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  • Did U.S. Airlines Learn From 2008?
    Posted by Madhu Unnikrishnan 4:59 PM on Aug 30, 2011

    The U.S. airline industry just can’t seem to catch a break. Volatile fuel prices and an anemic economy are conspiring to wipe out the meager profits eked out last year. In fact, for the first half of this year, the publicly traded U.S. carriers reported a combined $290 million loss, and the rest of the year looks dicey.

    In 2010, the industry posted a $2.2 billion profit, after losing an aggregate $65.1 billion from 2001-09. Analysts then trumpeted that the industry had turned the corner, reaping the fruits of a couple of years of relentless capacity discipline and aggressive sourcing of new streams of ancillary revenue.

    A profit, however slight, is nothing to sneeze at. However, one profitable year was simply too small to offset airlines’ alarming inability to deal with unforeseen market forces. Growing demand in the world’s large developing economies, which were hurt less by the rich world’s continuing financial malaise, drove up oil prices. Then the Arab Spring exploded, further threatening oil supplies.

    Oil’s recent slip to around $80 per barrel is small consolation. “We don’t put crude in the airplanes,” says John Heimlich, chief economist for the Air Transport Association, a trade group for U.S. carriers. The price of jet fuel remains stubbornly high, and Heimlich’s estimated price of roughly $3 per gallon ($125 per barrel of jet fuel) remains unchanged for the remainder of the year. It also reflects a crack spread—the difference between crude oil and a refined product—of $40 per barrel, the highest since Hurricane Katrina devastated U.S. Gulf Coast refining capacity in 2005.

    And Wall Street has again taken notice. The market capitalization of the entire U.S. airline industry—a measure of what the market thinks the industry is worth—is $26.2 billion. By comparison, a single company—online auction site eBay, is valued at $36.6 billion—which itself is a pittance compared to ExxonMobil’s $351.6 billion market capitalization. “Airlines have been destroying shareholder value for most of a decade,” says Vaughn Cordle, chief equities strategist for consultancy Airline Forecasts.

    Airline revenue is correlated to GDP growth, so a fall in economic growth forecasts means rough sailing for airlines. Forecasts for weak U.S. GDP growth—slashed to 2% for the rest of the year—could require airlines to do some soul-searching. “This may be the time for airlines to look into their crystal balls and figure out what market they can make money in,” says transportation consultant George Hamlin.

    One way to do so is to pull seating capacity out of the system. Airlines showed discipline when fuel prices spiked in 2008, but have been cautiously restoring capacity; it went up in the first three quarters of this year. Faced with a tough fourth quarter, airline schedules show a 0.5% seat decrease compared with the same period in 2010, but that is insufficient, notes Hamlin. Another 6-7% needs to be removed to shore up revenues, says Cordle. Whether airlines can give up their traditional battles for market share and behave rationally, however, remains to be seen.

    Tags: AWCOL, tw99

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