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 ………