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Southwest Airlines was one of the few US airline companies with the foresight -- and the balance sheet -- to hedge oil prices years ago. Most commercial airline companies declined precipitously after the terrorist events of 9/11 as consumers flew less for business and leisure[citation needed]. As a result of this shock, the industry faced increasing consolidation and key bankruptcies (including United, Delta and Northwest) as the sector struggled to regain its financial footing. Consolidation i
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  Southwest Airlines was one of the few US airline companies with the foresight -- and the balance sheet -- to hedge oil prices years ago. Most commercial airline companies declined precipitously after the terrorist events of 9/11 as consumers flew less for business and leisure [ citation needed  ] . Asa result of this shock, the industry faced increasing consolidation and key bankruptcies (including United ,  Delta and  Northwest ) as the sector struggled toregain its financial footing. Consolidation is beneficial in two ways for airline companies, as it typically reduces redundant operating costs and raisesrevenues through higher fares.Compounding the issues around declining consumer demands was the concurrent rise in oil prices, which typically constitutes 30% of an airline'soperating cost and is the major expense for commercial airline companies. Some companies such as  Southwest  had the foresight to lock in low fuelprices using hedging strategies, but most airlines, including the two largest by revenue passenger miles-- American Airlines  and United Airlines --have nohedging strategies in the foreseeable future and will suffer the most if oil prices continue to rise. Industry Specific Metrics Aircraft Utilization : The most basic metric for an airline is aircraft utilization. This is a measure of the average number of hours that each aircraftis flying in each 24 hour period. Planes that are flying are probably making money. Planes that are sitting on the ramp, whether undergoingmaintenance, suffering delays due to weather or waiting for crews to fly them are not making money. Utilization is a statistic that varies fromcarrier to carrier and is normally considered a closely guarded corporate trade secret and is not tracked by government. Part of the art inrunning an airline is keeping utilization high. Load Factor  : The next most important metric for an airline is the Load Factor, which measures the percentage of available seats that are filledduring a specific period. In 2007 load factors for major airlines ranged from 72-84% [ citation needed  ] . In 2008 U.S. airlines averaged a Load Factor of 79.74% on domestic flights and 78.74% on International flights  [1]   Available Seat-Miles (ASM) : The ASM metric is used to track seat supply among airlines. ASM is equal to the number of available seats timesthe number of miles flown. Revenue Passenger-Miles (RPM) : RPM measures the number of seat miles flown for which the company earned revenues. That is, RPMequals the number of filled seats times the number of miles flown.  Yield : The amount of revenue earned per RPM is known as the airline's yield. This metric is generally expressed in cents and ranged from 9.8-13.1 cents for the major airlines in the first half of 2007 [ citation needed  ] . Fuel Costs : Most factors that affect the profitability of airlines are fairly stable, except for fuel costs. Fuel costs are facing extreme risk from thethreat of   Peak Oil .During January 2009, airline fuel costs averaged $1.76 USD per gallon [2] .  Trends and Forces Joseph Weisenthal said in a recent post Airline-In-A-Box: Few businesses have as many variables and challenges as airlines. They are capital-intensive. Competition is fierce. Airlines are fossil fuel dependent and often at the mercy of fuel price volatility. Operations are labor intensive andsubject to government control and political influence. And a lot depends on the weather. The Dual Mandate Problem  The general public, including most investors, is not aware that congress long ago created what is referred to as a dual mandate for regulation of theairline industry. This means that the  Federal Aviation Administration  ( FAA ), which is a sub-agency under the  U.S. Department of Transportation  ( U.S. DOT ),is charged with both the promotion of the airlines and the safety regulation of the airlines. This creates an obvious conflict of interest and the dualmandate has been questioned and criticized for decades. The question has been asked if the FAA should be divided into two separate divisions, onethat would function as a Department of Airline Promotion and another that would function as a Department of Safety. Another proposed solution isto shift the sky police functions involving safety to the   National Transportation Safety Board  (  NTSB   ). Although the NTSB seems like it might be a goodsolution to police safety, the political realities of the U.S. Congress, the FAA hierarchy and the extreme size and funding imbalance between the twoagencies make it impractical and unlikely that any shift would be feasible. The FAA generally maintains that they do not directly promote the airlines,which is true in the sense that the public doesn't see billboards and television commercials and email campaigns from the FAA promoting airlines.However, the FAA indirectly promotes the airlines in a huge way on a daily basis by imposing generally lax standards and enforcement. In fact, it is awell known historical fact that the FAA is so bad at safety enforcement that there exists what is called in the airline industry the Tombstone Imperative which refers to the fact that over and over again the FAA has known about serious safety issues and refused to correct them and the result was deadpeople.