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2009 Business Travel Survey

US airlines swap fuel prices for demand crisis

Jun 02, 2009

U.S. airlines ended 2008 in a much smaller and less profitable industry than the one that they entered, dropping about 9 percent of capacity, watching seven smaller airlines liquidate, shedding nearly 28,000 full-time jobs and approaching $20 billion in net losses.

The year began with mounting oil costs, which reached a crescendo of nearly $150 a barrel in July, then as fuel spiraled downward, the sustained recession sent demand along.

"Looking back at 2008, the environment was very challenging throughout the year," said Continental Airlines CEO Larry Kellner during the carrier's full-year earnings call this January. "Crude oil prices were extremely volatile, peaking as high as $147 per barrel in July, and then dropping to a low of $32 per barrel in December. Add in the revenue environment deteriorating as the economy weakened, and you have an operating backdrop that rivaled any we've seen in our industry for many years."

U.S. carriers spent 2008 recalibrating to combat fuel costs through efficiency gains, capacity cuts, headcount reductions and ancillary revenue initiatives, which made them better prepared to weather the economic crisis. Yet the profit outlook for 2009 remains bleak.

"In effect, we've swapped the oil prices of 2008 for the travel demand crisis of 2009," American Airlines CEO Gerard Arpey told investors in a first-quarter earnings call in April. "We are also facing disruptions in the capital markets and, like the recession and resulting decline in travel demand, the tightening of the credit markets is a challenge, not only for American but for the entire industry and other industries as well."

Topping labor as the airlines' largest expense in 2008, fuel cost was the biggest driver of airline losses last year. Noting that every dollar increase in a barrel of fuel adds $448 million in expenses to carriers' bottom lines, the Air Transport Association noted the cost of fuel was between 30 percent and 40 percent of total operating expenses for most carriers last year—well above the historical range of 10 percent to 15 percent.

Airlines spent $15.9 billion more on fuel in 2008 compared with 2007, according to ATA chief economist John Heimlich.

"That incremental expense, which was the largest year-over-year expense we've ever had, was done on 5.3 percent less consumption," Heimlich said. "The price increase was that big that it offset a reduction of just over one billion gallons consumed. Some of that was done through efficiency, a lot through contraction."

Averaging nearly $100 a barrel in 2008, the volatility in fuel pricing spurred major carriers to hedge—which turned out to be a costly insurance policy for many.

"When the price of oil started to drop, that should have been good news," said former American Airlines CEO Don Carty, now chairman of Virgin America and Porter Airlines. "Two things happened to make it worse: One, which was not self-inflicted, was the falloff in demand. The second thing, which was self-inflicted, was the airlines saying, 'Aha! $100 barrel of oil, I've got to get some of this while the price is right.' Then, of course, it dropped."

To cope with the highest fuel costs in history, airlines last year slashed capacity, retired aircraft and reduced headcount. By the fourth quarter, the U.S. industry had reduced domestic available seat miles by 9 percent from the fourth quarter of 2007. Carriers parked aircraft in the desert, reduced frequencies, traded larger aircraft for smaller planes on some routes and abandoned some markets altogether.

A General Services Administration report issued in April said 38 airports lost all commercial airline service in 2008, "roughly twice the number that lost all service for the same periods in 2006 and 2007." GAO also noted U.S. airlines last year reduced the number of active aircraft in their fleets by 18 percent "by eliminating mostly older, less fuel-efficient, and smaller—50 or fewer seats—aircraft."

Domestic airlines last year maintained a degree of pricing power, and initiated a number of charges, fees and surcharges.

U.S. Bureau of Transportation Statistics data showed full-year 2008 domestic airfares grew by nearly 7 percent, compared with 2007. However, airlines' ability to increase pricing faded quickly as demand dived in the third quarter, and fares declined in the fourth quarter.

Rick Seaney, CEO of, said domestic carriers last year initiated 22 fare hikes, 15 of which were successful. However, the industry's last attempt at a fare hike in 2008 came in July.

Airlines found several ways to grow revenue without raising fares, from charging for select coach seat assignments and meals to the introduction of inflight Internet and now-pervasive baggage fees and fuel surcharges.

According to BTS data, the 21 largest U.S. carriers in 2008 earned more than $1.1 billion in excess baggage charges—a record figure largely due to the $15 first-bag fees and $25 second-bag fees widely adopted last year.

"Unbundling works," United Airlines COO John Tague told investors this year. "The revenue generated from these products and services is now a proven and meaningful contributor to United's bottom line. Our philosophy in this regard is simple: Know what products and services our customers value and are willing to pay for."

