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 ………

Is Oil A Cancer Or A Cure?

As I write this morning, I am without an internet connection. On Monday and Tuesday of this week I was in Chicago speaking to, and participating in a roundtable discussion with senior executives of the International Association of Exhibitions and Events. A most enlightened group that depends heavily on the airline industry to deliver people and goods to the large trade shows they run. Rather than run from the issues plaguing this industry and others, this group was meeting to strategize on proactive stances and rethink their many successful approaches – many of which were designed around a low fuel environment.

Today, I sit in rural Maryland as the coolest, little guy in my world, Sam, plays in his first Titleist Tour event. Not being the doting one, I watched him hit a very good tee shot down the right side of the first hole then strap his bag on his back and begin play. And I found a quiet spot under a tree to write. In case you have not figured it out by now, the game of golf is a passion and it is way cool to watch Sam embrace the game and pay respect to the many traditions that make the game so great.

I Think We Are Beginning to Actually Define Overcapacity

The naïve notion that high load factors somehow suggested that there is no overcapacity is in the process of being put to bed. A better term to have used would have been uneconomic capacity because we know that on many flights that there are somewhere between 10 – 30 seats that too often get sold for less than the cost to carry the passenger occupying one of those seats.

My guess is some readers here have also been questioning my lack of writing over the past 4-5 weeks. For the same reason that I got out of the day to day grind of the consulting business where I devoted an inordinate amount of time to restructuring airline labor agreements. How many ways can you tell someone or a work group that their collective bargaining agreement has cancer? How many ways can you write that the treatments being recommended may/or may not work? Another attribute of cancer survivors is attitude – a positive attitude has proven time and time again to transcend many things that require wholesale change. And it does not take an Oncologist to tell anyone that.

Is the price of oil a cancer or a cure for the industry’s ills? I do not know the answer and the question is probably best left to the individual. For some, the price of oil is a cancer in that its very presence will prevent certain stakeholders from achieving what they somehow believe they are entitled to. More than likely a positive outcome will be prevented by the lack of acceptance that additional treatment is necessary and succumb to the “woe is me” attitude. For others, they will accept that the treatments taken over the past 5 years are simply not enough and that more has to be done – and the only path left is invasive. [for those that will comment that I am suggesting more concessions, I am not]

Already this week, labor news surrounding the industry has been plentiful. I wake up in Chicago on Tuesday morning to the headline on the front page of the Chicago Tribune that United will furlough 950 pilots between now and the end of 2009. Later that day, the Delta and Northwest pilots announce that they have reached a tentative agreement on a joint contract covering both the Delta and Northwest pilots. In addition, a protocol agreement has been put in place to merge the seniority lists prior to closing of the transaction. Today American Airlines began to detail its previously announced service cuts. And New York is prominent on that list.

The United news of pilot furloughs is the first real indication just how far that carrier is willing to go to find its profitable core. Clearly, the carrier recognizes that major changes/treatments are necessary. United has been quite busy of late announcing an alliance with Continental; making a number of fare rule changes including bringing back the unpopular Saturday night stay provision; being so bold that it would put down 100 aircraft units; and entertaining any and most of the ideas – including some of their own - regarding charging for most unbundled services.

Layoffs associated with aircraft retirements will be many as we work toward the fall and winter months of 2008. But I do not see the numbers of jobs lost approaching the 125,000 jobs lost post 9/11. Unless we liquidate a large airline or two.

The Confused Business Travel Coalition

On the heels of the Business Travel Coalition testifying against the proposed Delta and Northwest merger on two separate occasions, the confused advocacy group underwrites a study suggesting that the current crisis (the price of oil) facing the industry is leading to a catastrophe. A crisis for some stakeholders to be sure. But a catastrophe?: absolutely not. Why is it a catastrophe if inefficient players are finally removed from the industry? Or if uneconomic capacity is finally removed from the system?

This industry will be here after this storm has passed. Only the liveries on the tails will be different unless invasive treatment is accepted, implemented and met with a survival attitude. Based on this group’s track record, I thought it was a catastrophic event if carriers merged. Now everything is a catastrophe. Maybe the upcoming lesson on network economics in the fall will shed some light on approaches other than the group's tired refrain that the “sky is falling”.

In this environment combined networks, whether it is through merger activity or through the formation of an alliance, promise to preserve more capacity than if carriers operated individually. As carriers begin the process of weaning capacity, the industry will get a real live lesson on the interdependencies between nodes that exist within network industries. We will take a cue from consumers as to whether the Southwest’s, jetBlue’s and AirTran’s can satisfy all consumers wants from air travel in the domestic industry. I am prepared to bet that all consumers will not be happy with their limited services - but we will see.

So while the news is bad and additional dislocations are all but assured, I see the price of oil as a cure to 30 years of cancer that never received the proper treatment. When we come out of the other side, however long it takes, it will be better as many bad business practices that have plagued this industry will have been eliminated. And not thought to have been eliminated when they were actually in remission.