-- PGSanalyst  21:11, March 14, 2009 (PDT) The Railway Labor Act Problem The general public, including most investors, is also not aware that labor in the airline industry is regulated by the  Railway Labor Act .This is arguablyamazingly strange and curious that one of the major modern industries, developed in the early 20th century, and now providing part of the industrialbackbone for commerce and industry in the 21st century, is regulated by a body of law that was srcinally passed to protect wealthy railroad investorsfrom railroad strikes in 1877. As a general rule, airline labor is not allowed to strike, similar to the prohibition on strike actions  for Federal Employees andemployees of some states. For example, the  Airline Pilots Association  (ALPA) functions as the  collective bargaining  agent for most, but not all, of theairlines in the U.S. and most ALPA collective bargaining contract terms provide very, very limited circumstances under which a strike is legallyauthorized. Another example of the difficulty of labor expressing it's grievances by means of a strike is the 1981  Professional Air Traffic Controllers  (PATCO) strike that ended with President Ronald Reagan firing the controllers by using the authority of the Taft-Hartley Act  that was passed in 1947 togreatly reduce the power and influence of unions in the U.S. The basic thing for a wise investor to understand about labor issues is that happy peopleare generally more productive than unhappy people and limiting by means of regulations people's right to express their grievances may not promotehappiness of the labor pool and thus adds risk to investments in those businesses in industries affected by labor relations risks.-- PGSanalyst  21:11,March 14, 2009 (PDT) Consolidation After the events of 9/11, the domestic commercial airline industry went into a precipitous freefall, prompting consolidation of several airlines andbankruptcies of others. Elimination of airlines, through consolidation or bankruptcy, benefit both revenues--through higher fares--and costs byeliminating redundant expenses and routes. Additional terrorist attacks or declines in the overall domestic economy could accelerate consolidation asweaker airlines get acquired by financially stronger ones or become insolvent.Airlines worldwide have also sought to share costs by creating partnerships or alliances. Through these agreements, airlines can share facilities andoperational costs (e.g., maintenance facilities, sales offices) and negotiate volume discounts on large purchases. Passengers benefit from lower prices  (due to lower expenses) as well as optimized routes and pooled loyalty rewards, especially in regards to international travel. Since the deregulation of the airline industry begain, airline ownership has been limited to companies and individuals of the operating country. THis has prevented major international mergers and acquisitions from occuring. Recently, the US government has announced its intentions to relax these regulations and clear the way for  international   m&a deals in the airline industry. [3]  This could create significant cost-saving and synergy in the rapidly deteriorating industry.The three major global alliances are: Worldwide Airline Alliances   AlliancePassengers per Year (MM)% RPM Share Approx.(2005)Key U.S. Airlines Star Alliance 413 25% United, US Airways, ContinentalSkyTeam 373 20% Northwest, DeltaOne World 320 15% American Spotlight on Oil Prices Oil Prices are a key factor for airline operations because Jet Fuel costs are directly linked to the cost of the oil that must be refined to produce Jet Fuel.In 2008 fuel is constituting about 34% of an airline's costs, as opposed to about 13% in 2002. [4]  For the budget airlines such as  Jet Blue and  AirTran , thisshare rises to nearly 50%. [5]  The rise has been very drastic just in the first six months of 2008. At the start of the year, jet fuel cost $850 a metric ton. Asof June, the cost is now approximately $1300 a ton. [6]  Jet fuel is extremely correlated with  spot petroleum prices ,which have risen significantly over thepast several years. On the flip side, the stock prices of domestic airlines tends to be highly negatively correlated to jet fuel prices, indicating thesensitivity of this historically low-margin business to fuel expenses.In an exogenous event for the fuel procurement of airlines, oil companies are increasingly making airlines pay up front for fuel. In the past, the airlineswere allowed to use fuel on credit and pay up to weeks later. Now, the oil refiners  are eliminating