The dominant concern among major airlines this year continues to be the dramatic pullback in demand, particularly from the high-yield corporate and premium segments, which—five months into the year—showed few signs of recovery.

According to GAO, year-over-year passenger traffic declines began in the second quarter of last year and by the fourth quarter, passenger volumes were down nearly 8 percent from the same period in 2007.

April 2009 airline traffic reports showed some signs of improvement over March and airline executives pointed to stabilization in revenue and demand declines.

Carriers have maintained relatively high load factors, thanks in large part to capacity cuts and lower fares, but year-over-year revenues continue to fall further than traffic.

ATA last month in a report on April 2009 traffic said the number of passengers fell by 6.3 percent from April 2008, but passenger revenue was down by 18 percent—a divide that shows a weakness in generating passenger revenue.

GAO in its report noted, "The demand for air travel now appears to be weaker than expected—especially among business and international travelers—and revenues appear to be declining. Today, the outlook for the industry's profitability in 2009 is uncertain."

Like most other major carriers, AirTran Airways followed a 2007 profit with a 2008 net loss—$273 million. However, AirTran was one of the few major airlines that managed to reverse its fortunes in the first quarter of 2009, posting a profit of $28.7 million, "which represents an all-time first-quarter record net income for the company," CEO Bob Fornaro told investors.

Fornaro attributed the gains to significantly reduced fuel costs, record quarterly load factors and other cost-cutting initiatives. AirTran late last year stole the mantle from Southwest as the lowest-cost passenger airline.

Though the carrier consistently has been in growth mode throughout its history, AirTran is scaling back capacity this year by up to 4 percent to cope with lower demand.

For 2009, Fornaro said, "The key goal for us is to make sure we never get put into a position that we were in 2008, and that's really what motivates us. I don't think you're going to see much reason to see growth in 2010, and I think if you are going to see any growth in the industry, it is at least 18 months to two years off."

Offering one of the rosiest profit outlooks among domestic airlines, Fornaro said, "We expect to have a good year and we expect to be profitable in every quarter, but having said that, I would not be considering adding capacity this year because we have a weak revenue environment and we are waiting for it to turn."

Alaska Airlines posted a full-year 2008 net loss of nearly $136 million, which it attributed to charges associated with fuel hedging, aircraft sales and employee severance. Excluding those items, Alaska claims an adjusted net profit of $16.4 million for 2008.

Alaska Air Group, which includes Alaska Airlines and Horizon Air, posted a $19.2 million first-quarter net loss—narrowing the $37.3 million in red ink posted for the same period in 2008. Alaska Airlines last year reduced fourth-quarter capacity by 8 percent, while Horizon cut available seat miles by about 20 percent for the fourth quarter, compared with the same period in 2007.

Even with its aggressive capacity reductions, growing ancillary revenue streams and increased fares in 2008, American Airlines was unable to match the profits posted in 2006 and 2007. The carrier followed its 2008 full-year loss of nearly $2.1 billion with another $375 million loss in the first quarter of this year—with consolidated passenger revenues down 17 percent for the first three months.

American continues to see weakness in demand and pricing—though executives in April said some green shoots were emerging in the outlook, though not enough to outweigh the ongoing demand and revenue slump.

Hedging activities saved the carrier $380 million in 2008, and for the first quarter in 2009, Arpey said American "paid about $550 million less for fuel than we would have paid at last year's first-quarter prices, and as you may recall, first quarter of 2008 fuel prices were reasonably tame by last year's standard." Still, Arpey said, "Unfortunately, that dramatic decline was outpaced by the decline in revenues."

The carrier last year took the lead in slashing U.S. capacity, reducing available seat miles in the fourth quarter by 12 percent. American this year is broadening cuts in international markets to reduce international capacity by 2.5 percent this year, on top of a 2.7 percent reduction in 2008.

Though American CFO Tom Horton told investors that for the first quarter this year, "Corporate account revenue continues to be challenged, with year-over-year revenue declines greater than the system average," Arpey in a memo to employees said the carrier "picked up some significant new corporate accounts in the last few months."

Still, American said it is cautiously optimistic about business travel picking back up in the second half of the year.

"I think a lot of companies, if history is any indication, will not stay as hunkered down because travel is an integral part of their business, and so they need to have sales conferences, they need to go to conventions, they need to drum up business," Arpey said.

Meanwhile, the carrier is anticipating Department of Transportation approval of its antitrust immunity application with British Airways and Iberia Airlines in the second half of the year, which would enable the carriers to jointly plan schedules, set prices, share revenue and cultivate clients on transatlantic routes.

