Horton Says American Means It

Last month, in a blog post Begging ……. The Questions, I wondered aloud if the US industry, that had announced capacity cuts in July as crude touched $147 per barrel and jet fuel approached $180 per barrel "in the wing", would rollback their capacity cutting plans as oil prices have dropped nearly $40 per barrel since.

At least in Ft. Worth, announced capacity cuts will be actual capacity cuts. Tom Horton, American’s CFO said the domestic capacity cuts are permanent in an interview with the Associated Press. Horton touches on two important cost benefits that will be realized by the decisions his company is taking: 1) the fleet being retired is not efficient from a fuel consumption perspective; and 2) older aircraft require much greater expenditures to maintain.

American Airlines has been aggressive in its capacity planning and has been joined by United and others. Airports around the air transportation system will certainly point to the fact that oil has dropped significantly in the past two months. But we cannot lose sight of the fact that the price of crude oil is only part of the equation; remember the crack spread or the cost to refine crude oil into jet fuel.

The industry is still paying roughly a $140 per barrel equivalent for jet fuel. On average, the industry spent the equivalent of $90.93 per barrel for jet fuel in 2007. It is the difficult management actions that are being undertaken like capacity reductions, ancillary fees and additional employee dislocations that are giving Wall Street some hope that the industry just might be profitable in 2009. But, that all depends on the actual condition of the economy doesn’t it? And I am not sure we can even get an accurate temperature read today.

A Demand Prism?

Let’s not lose sight of the important guidance the cargo side of the business gives to the passenger business despite the fact that they are very different business models. It was the cargo sector that first warned of a slowing economy earlier in the year and the effects it saw on its business outlook. The cargo business addresses more traffic that is demanded on a just-in-time basis and as a result is less price-sensitive. The cargo business is a more leading indicator of things to come. The passenger business sells a significant level of its product well ahead of the actual delivery and tends to be more price-sensitive for a majority of its demand.

Last night, William Greene of Morgan Stanley wrote a piece on Federal Express. It was entitled: Weak Guidance Highlights Cyclical Pressures. And I quote: "Cyclical headwinds clearly a challenge for earnings. As we noted when we downgraded FDX shares back in late July, we struggle to find a compelling reason to own parcel stocks. Although lower fuel prices have pushed off some of our secular concerns about a permanent modal shift, a global slowdown is undermining one of the few remaining areas of strength – international. Moreover, air fuel surcharges are still high from a historical perspective and domestic volumes remain under pressure."

A couple of things in closing. Oil is down but still 50 percent higher after the fall than the average price paid in 2007. And, passenger airlines now face the reality of economic forces and the actual health of consumer’s pocketbooks as the peak travel season just completed was sold in February and March of this year. Fuel coming down is good for all of us, but its fickle nature should not be ignored. Nor should it suggest that the hard decisions made by the industry earlier in the year to park capacity are no longer necessary.

Interesting too is Greene’s assessment that international markets might be weakening. Does the cargo sector offer a prism for the passenger side of the business? I think so and you do not have to read aviation news from around the world everyday to reach that conclusion.

I must say I am amazed that I have not read any uneducated and uniformed reporting to date that suggests that the capacity cuts are not needed given the fall in crude oil prices – but I am sure that I will. Maybe even one written in 2002?

More to come.

Rambling, Musing and Pondering on Airline Industry Issues

In past years, the industry’s trade associations have not always been strong voices for issues, particularly economic issues, impacting the industry, whether it is the global industry or the US industry. In recent years that has changed. Each respective organization is fortunate to have two very capable Chief Economists: Bryan Pierce with the International Air Transport Association; and John Heimlich with the (US) Air Transport Association. The data and analysis provided by each should be a link on every serious industry watchers favorite list. And watch them daily, as meaningful insight is provided by each man.

The IATA Annual General Meeting opened today in Istanbul and IATA CEO Giovanni Bisignani warned that the global industry is on course to lose $2.3 billion if oil should average $107 per barrel and $6.1 billion if oil should average $135 per barrel. Less than a year ago, IATA was forecasting a global industry profit in excess of $10 billion. Bisignani has been a loud voice on the need for consolidation in the global industry citing important facts regarding this industry’s unhealthy and fragmented state. I really like this guy and I particularly like his call for a clean whiteboard as this blogger has wanted the UPS whiteboard guy to redraw the global map for some time.

United; United-US Airways; American; and Jim “Hell NO”berstar

I don’t know about you, but I am very happy that United said “NO” to walking down a road toward a formal combination with US Airways last week. Something just did not feel right about that one. Yes the labor issues were significant. The IT issues were significant. The combined networks left a bit to be desired from my perspective as the regulators would surely have required some auctioning off of valuable airline real estate. United has more than its share of problems to be sure, but the deal was far better for US Airways’ stakeholders from my perspective as there is little the Phoenix-based carrier could offer in terms of route portfolio diversification.

