Fuel bet has big impact
Pre-purchase has helped Southwest soar, brought pain to rivals
12:00 AM CDT on Saturday, April 29, 2006
By ERIC TORBENSON / The Dallas Morning News
PHOENIX – The single largest influence on the airline industry's struggling financial fortunes in the past three years?
It's Southwest Airlines Co.'s fuel savings program, according to several airline chief executives speaking at the Phoenix Aviation Symposium this week.
"The Southwest fuel hedge has had as much to do with the industry's ills as anything because they set the fares and they're the ones who set their fares at their costs," said Doug Parker, CEO of US Airways Group.
Southwest pre-purchased nearly all of its jet fuel three years ago, making a big bet that energy prices would rise.
The Dallas-based discounter was one of the few carriers with a balance sheet strong enough to make the move, which is shaping up to be the industry's masterstroke of the decade.
Southwest has saved hundreds of millions of dollars in fuel costs, and still has 70 percent of what it needs pre-purchased at prices equivalent to $36 a barrel.
Crude oil is selling for more than $70 today, and refined jet fuel is selling at the equivalent of more than $80 per barrel because it's expensive to make from oil.
That huge advantage has allowed Southwest to keep its fares far lower than where rivals have wanted, forcing others with much higher fuel bills to match in most top domestic markets.
"We make no apologies for running our company responsibly and having the foresight to prepare for the rise in fuel costs," said Southwest spokesman Ed Stewart. "It's just part of us trying to run our business at a profit."
Still, Southwest recognizes that its fuel "holiday" is coming to an end, and has already raised fares modestly twice this year.
At the panel here, executives said they expect Southwest, with the industry's leanest operating costs, will have no choice but to raise fares further.
"We don't feel overly victimized by high fuel costs," said John Tague executive vice president for marketing at United Airlines Inc., which has emerged from bankruptcy protection and still believes that the network model works well at virtually any fuel price. "We think there's enormous amounts of revenue to be unlocked out there."
Now executives such as Mr. Parker and Mr. Tague are hopeful that the industry's very cheapest fares will evaporate as Southwest faces its new reality.
"I think we'll see the silliest of fares go away – the $198 transcon fares, for example," Mr. Parker said.
Too much capacity
While Southwest's fuel cost advantage has forced carriers to the brink of failing, the industry still has too much capacity by many measures.
"We have partial winners and partial losers, but we never really see the real consequences of fully losing," said Mark Dunkerley, chief executive of Hawaiian Airlines Inc.
But even in the best of times, airlines aren't generating good margins that allow them to get through lean times.
"None of the big airlines are generating margins that would create acceptable return on invested capital," said Harry Pinson, managing director for Lazard Freres. It's difficult to find a good case for airlines to buy new aircraft because they can't adequately cover that cost, he added.
"Too much capacity came back too quickly after 9/11 and fuel costs have delayed the industry's return to profitability," said Richard Schifter, partner with Fort Worth-based Texas Pacific Group, a frequent airline investor. The pain felt by carriers and employees should brace surviving carriers for the next downturn, he said.
"The next time the economy weakens, it will kill airline profitability but may not be as bad as this time around" for carriers because they will have stronger balance sheets, he said.
'On its own'
Some carriers will be in better shape than others, Mr. Schifter said, and Fort Worth-based American Airlines Inc. faces "extraordinary challenges" after rival Northwest Airlines Inc. and Delta Air Lines Inc. emerge from bankruptcy protection.
"They will come out with significantly lower labor costs, leaving American sort of hanging out there on its own. It will take a lot of creativity for American to get out of that position," he said.
"We've acknowledged that we're not where we need to be," said Beverley Goulet, American's treasurer and vice president of corporate development.
By using continuous improvement and working closely with its labor unions, the world's largest carrier aims to cut expenses further to keep up with foes that are using the leverage of bankruptcy restructuring, she said.
Some observers think both Northwest and Delta won't survive alone as they restructure. Because airlines have so much power in bankruptcy to discharge debt, pension obligations and reshape their aircraft fleets, they can customize themselves to be attractive partners.
The success of the US Airways Group merger with America West Airlines has venture capitalists hoping to find a similar quick-hit merger.
Not so fast
But Ms. Goulet threw in a cautionary note from American's 2001 acquisition of the assets of Trans World Airlines, which showed how challenges from combining unionized workforces can overwhelm benefits from a merger.
"As recently as last year we were still dealing with an arbitration case between TWA and Ozark Airlines that dated back to 1985," she said.
"Our experience in this area hasn't been real good – we bought AirCal, Reno Air and TWA, and if you look at the hubs of those carriers, in each case we're not as big as they were when we bought them," said Dan Garton, executive vice president of marketing for American. "We're not going to be a leader in this consolidation path."
That urge to merge must come with restraint. "Consolidation without capacity reduction isn't going to create any value," said Mr. Parker of US Airways.
But as Southwest awakens to its new fuel reality and prices its tickets according to its higher costs, the entire industry stands to benefit, he added.
