery to transform itself to a US industry leader.

The only thing different today is that the transformation is more difficult. In the 1980s it was important to build a network, with a cost structure, that gave a carrier some form of presence/dominance within a particular US geographic region. Today it is about building an entity that maintains is preeminence in the US domestic market while spreading its reach to all world regions with a cost structure that allows it to compete where external forces are increasingly complex. Mr. Reed, airline labor, airline consumer activists and Rep. Oberstar would all have us believe that today’s airline world should remain focused on Altoona rather than Auckland; Duluth rather than Dubai.

Carmen in his comment to me mentions pandering and appeasement against a backdrop of a leadership void. Where I am stuck, is that I think there is finally leadership within the industry and there is a vision as to where this industry needs to morph to. When there is leadership and vision, there will be reasons to say no. And today’s CEOs are saying no to a return to the way things have been. They are saying very clearly and in their own way, no to the various issues that led each of their respective entities into bankruptcy or restructuring.

Definitely Not the Time for Hush Money

I asked Carmen in my response: “but isn't what labor wants is an historical return to pandering and appeasement? Throwing good money at the age old problems only makes people happy in the short term. Then the industry has to return and ask for concessions because they can no longer afford the hush money that was negotiated. I am all for saying no and trying to find a way to break this age old pattern. And I think finally this industry has a group of CEOs that can and will say no rather than push off the tough decisions that have been deferred over the past 3-4 negotiating cycles. Popularity contest -- NO. Necessary action – YES”.

It seems that the Northwest employees were more than willing to vote Steenland out in the event of a Northwest – Delta deal. And apparently he was willing to drop his “ego” and step aside in the event of a transaction that he and his board deemed in the best interests of all stakeholders.

My bet is Mr. Tilton and others would/will do the same in return for a deal that satisfies a vision. United has been out front in the consolidation view to be sure. But, United has been out in front suggesting they would put down capacity in the event of high oil prices also. And that simply sounds like managing the business to me. Mr. Reed pleads with United’s Board to “give Tilton his due, provide him fair compensation for time served—and begin the hunt for an executive who can build on his accomplishments and take an independent airline to greater heights”.

But Tilton’s work at United is not yet done and therefore the United Board should no more pay Tilton his hush money to walk today anymore than the prior United administration should have paid the United pilots the hush money to end the dreaded “Summer of 2000” that ultimately landed the carrier in bankruptcy. And certainly Mr. Arpey should not be paying his pilots, flight attendants or any other employees the amounts of hush money they are seeking over an executive compensation plan designed by American's Board. A compensation plan that could have been altered by the Board, not by Mr. Arpey and his management team.

Breaking the boom-bust cycle is much more important than perpetuating the status quo. Maybe we should invoke the force majeure clause on the self-imposed gridlock toward change which afflicts our industry …

To call for one CEO's head when an entire group of industry CEOs recognize that the status quo just does not work is well.......unfortunate.

More to come.

Ironical Catalysts; Seniority No More?; and One Last Comment on Force Majeure

Ironical Catalysts

Isn’t it ironic that the number one catalyst cited as driving a consolidation phase for the US industry is now being discussed as the number one reason that consolidation is being put on the back burner – or even being pulled off of the stove? Ted Reed of the Street.com writes a column offering the Northwest pilot’s take on the industry at $110 per barrel oil as well as their views on how oil might stand in the way of executing what the pilot leaders termed as “an aggressive business plan” by the other carrier [read Delta even if not mentioned by name].

On the surface, Mr. Reed’s story might be read as the Northwest pilots pointing to anything and everything rational that could provide cover for not reaching agreement over an emotional issue. On the other hand their counterparts at Delta, whether ALPA or management, are not suggesting much compromise, let alone capitulation, either. So we have a stand off. The Northwest pilots have a bird in the hand, assuming that no adjustments are made to the terms of the single collective bargaining agreement, versus Section 6 negotiations in 2011. And as I have written here, only the MEC can decide that issue.

What is encouraging about the industry today is its willingness to address some difficult issues with swift and decisive actions – like making the hard choice to further reduce capacity. But these decisions are not limited to Delta. We now have CEOs in the industry that are willing to address these tough issues that prior management teams would have decided to “fly through”. And in the last week, jetBlue, AirTran and Frontier have all sold aircraft or delivery positions largely to augment their respective liquidity positions.

When I first read Mr. Reed’s column this morning, fresh off of a 24 turn between Los Angeles and Washington, I interpreted it to suggest that consolidation is dead. That is not what he is saying at all. But US Airways sure views the lull in the action as a potential entry point to get back in the game as Mr. Reed reports.

Seniority No More?

Let’s segue from seniority integration into seniority. Today, the Washington Post’s Steven Pearlstein writes in his column about industry woes, commercial airline pilot careers and questioning seniority generally.

He concludes with the following two paragraphs: “The reason it's so hard for airlines to find a fair and rational way to combine pilot seniority lists is there is nothing fair and rational in the way seniority is used. It causes a disconnect between performance and reward, discourages movement of employees between and within companies, creates a corrosive caste system that breeds resentment among junior employees and an overblown sense of entitlement among those who are most senior”.

