Will the boom in air travel and airline profitability last forever? Methinks not.
UPDATE: This article on Bloomberg (among others) illustrates the problem. Airlines are increasing capacity at a rate higher than travel is increasing. Fuel costs are going up, but airlines can't raise prices for fear of losing seats. Fare wars may start, causing all airlines to lose money.
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Back in October, the President of American Airlines boasted that they "never would lose money again!" which scared me to death. I sold all my airline stocks the next day. One thing I have learned over the last 50 years is that when someone says something will never drop in value, it is likely due for a huge drop. Pride goeth before the fall, or in this case, hubris.
And a recent article online seems to confirm that, at the very least, the halcyon days of the airline business are behind us. Several factors are conspiring to change the way airlines have worked for the last decade or so. We could go back to the dog-eat-dog model of the 1980's and 1990's.
In case you missed class, airlines used to be a heavily regulated Oligopoly. The government set routes and fares, as well as the type of equipment to be used. Air fares were staggeringly expensive - costing enough to buy a good used car back in the day. Planes flew with empty seats - often half the plane or more. Frequent flyer miles were used to entice business travelers to fly a particular airline, as "free flights" for the family vacation basically sold seats that were empty anyway.
Each country had its national "flag carrier". The UK had BOAC. France had Air France. Italy, Alitalia, and so forth. We didn't have a "flag carrier" although Juan Trippe heavily lobbied Congress to make Pan Am that carrier - and he went so far as to put huge American flag decals on the tails of his planes. Perhaps that is why American Airlines chose the name that it did.
Back in the day, before deregulation, I flew on a 727 from Syracuse Hancock to Hartford Bradley, with a stop in Albany, and I was one of maybe five passengers on the plane. That's how messed up regulations were. Then in the late 1970's, airlines were deregulated under Jimmy Carter, and everything changed. Suddenly, there was competition in the air - small carriers bought used planes and offered cut-rate fares. Richard Branson started "Virgin" airlines. The entire airline industry changed.
And as a result, profits vanished overnight. The high overhead and outright waste of the traditional regulated carriers - as well as high union wages - sent them on a slow path toward bankruptcy. Pan Am ended up stricken, and the Lockerbie disaster put it over the edge. Even without that terrorist incident, Pan Am would have foundered in short order - they were already selling off routes and trying to downsize. And after 9/11 airlines suffered more, as people stopped flying in droves. The economic recession of 2009 certainly didn't help matters, either. Airlines have been in and out of bankruptcy court for the last few decades, on a regular basis.
But in the last decade, since the economic recovery, it seems like we've entered a new era. Fuel prices were relatively low, and air travel was up. Airlines stopped the self-destructive fare wars, and indeed, seemed to be cooperating behind the scenes (and price and route-fixing has been alleged). Mergers and consolidation have reduced the number of carriers and reduced competition. Airlines no longer have to worry about some upstart low-cost carrier with a fleet of used MD-80's stealing away their lucrative Florida business.
New fares were introduced - and new fees. Profits soared. Air travel became more and more unpleasant - but more and more people traveled. The airports, once the enclave of the "jet set" and the upper classes, became the new bus terminal, as the great unwashed masses took to the skies.
But all of that might change, and change soon. The price of oil is creeping up, despite increased production in the United States. Oil prices are subject to the laws of supply and demand - and demand is way up. People are buying gas-guzzling trucks and SUVs, and air travel is up as well. So while we have all this fracking oil, we are burning it as fast as we frack it.
Competition is heating up as well. As the United article notes, cutting back on routes and seats turned out to be a disaster for that company. Investors pestered the board to cut back on routes after the Continental merger. United did, but just ended up handing seats and routes to American and Delta. Now, those same outside investors are demanding the company increase routes and capacity. Maybe companies shouldn't listen to outside investors!
But the net result will be a return to fare wars, as overcapacity will force airlines to slash fares to poach customers from one another. Combine this with increased fuel costs and increased labor costs (in a tight labor market) as well as rising interest rates and inflation and... well, I sold my airline stocks. I did well, made capital gains, got paid dividends and then got out. Stocks are not forever.
Speaking of labor problems, the idea that airline personnel are overpaid is sort of a thing of the past. It depends on which airline you are talking about and how much seniority the person has. Some of the "old school" pilots from legacy airlines are raking in the dough, and getting all the choice routes. But new pilots, starting out on commuter routes are hardly making anything. In a tight labor market, this could spell trouble. A walk-out or even the threat of a strike could create havoc for the airline industry. And rising labor costs certainly won't help the airlines' bottom line.
The media is postulating that 2018 will be a banner year, with tax cuts driving the economy to new heights. But if you read the tea leaves, you see signs of trouble. The tax cuts may drive the economy to an artificial high, I suspect, as this one time repatriation of income drives a flurry of mergers and acquisitions as well as expansions. The problem is, eventually the system reaches a new equilibrium. When corporations get lower taxes, this may mean windfall profits for a year or two, until a competitor lowers prices (as they can now afford to do) and thus, every player in that market space has to follow suit. The big profits go back to being competitive profits, in short order.
And I think right there is the problem for the airlines, or indeed, any business. While they may start out as wild profit-making ventures in new markets, eventually others see these profits being made and decide to jump in. Railroads, Automobiles, or Smart Phones, it makes no difference. Eventually, the item in question becomes a commodity item and the profit margins get thinner and thinner. It is the nature of our capitalist system, and indeed the genius of it - it provides lower cost products, over time.
This is why I get nervous when an airline CEO says that they will never lose money ever again. Or why I am skeptical that Apple can keep selling products for huge profits indefinitely. The history of business tells a different story - competition drives prices and profits down, over time. And so it will be, for the airlines.