E-mail [email protected]
Pre-purchase has helped Southwest soar, brought pain to rivals
12:00 AM CDT on Saturday, April 29, 2006
By ERIC TORBENSON / The Dallas Morning News
PHOENIX – The single largest influence on the airline industry's struggling financial fortunes in the past three years?
It's Southwest Airlines Co.'s fuel savings program, according to several airline chief executives speaking at the Phoenix Aviation Symposium this week.
"The Southwest fuel hedge has had as much to do with the industry's ills as anything because they set the fares and they're the ones who set their fares at their costs," said Doug Parker, CEO of US Airways Group.
Southwest pre-purchased nearly all of its jet fuel three years ago, making a big bet that energy prices would rise.
The Dallas-based discounter was one of the few carriers with a balance sheet strong enough to make the move, which is shaping up to be the industry's masterstroke of the decade.
Southwest has saved hundreds of millions of dollars in fuel costs, and still has 70 percent of what it needs pre-purchased at prices equivalent to $36 a barrel.
Crude oil is selling for more than $70 today, and refined jet fuel is selling at the equivalent of more than $80 per barrel because it's expensive to make from oil.
That huge advantage has allowed Southwest to keep its fares far lower than where rivals have wanted, forcing others with much higher fuel bills to match in most top domestic markets.
"We make no apologies for running our company responsibly and having the foresight to prepare for the rise in fuel costs," said Southwest spokesman Ed Stewart. "It's just part of us trying to run our business at a profit."
Still, Southwest recognizes that its fuel "holiday" is coming to an end, and has already raised fares modestly twice this year.
At the panel here, executives said they expect Southwest, with the industry's leanest operating costs, will have no choice but to raise fares further.
"We don't feel overly victimized by high fuel costs," said John Tague executive vice president for marketing at United Airlines Inc., which has emerged from bankruptcy protection and still believes that the network model works well at virtually any fuel price. "We think there's enormous amounts of revenue to be unlocked out there."
Now executives such as Mr. Parker and Mr. Tague are hopeful that the industry's very cheapest fares will evaporate as Southwest faces its new reality.
"I think we'll see the silliest of fares go away – the $198 transcon fares, for example," Mr. Parker said.
Too much capacity
While Southwest's fuel cost advantage has forced carriers to the brink of failing, the industry still has too much capacity by many measures.
"We have partial winners and partial losers, but we never really see the real consequences of fully losing," said Mark Dunkerley, chief executive of Hawaiian Airlines Inc.
But even in the best of times, airlines aren't generating good margins that allow them to get through lean times.
"None of the big airlines are generating margins that would create acceptable return on invested capital," said Harry Pinson, managing director for Lazard Freres. It's difficult to find a good case for airlines to buy new aircraft because they can't adequately cover that cost, he added.
"Too much capacity came back too quickly after 9/11 and fuel costs have delayed the industry's return to profitability," said Richard Schifter, partner with Fort Worth-based Texas Pacific Group, a frequent airline investor. The pain felt by carriers and employees should brace surviving carriers for the next downturn, he said.
"The next time the economy weakens, it will kill airline profitability but may not be as bad as this time around" for carriers because they will have stronger balance sheets, he said.
'On its own'
Some carriers will be in better shape than others, Mr. Schifter said, and Fort Worth-based American Airlines Inc. faces "extraordinary challenges" after rival Northwest Airlines Inc. and Delta Air Lines Inc. emerge from bankruptcy protection.
"They will come out with significantly lower labor costs, leaving American sort of hanging out there on its own. It will take a lot of creativity for American to get out of that position," he said.
"We've acknowledged that we're not where we need to be," said Beverley Goulet, American's treasurer and vice president of corporate development.
By using continuous improvement and working closely with its labor unions, the world's largest carrier aims to cut expenses further to keep up with foes that are using the leverage of bankruptcy restructuring, she said.
Some observers think both Northwest and Delta won't survive alone as they restructure. Because airlines have so much power in bankruptcy to discharge debt, pension obligations and reshape their aircraft fleets, they can customize themselves to be attractive partners.
The success of the US Airways Group merger with America West Airlines has venture capitalists hoping to find a similar quick-hit merger.
Not so fast
But Ms. Goulet threw in a cautionary note from American's 2001 acquisition of the assets of Trans World Airlines, which showed how challenges from combining unionized workforces can overwhelm benefits from a merger.
"As recently as last year we were still dealing with an arbitration case between TWA and Ozark Airlines that dated back to 1985," she said.
"Our experience in this area hasn't been real good – we bought AirCal, Reno Air and TWA, and if you look at the hubs of those carriers, in each case we're not as big as they were when we bought them," said Dan Garton, executive vice president of marketing for American. "We're not going to be a leader in this consolidation path."
That urge to merge must come with restraint. "Consolidation without capacity reduction isn't going to create any value," said Mr. Parker of US Airways.
But as Southwest awakens to its new fuel reality and prices its tickets according to its higher costs, the entire industry stands to benefit, he added.
E-mail [email protected]