Continental Airlines held its full-year 2008 losses to $585 million, compared with the billions of losses posted by other legacy airlines.

Continental cited the high cost of fuel for its losses last year, as it paid $5.9 billion at the pump, nearly $2 billion more than it paid in 2007. After fuel costs peaked in July, demand concerns began to trump cost concerns.

"Beginning in October, we began to see a negative revenue impact from a weakening economic backdrop," said president Jeff Smisek during a full-year earnings call this year.

The decline in traffic and subsequent drop in yields led Continental to report a $136 million net loss for the first quarter this year. Continental attributed its sustained load factors more to capacity cuts and lower fares than to healthy demand, noting a significant hit on revenue.

Smisek during the carrier's first-quarter earnings call in April said 2009 poses a number of challenges, as even those business travelers who continue to take to the skies are doing so at lower fares. Smisek noted "a relaxation of some fare rules, thus lowering the fences between business and leisure demand and allowing business travelers to book at much lower fare levels."

Continental by the fourth quarter last year reduced its mainline capacity by 8 percent. This year, it expects mainline capacity to fall by up to 5 percent, with international declining by up to 3 percent.

In light of the merger between SkyTeam partners Delta and Northwest, Continental is shifting alliance loyalties to Star Alliance—fortified by a joint venture with United, Lufthansa and Air Canada that received tentative DOT approval in April. Continental said it officially will exit SkyTeam on Oct. 24 and promptly shift to Star.

Delta Air Lines' merger agreement with Northwest Airlines may have failed to inspire other airlines to move forward with similar arrangements, but their bid to become the largest global airline succeeded in October when the U.S. Justice Department gave the final nod.

The carrier's massive $8.9 billion loss for full-year 2008 is attributed to colossal fuel costs, expenses related to closing the merger, severance payouts and unrealized bets on fuel hedging. Full-year figures only include Northwest data after their merger closed on Oct. 29, 2008.

"If you were to exclude the special items and the impact of the out-of-period fuel hedges, Delta reported a net loss for the full year of $503 million," president Ed Bastian told investors this year. "We realize interpreting our financial results may be somewhat difficult and choppy over the next few quarters, since under Generally Accepted Accounting Principles we are required to compare our total Delta and Northwest results for the current period with the stand-alone Delta results in the prior year."

With the expenses of the merger largely behind it, Delta expects to begin reaping the benefits this year and achieve $2 billion in annual synergies by 2012. Delta and Northwest continue to integrate operations, expecting a single operating certificate from the U.S. Federal Aviation Administration in late 2009 and a consolidated reservations platform in early 2010.

Bad bets on fuel hedging helped propel the carrier to a $693 million loss for the first quarter this year. However, CEO Richard Anderson told investors, "Excluding special items and fuel hedge losses of $684 million, we had a break-even quarter."

Delta's total revenue fell 15 percent in the first quarter this year. Though the carrier continues to report soft yields, ancillary revenue, including baggage fees, brought in $900 million in the first quarter, up 18 percent from the same period in 2008.

"We have seen some signs of stabilization as the revenue environment appears to have bottomed out, but it's still a bit early to call and we expect to face significant headwinds throughout 2009," according to Anderson.

To match lower demand, Delta removed 10 percent of its domestic capacity in the second half of 2008. The carrier in September will begin to cut international available seat miles by 10 percent.

CFO Hank Halter told investors during the carrier's first-quarter earnings call, "For the full year, we still expect to be profitable as merger synergies, along with the benefits of lower fuel prices and capacity reductions, offset the deterioration in revenue."

Reporting its $76 million full-year 2008 loss to investors this year, JetBlue Airways CEO Dave Barger said, "While we're never happy to report a loss, given that our 2008 fuel expense increased $400 million compared to 2007, I truly believe our team did an excellent job."

To mitigate high fuel costs, the carrier last year shifted a great deal of service from transcontinental routes to leisure destinations, bulked up its portfolio of ancillary revenue, charged the highest average fares in its history and for the first time reduced net capacity. "We've slowed our growth considerably over the last few years," Barger said, noting that for the first quarter of 2009, capacity was down by 5 percent. The cuts enabled the carrier to charge higher fares last year, he said, noting that the average JetBlue fare grew 13 percent in 2008 over 2007 and that the company posted its highest average monthly fare in its history in December at $151 one-way.

"We benefited from our heightened focus on ancillary revenues, which grew almost 90 percent year-over-year to roughly $350 million in 2008, representing about 10 percent of our total revenue," Barger said.

