Column: A Remarkable Summer in the Airline Industry

By Steve Swidler
August 2008

By any measure, it has been a remarkable summer in the airline industry. Airlines have significantly raised fares, unbundled services (baggage, seat selection and even beverages now incur additional charges) and cut back the number of flights in many cities. And while I’m talking mainly about the U.S. airline industry, globalization and international travel in the 21st century suggests that any industry changes will affect air carriers the world over.

The spark behind these changes is, of course, the rising price of oil which has significantly increased airlines’ operating costs. Even with additional revenue sources, airline profits have been significantly slashed. Many carriers have announced negative earnings in the first half of 2008 with little sign that things will turn around anytime soon. That oil prices have driven profits downward this past year is dramatically illustrated in the following figure that plots the returns to a portfolio of airline stocks against crude oil:

The figure clearly shows the inverse relationship between oil prices and profitability. As oil reached a peak of $US 145 a barrel earlier this summer, airline stocks declined nearly 70% from their level a year earlier. The significant fall in market capitalization caused by high oil prices prompted two other remarkable events in the airline industry this summer.

The first was a talk by Robert L. Crandall, former President and CEO of AMR Corporation (American Airlines), to the Wings Club at a June 2008 luncheon. In his speech, Mr. Crandall discussed his view of the state of the industry and then prescribed his cure for the chronic financial and operational problems faced by airlines. (For a complete transcript of his talks, see: http://www.wingsclub.org/eventspeeches_2008-06.html) The basic tenet of his talk was that deregulation has worked poorly in the airline industry. He went on to state, “… that market forces alone cannot and will not produce a satisfactory airline industry, which clearly needs help to solve its pricing, cost and operation problems.” This line of thinking led him to conclude that, “a dollup of regulation, along with new government policies and appropriate investment, would help the carriers get back on the right track.”

Mr. Crandall’s belief that deregulation has not worked is an opinion echoed by others. Congressman Steve Cohen of Tennessee has called for re-regulation, while labor unions including the International Association of Machinists and the Airline Pilots Association also have argued for government intervention to stabilize the industry.

However, these sentiments are not universally shared by those connected to the industry. In a Cox News Service story of June 30, Delta President and CFO, Edward Bastion stated that deregulation “has been a great success” and that “(A)ir travel today has never been more affordable and significantly lower in real dollars costs.” In the same article, AirTran general counsel, Richard Magurno asserted that “In a regulated environment, AirTran would not be able to provide the deep-discounted fares that presently have exploded in the Atlanta market.” Doubting the wisdom of renewed government intervention, Alfred Kahn, former chairman of the Civil Aeronautics Board and father of deregulation in the United States said simply, “I just don’t know what regulation would do.”

The second remarkable event of the summer was the release of a joint statement by major airline CEOs calling for Congress to curtail oil market speculation. Their statement is part of an industry campaign called, “Stop Oil Speculation Now,” or more simply “SOS Now.” (The letter and other information can be accessed at: http://www.stopoilspeculationnow.com) As we have seen, high oil prices have eaten into carriers’ profits, so a call from corporate leaders for an end to speculation is not particularly surprising. What is remarkable is the fact that the airlines are asking legislators to regulate another industry, in this case financial markets where oil contracts are traded.

Whether speculation was the cause for the spike in energy prices is open to debate. The question remains, however, whether it is proper for one industry to seek government help that would require regulating another industry. Moreover, even if the carriers’ basic premise that high oil prices have been caused by excessive speculation, it begs the question of why government intervention is needed. Airlines have the ability to hedge fuel costs, yet many carriers choose to do little or no risk management. One carrier that does extensive hedging of oil is Southwest Airlines; nevertheless, their Chairman and CEO, Gary Kelly also signed the SOS Now letter. It might further be noted that Southwest Airlines recently announced a second quarter 2008 net income of $321 million, the Company’s 69th consecutive quarterly profit.

Yes, it has been a remarkable summer in the airline industry. The call for government intervention has gone out from virtually every major U.S. airline. Whether Congress will take up the industry’s banner remains to be seen. In the meantime, Aerlines would like to know what you think about the industry’s appeal for government help to solve many of the problems related to oil prices. Thus, we encourage you to answer our brief survey below so that we can report our readers opinions about this very important issue.

(Please also provide your opinion on this column through Professor Swidler’s Survey).

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