Say Goodbye to Cheap Air Travel

Several years ago, when I began to realize the implications of peak oil, I wondered: Will I ever get to see Asia? Or Africa?

I had no doubt that the air travel business was in for a world of hurt, once oil prices started going up fast. And when that happened, air travel to such far-flung destinations would be out of reach for regular folks like me.

I just didn’t think that day would come quite so soon. I can already see my window of opportunity to lay on the beaches of Thailand, or hike the rugged mountains of Tibet or Japan, closing.

In the last 90 days, jet fuel prices have spiked 38%, rising along with crude.

It was no surprise to me, then, to see some of the smaller carriers starting to go belly up this year. As oil has hit record high after record high, fuel costs have actually exceeded labor costs for many airlines, accounting for as much as 40% of operating expenses.

They just couldn’t price their tickets high enough to keep the business aloft. Of the 769 million travelers who boarded U.S. flights last year, we might think a sizeable percentage are on discretionary trips.

(Likewise, fuel prices are hurting the trucking industry and causing truckers to strike. For some, diesel costs have spiked about 90% in the last six months alone, far outpacing the cost increase of gasoline. Who wants to operate at a loss?)

The budget carriers, already surviving on razor-thin margins, have seen their profits simply evaporate.

So far, eight airlines have officially bitten the dust:

  • Aloha Airlines
  • ATA Airlines
  • Champion Air
  • EOS Airlines
  • MAXjet Airways
  • Oasis Hong Kong Airlines
  • Skybus Airlines
  • Skyway Airlines
One of them-ATA Airlines-even left some soldiers from Vermont stranded in Iraq, unable to get home as the company went bankrupt.

Frontier Airlines is now bankrupt, too…and they won’t be the last to go, either.

The bigger carriers with deeper pockets (and more unsold seats) have kept prices relatively low while burning through cash reserves as their own fuel costs mounted. American Airlines is now losing about $3.3 million a day, and at the current rate, could burn through its $5 billion in cash reserves in as little as four years. And it has the biggest cash reserve in the industry.

When you’re bleeding like that, skimping on maintenance, taking safety risks like flying with inadequate fuel reserves, and nickel-and-diming your passengers will only buy you a little time.

Consequently, the bigger carriers are looking to mergers in an attempt to save their skins.

Northwest Airlines and Delta Air Lines have proposed a merger, which is now under review. The Northwest CEO recently said that the merged entity will likely be smaller than the sum of the parts, due to soaring fuel costs.

If the merger receives the approval the Justice Department and Congress, it’s likely to spark a wave of additional mergers. UAL, the parent company of United Airlines, is already in talks with both Continental Airlines and US Airways, and I anticipate more to come.

Other carriers are turning to debt, to ride out what they hope is a limited era of unprecedented fuel costs.

The last of Britain’s business-class only airlines, Silverjet, just borrowed $25 million from an unknown Middle Eastern investor (reputed to be an Abu Dhabi investment fund) to get it through the rest of the year…with a promise that it could borrow another $75 million in the future.

Tricky Trading

The U.S. airline sector as a whole posted an $11 billion loss in the first quarter of this year. “When all the results are in, this will be one of the worst quarters for the industry in its history,” said John Heimlich, chief economist for the Air Transport Association.

Every major carrier except Southwest Airlines recorded a loss. Southwest posted a $34 million profit.

How did Southwest do it? By hedging 70% of their fuel costs. The next most hedged was Northwest, at 45%, and all the rest were under 24%. Their hedging strategy is simple: They buy fuel futures when the market is soft. Southwest is now benefitting from having the foresight to start hedging a full decade ago.

To capitalize on my own foresight, I have wanted to short the airlines so badly for several years running. But I never did, for three reasons.

One, there is always the possibility of yet another airline industry bailout by the feds, which is a deadly risk if you’re short.

Two, it’s a business with a long growth pattern. Airbus and Boeing are still sitting on a long book of backorders and projecting that they will double the fleet size over the next several decades. Historically, shorting the airlines has been a good way to get your head handed to you.

And three, I couldn’t find any good ways to play the short side of the air industry in general. There are no airline ETFs, and for good reason. It’s mostly a money losing business, with extremely slow growth rates and enormous risk and capital requirements.

There is, however, a way to profit from the airline industry collapse, which we’ll get to in a moment.

One additional factor is weighing against the airline industry, and that’s climate change. Air travel is estimated to account for somewhere between 4-9% of all emissions, and people are beginning to think twice about hopping a flight when perhaps a teleconference would do. Increasing public sensitivity to the climate change issue will add pressure to the industry’s burden.

By Chris Nelder

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