“Airline customers, employees and shareholders would all be better off if the industry spent less time and energy figuring out how to combine seniority lists and more time on how to eliminate them”.

Back in December, two days before Christmas in fact, swelblog.com questioned whether seniority worked for each airline management and labor. Now two days before Easter, a similar question is being raised by Mr. Pearlstein. While some of what Mr. Pearlstein suggests is impossible given equipment qualifications, he raises a fair issue. It is fair particularly when an industry is in serious need of a total overhaul.

While I am confident that any suggestion of seniority will raise the ire of organized labor, this is the time to explore such issues. It is time because many of the legacy constructs within this industry are prohibiting it from moving forward – and seniority is but one. And based on the many issues burdening the industry that are not of its own doing, everything should be on the table and everything explored.

A Little More on Force Majeure

Clearly my prior post generated some comments and most were not in agreement with what I had written. I knew that when I wrote the piece it would not be embraced by all. I certainly expected the note from the American pilot. I did not expect the “call out” by Blackbook, who is one this blog’s most astute commenters. Blackbook's fair questions and comments, and my answer to Blackbook, are available for all to read in the comment section.

While Force Majeure has many, many legal issues surrounding its use and I, admittedly, am not qualified to answer those questions, my intent was to raise a number of issues out there that bother me and to look at pools of expense that could be explored for cost savings. On Thursday of this week, Suzanne Marta of the Dallas Morning News blogged on research notes written by Kevin Crissey at UBS and Jamie Baker at JP Morgan.

Mr. Baker writes: "We would note that with the exception of the immediate aftermath of 9/11, the only time the industry even approached a single-year capacity correction of this magnitude was during the Gulf War I recession - and it required the failure of Eastern, Midway, Pan Am, several discount airlines, and bankruptcies at America West, and Continental to get there."

Immediately following 9/11, certain force majeure clauses were invoked. While force majeure may not be the effect - or even the right action - stemming from today’s environment, the macro environment has many attributes of a cause.

Invoking the Force Majeure Clause: Oil Taking Its Toll

...and Thinking About Northwest - Delta

As I prepared to write this week, I had outlined a piece around the NCAA basketball tournament generally and Selection Sunday specifically. I was going to talk about how the Delta-Northwest deal, destined for a #1 seed a month ago had become a “bubble” deal over the past month because of a less than stellar end to the conference schedule and “one and done” in the conference tournament. And then I was prepared to place them in the last 4 teams out group.

But rather than just isolate Delta-Northwest, I think it is time for the industry to think about consolidation in yet another way. Typically we think about consolidation as two entities combining through merger activity. But there is financial consolidation as well. It is similar to what we experienced during the 2002-2006 period where an industry contracts on its own volition. It is probably time to begin another round of contraction as the price of oil makes it very difficult for the industry to maintain its current service offerings.

Introduction to Force Majeur for Those on Capitol Hill
and a Refresher for US Airline Labor

From where I sit, the NCAA tournament will make great theater as always but will pale in news as to what I see coming for the US airline industry. In my last blog post, I purposefully left the piece hanging on an issue for labor and the politicians to seriously consider: “Politicians and labor should think real hard about the fallout that could stem from the current economic environment [read to include high oil prices] versus what the perceived fallout could be in a consolidation scenario”.

As the market opened this morning, oil traded near $112 per barrel. Whereas the price has pulled back from those highs, it is becoming clearer that oil is going higher as the highs get higher and the lows get higher. Heeding warnings from the industry that capacity will be closely examined at these prices, I began to write this piece.

Then as I was writing, I did my usual check of the headlines as the day wore on. In one check of the day’s news, I read, as everyone should when you are not reading here to steal a Maxon line, a blog post by David Field of Airline Business on his blog named appropriately Left Field. Mr. Field cites quotes directly from Delta’s Anderson, Northwest’s Steenland and Continental’s Kellner each questioning the size of their respective networks in the face of $105 per barrel oil.

Defining Force Majeure

Typically we do not like to talk about force majeure issues in the industry, but I am thinking it is time. Wikpedia defines force majeure as:

Force majeure (French for "greater force") is a common clause in contracts which essentially frees both parties from liability or obligation when an extraordinary event or circumstance beyond the control of the parties, such as war, strike, riot, crime, act of nature (e.g., flooding, earthquake, volcano), prevents one or both parties from fulfilling their obligations under the contract. However, force majeure is not intended to excuse negligence or other malfeasance of a party, as where non-performance is caused by the usual and natural consequences of external forces (e.g., predicted rain stops an outdoor event), or where the intervening circumstances are specifically contemplated.