It took us 30 years to get into this mess and it will take time to get us out.

Despite industry consensus, Tilton did not pursue a deal for deal’s sake. Instead he said "NO" – at least from public reports. The historic US industry leaders – American and United – both began the process of battening down the hatches last week. Each carrier began to make announcements and pronouncements that their respective businesses would be managed in the near-term as stand-alone entities. So Jim “Hell NO”berstar looks less like a soothsayer as the wave of industry deals he suggested has come to a halt.

I like the decisions. I particularly like United’s decision because Tilton has been saying that the industry needs to restructure. Consolidation is part of the restructuring he has suggested. Consolidation has been the operative word used for mergers in the industry – but mergers rarely consolidate much if anything. Consolidation has been the scare word used by the naysayers to signal that consumers will get hurt. Consolidation has been used by labor to extract monopoly rent only to return to the bargaining table to give most of the rent won back to the respective company. Consolidation has been used by those on Capitol Hill to suggest that service will be lost.

Well, we are about to begin a real consolidation of the industry and it cannot be laid at the feet of a merger and acquisition proposal/era. Capacity will be cut because it is not economic to run individual networks of the scope that are operated today. Prices will go up, but not because of a merger and acquisition proposal but rather because a business that needs to pass on the costs of providing the service. Labor will negotiate their next contracts just as they have before, except for the Delta pilots that recognize that certain scope restrictions standing between revenue and principal are not in anyone’s interest. And the condition of the economic environment will be taken into account in either direct or mediated talks or whether the case lands in front of a Presidential Emergency Board.

American and United are, and will be making some tough decisions. Delta and Northwest have made a tough decision to join hands. But that decision is in the best interest of two companies that are so dependent on network scope to maintain service to a maximum number of points. Northwest would be particularly hard-pressed to maintain all of the service it provides. Continental is blessed by geography but still has fragility in its financial position. And the question becomes for the remaining legacy carrier, is US Airways’ cursed?

As for the sectors incorrectly referred to as Low Cost and Other Carriers: Southwest is blessed with capital and well all that is-Southwest; Alaska, jetBlue and Virgin America are arguably blessed with a brand; and AirTran is blessed – in the near-term with flexibility of selling off delivery positions to help it today - but could hinder it tomorrow when the market does make a turn for the positive.

This really is a cool time in the industry’s history. A time that will be embraced by the survivors. The "oil era" will be sure to have its place in history. And for some the slippery slope caused by the commodity will land some in airline oblivion; for others it will end on a path toward something much better than today.

The Price of Oil and Attributes of a “Bubble”

Over the weekend, a number of articles appeared suggesting that the oil chart replicates some of the stock – or shall we call them commodities’ – charts of the late 90’s. One thing I have learned from years in this industry is not to second guess the markets and not to try and predict the price of oil. Do today’s oil prices have “bubble” attributes in the traditional sense – yes. Does history suggest that anything that is market influenced will remain on this trajectory – no. And this is yet another reason why, if I am labor, I would be putting some chips with insurance on the come line. Leverage with the business is the only hope of coming close to replacing a majority of what was given up during the restructuring period. Only it will be in a one-time payment and not a legacy payment embedded in a contract.

CEOs, Policy Makers and Shareholders

I like to refer to today’s CEOs as “Agents of Change”. Popular? – no. Hell bent on change – yes. Standing in the way of preventing the past practice of doing business – yes. Concerned about their place in history – yes. Afraid to get dirt thrown their way in the process – no. Bringing the shareholder into the “virtuous circle” of airline industry prosperity – yes.

With the exception of Delta-Northwest, the litmus test is underway. Each of the legacy carriers is on a path toward restructuring their respective businesses. The naysayers should be happy. Of the six legacy names, the current construct will preserve five. Yet service will be cut and prices will go up – and it will not be because of consolidation in its historic definition. It will be of business decisions necessary to preserve the capital of the day’s stakeholders. Not all of them. But….. Today’s CEOs will do that as their fiduciary duties begin and end with that fundamental charge.

Labor will be tested and will probably say on some Monday morning: “Man, that merger proposal may have been better than riding out a business that has to make these decisions to cut, cut, cut”. Congress will ask: “Maybe this business is not a utility that serves my region’s airport? Some sort of rethinking the emotional issues may have provided my constituents with something better?” Regulators will say: “I knew if we kept our hands off the US market would be better served”. And hopefully the Executive Branch policy makers will say: “this boom and bust is good for no one, so let’s give them a clean whiteboard and if it gets out of hand will step up. But the way we are doing this just does not work”.

And the shareholders will finally say: “the barriers – oh I mean excuses – have been removed and if this guy cannot do it now then let’s find another guy”.

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.