The carrier in the past year has shifted focus from its bread-and-butter transcontinental routes—once comprising 50 percent of its network, now down to about 30 percent—to leisure-oriented Caribbean destinations. In the first quarter, transcontinental capacity declined almost 30 percent while growing nearly 40 percent between the United States and the Caribbean.

Along with AirTran, JetBlue was the only major domestic airline to post a first-quarter profit, which totaled $12 million. "The actions we have taken over the past few years to build our brand, reduce capacity, bolster liquidity and strengthen our financial position have clearly helped us manage the challenges of a weak economy," Barger said. "We expect to earn a profit in every quarter of 2009."

True to its 36-year tradition of annual profitability, Southwest Airlines was the only major domestic carrier to finish in the black in 2008—thanks in large part to its initially enviable fuel-hedging position. Though the carrier stumbled on rare third- and fourth- quarter net losses last year, Southwest posted a $178 million net profit for the full year.

As the cost of crude abated, Southwest's advantage turned into a liability. "Southwest's fuel hedges, which had been a source of major competitive advantage over the last few years, had quickly become a major drag," UBS airline analyst Kevin Crissey wrote in a research note this year, noting that the carrier is "financially more like other airlines than it has been for a long time."

Southwest CEO Gary Kelly said that "fuel hedging has saved us over $4 billion this decade alone," though with benefits waning amid lower market crude prices, the carrier "de-hedged" its fuel position for 2009 with only about 10 percent hedged, significantly down from the more than 60 percent initially slated.

Southwest's year-over-year fuel bill for the first quarter was down more than $170 million. Still, the carrier reported a net loss of $20 million for the first three months of the year, representing its first first-quarter loss since 1991. For the first time in its history, Southwest is shrinking net capacity, expecting available seat miles to be down about 5 percent this year.

"Even with that, we are delighted that we will be able to at least for this year continue to expand our route map, so while we will not be increasing our flight activity, we will be reallocating some of our flights to some new opportunities," Kelly told investors in April.

Southwest is modifying its history of focusing on point-to-point service to alternate airports and expanding its presence in such major airports as Boston, Milwaukee and Minneapolis, and its entry into the New York City market with service to LaGuardia is slated to start this month.

United Airlines' aggressive approach to capacity management, cost containment and ancillary revenue generation was not enough to offset the staggering $5.3 billion loss its parent company reported for the full year 2008. Absent special items that include $2.3 billion for goodwill impairment and a $1.1 billion loss on fuel hedging, the company posted a full-year loss of $1.7 billion.

The carrier last year aggressively unbundled its services and expects to achieve $1.2 billion from fees and ancillary revenue this year, up from about $300 million in 2008.

United in February 2008 was the first to announce the now-pervasive $25 second-bag fee, and since has rolled out a portfolio of a la carte travel options that include a first-bag fee, the Award Accelerator, which maximizes frequent flyer mile accumulation, door-to-door baggage shipping in partnership with FedEx, the Premier Line option, which lets non-elite passengers move more quickly through security, and Economy Plus seats, to which flyers can pay a fee to upgrade.

United last year removed about 10 percent of its mainline available seat miles, with U.S. capacity down more than 14 percent in the fourth quarter. The carrier in the first three months of 2009 reduced international available seat miles nearly 14 percent.

Continuing to pay the price for bad fuel-hedge bets, United for the first quarter this year posted hedge losses of $242 million, helping to drive its $579 million net quarterly loss.

Soaring fuel costs, $356 million worth of failed hedging expenses and other special charges helped drive US Airways to a $2.2 billion loss last year. In addition to reducing headcount, "We took aggressive steps to respond to high fuel prices, such as reducing capacity, instituting new a la carte fees and increasing our liquidity in a very difficult credit environment," CEO Doug Parker told investors this year.

US Airways for the first three months of 2009 reported a net loss of $103 million, as fuel hedging continued to taint its balance sheet—though Parker told investors in April, "Hedging gains and losses are not long-term sustainable items, but rather more timing issues."

The carrier during the first quarter noted that excluding hedging losses and special items, US Airways would have generated a net loss of only $63 million.

In the first quarter of 2009, US Airways continued to see a decline in business demand and lower yields from its leisure passengers, "as the industry resorted to aggressive discounting to fill seats," Parker said in April. "It's important to note, however, that leisure demand measured by load factor was still strong."

Parker expected US Airways' ancillary revenue initiatives and activities, including baggage fees, to generate between $400 million and $500 million this year.

The carrier expects that domestic capacity will fall by up to 10 percent this year and total available seat miles will drop by up to 6 percent over 2008. "Because of the global economic weakness and uncertainty, 2009 remains difficult to forecast," Parker said.

US airlines swap fuel prices for demand crisis
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