this free credit line and making the carriers prepay.This will cause a negative shift in the short term cash situation for the airlines as they can no longer keep cash from revenues on the books for thiscredit line period. [7]  On June 4, the International Air Transport Association drastically lowered their profit forecasts for the industry. The group now projects that globalairlines will collectively lose $2.3 billion if oil averages $107 for 2008. If the price averages $135 for the last six months of the year, airlines will lose $6.1billion. [8]  However, on 1 October 2008   Northwest Airlines (NWA)  CEO Doug Steenland claimed that his company can maintain profitability even if oilstays at $100 a barrel. [9]  Some airlines have utilized hedges to lock in the price of fuel and hence insulate themselves from oil price volatility. Southwest  was perhaps the most forward-looking of airlines, and has hedged significant portions of its fuel expenses through 2010 at variousprices per barrel below the current market rate. The company will reap benefits compared to other airlines if oil prices continue to rise or remainat current levels. On the other hand, if prices fall below Southwest's hedging levels, they will be at a disadvantage to other airlines. American Airlines and  United Airlines ,on the other hand, have no remaining fuel hedges in the foreseeable future as of 2008. Other airlines havelimited remaining hedges. Peak Oil  Peak Oil  experts from the oil industry are already warning of impending catastrophic drops in oil production that will severely limit the future growth of the airline industry and cause extreme increases in Jet Fuel costs and other oil related costs including fuel for airline support infrastructure such asmaintenance vehicles, External Ground Power Units (GPUs), crew transportation vans, airline food costs, etc., etc.. Some scientists and industryexperts are seriously discussing the viability of the entire global airline industry and asking the question of whether their grandchildren will ever even flyon a commercial aircraft? The mere fact that these questions are being asked and remain unresolved should cause a wise investor to carefullyconsider the long and short term impacts of Peak Oil on the airline industry as a whole.-- PGSanalyst  21:23, March 14, 2009 (PDT) Business vs. Leisure Travel Business travel is important to the commercial airline industry for two major reasons. First, it commands a much higher average ticket cost,approximately 5 times higher than the average leisure fare. Second, business travel is less elastic changes in macro-economic trends than leisuretravel, which may be considered a form of luxury.In the past 24 months, leisure fares have dropped slightly, ranging from $110 to $100In the same time frame, business fares have increased significantly, from around $350 to $500 Domestic vs. International Travel International travel accounts for about one-third of all traffic and capacity for the major carriers. Comparing 2007 year to date to the same time period in2006, these major carriers saw international travel increase by about 5% , which is faster than domestic travel, which was relatively flat. Growth indomestic travel has been soaked up in large part by the regional discount carriers such as  Southwest  and AirTran .  History of Airline Bankruptcies Raises Risk Concerns For Investors [10] Over the period from 1990 through 2006 the Air Transportation Association of America reports that domestic airlines posted a cumulative loss of $22billion on cumulative revenues $1,866 billion. Since 1978, when commercial aviation was deregulated, no fewer than 137 carriers have filed for bankruptcy protection. And from the end of World War II, when aviation started to become big business, through 1994, the sum of the industry's profitsand losses was less than zero. Warren E. Buffett once remarked that it would have been a blessing for shareholders if someone had thought to shootdown Orville Wright at Kitty Hawk. [11]  One reason the major airlines are at higher risk for bankruptcy is that they use huge amounts of fixed capital --wide-body jets go for $100 million each and can't be readily liquidated which explains why many airlines do not own their aircraft but lease theminstead. Airlines also depend on a highly skilled labor force that requires large cash flow into training, benefits and pensions. Consider some other businesses for a moment: Microsoft has highly skilled programmers but little invested capital. Merrill Lynch has both, but its assets -- stocks and bondsmostly -- could be liquidated overnight. Steel has high fixed capital, but it can replace its workers more easily. Unbundling of costs usually bundled in ticket prices Business practices for much of the history of the airlines included bundling all costs of travel into a single ticket price. Although some unbundling of the costs in tickets has occurred to various degrees at some airlines in different parts of the world, since the summer 2008 spike in fuel costs manyairlines have chosen to broaden the practice, for example, charging the passenger for each piece of checked baggage [12] . 
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