Time-critical and other sensitive contracts may be drafted to limit the shield of this clause where a party does not take reasonable steps (or specific precautions) to prevent or limit the effects of the outside interference, either when they become likely or when they actually occur. A force majeure may work to excuse all or part of the obligations of one or both parties. For example, a strike might prevent timely delivery of goods, but not timely payment for the portion delivered. Similarly, a widespread power outage would not be a force majeure excuse if the contract requires the provision of backup power or other contingency plans for continuity.

A force majeure may also be the overpowering force itself, which prevents the fulfillment of a contract. In that instance, it is actually the Impossibility defense.

The understanding of force majeure in French law is similar to that of international law and vis major as defined above. For a defendant to invoke force majeure in French law, the event proposed as force majeure must pass three tests:

Externality

The defendant must have nothing to do with the event's happening.

Unpredictability

If the event could be foreseen, the defendant is obligated to have prepared for it. Being unprepared for a foreseeable event leaves the defendant culpable. This standard is very strictly applied.

Irresistibility

The consequences of the event must have been unpreventable.

A Non-Lawyer Discussion of Force Majeure

Force majeure (French for "greater force") is a common clause in contracts which essentially frees both parties from liability or obligation when an extraordinary event or circumstance beyond the control of the parties, such as war, strike, riot, crime, act of nature (e.g., flooding, earthquake, volcano), prevents one or both parties from fulfilling their obligations under the contract.

Name any airline that spent time in bankruptcy and was required to file a plan of reorganization that correctly estimated the price of oil in that plan. United assumed $55 per barrel and that was $50+ per barrel ago. Northwest just recently emerged and it assumed oil $40+ per barrel ago.

Based on the assumed price per barrel of oil, contracts were entered into with the regional affiliates of the major carriers. The price of oil has long been described an uncontrollable expense for the airline industry. Is this an act of nature, I do not know. What I do know, is that this rise in the price of oil is beyond the control of the industry. Moreover, this recent price push makes oil more expensive than it was on an inflation adjusted basis in the early 1980’s and we know that the period will always be defined as an oil crisis.

However, force majeure is not intended to excuse negligence or other malfeasance of a party, as where non-performance is caused by the usual and natural consequences of external forces (e.g., predicted rain stops an outdoor event), or where the intervening circumstances are specifically contemplated.

There is no negligence here by the industry or malfeasance by anyone. This is the market at work. The causes for the oil price increases are many but cannot be isolated to any one catalyst. And none of this is as predictable as rain on a hot summer night.

Time-critical and other sensitive contracts may be drafted to limit the shield of this clause where a party does not take reasonable steps (or specific precautions) to prevent or limit the effects of the outside interference, either when they become likely or when they actually occur.

To say that the industry has not taken reasonable steps to prevent or limit the effects of the outside interference would ignore the painful attempts to address cost structures that were simply not sustainable. As Jamie Baker pointed out last week in his research note, since 2002, the price of oil will have increased some $25 billion for the US industry while savings from labor over the same period amounts to $7 billion.

Through the restructuring period and practices that continue today, the industry cut costs to combat a declining revenue environment and to address the rising cost of oil. The industry has used hedges; pared domestic capacity as a way to reduce exposure to an unhealthy domestic market; increased international capacity as a way to increase revenue; cut back on amenities; cut distribution costs to a minimal level; reduced ownership costs; cut employee wages; improved employee productivity; improved asset utilization; terminated pensions; outsourced flying; outsourced maintenance; outsourced administrative activities; and experimented with hub structures to name a few of the hundred of cost cutting activities that have been employed.

Most, if not all, reasonable steps have been taken to prevent or limit the continued losses for the US industry – except for that outside interference called oil.

Included in the definition: A force majeure may also be the overpowering force itself, which prevents the fulfillment of a contract. In that instance, it is actually the Impossibility defense. As for the externality, the industry has nothing to do with the event’s happening. As for unpredictability, this industry has done everything it can do to counteract its influences. As for irresistibility, the consequences of the oil price rise were not preventable.

Delta and Northwest

About one month ago, I remember Bob Fornaro, CEO of AirTran Airways, referring to proposals made to his pilots in an oil-denominated way. Like Fornaro, Messrs. Anderson and Steenland I only hope that you tell your pilots and all other employees that the terms of the agreement you made in order to have a single collective bargaining agreement in place are now off of the table. You made an agreement where some of your pilots would receive 30% pay increases at $85-90 oil, surely those agreements should not be made at $105 oil. Invoke force majeur.

$20 per barrel ago, you said that your networks would be largely kept intact. Now today you seem to be hinting that the size of your networks may need to be reconsidered. Let’s just face the fact that there are too many regional carriers and too many hubs and as a result too much money being spent on serving communities that cannot economically support the frequency of access to the air transportation system today. Cutbacks like those Doug Parker of US Airways suggested were probably unavoidable at some point and at $105 oil, well……invoke force majeur.

In each case, these suggested actions seem prudent and can easily be explained by an unpredictable externality whose consequences could not have been predicted by you. Invoke force majeur.

Consolidation is still right. But as everyone has said it has to be the right deal for all stakeholders and given the externalities facing the industry, much harder choices will now have to be made.

More to come.