Here’s last week’s article for Energy and Capital, in which I discuss the failing airline industry and the excellent long-term outlook for rail.
Peak Oil and the Rail Revolution
Say Goodbye to Cheap Air Travel
By Chris Nelder
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:
Oasis Hong Kong 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.
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.
A Slow Boat To China
The equation is clear: skyrocketing oil prices, thanks to peak oil, are the death knell of cheap air travel. From here on out, as oil continues to rise, those cramped seats will get harder to find, and more expensive.
In time, air travel will once again be only for the rich. I expect it will end much as it began, with limited high quality service for a select clientele. Consider this: A seat on the first commercial air flight, a 23 minute hop from St. Petersburg to Tampa, Florida in 1914, cost more than $3600 in today’s money.
For us regular folks, this could be our last chance to see the world on the cheap, without devoting weeks or months to the traveling part.
According to Delta CEO Richard Anderson, ticket prices would have to rise 15-20% just to cover increased fuel costs. "You can’t underestimate the spike in fuel prices and how it is fundamentally changing the industry," he said.
But like most many aspects of peak oil, there may be a silver lining here. Life will slow down from its current frenetic pace, and that’s not such a bad thing. Maybe I’d enjoy a long journey by boat to Asia. Like the song from 1945 says:
I’d like to get you
On a slow boat to China,
All to myself alone.
To get you and keep you in my arms evermore,
Leave all your lovers
Weeping on the faraway shore.
Out on the briny
With the moon big and shinny,
Melting your heart of stone.
Darling, I’d love to get you
On a slow boat to China,
All to myself alone.
Some things take time. It’s not easy to melt a lady’s heart on a mere five-hour flight.
So in some ways, I’m not going to miss cheap air travel that much. Yes it’s convenient when you have to cross the country, but the whole experience has become so painful. Between the lost luggage, the cancelled flights, the discomfort, and being treated like a presumed criminal, I look at economy air travel as a last resort.
I actually opted to drive 15 hours home for Christmas for the last two years, rather than endure the 12-36 hour random experience of trying to fly at that time of year, with bad weather and cancelled flights and a crush of travelers. On a cost basis, I figure I at least broke even. But I enjoyed the trip far more, feeling like Jack Kerouac with the windows down and the stereo blasting big band music as I blew across hours of open desert on the old Route 66.
I know that some day, when fuel becomes too expensive and hard to get, I’m going to miss that experience.
But by that time, I hope to have an even better alternative: a rail ticket.
Rail: The Longest Safe Bet You Can Make
If you’ve ever had the pleasure of riding a modern high-speed railroad in Europe, you know why I say that.
Taking the TGV, the electric-powered French long-distance railroad, across the country from Paris to Provence was without a doubt the most enjoyable travel I have ever experienced. I boarded the train shortly before departure time without any security checks, and kept all my bags with me the entire way. I luxuriated in a huge leather reclining seat while being quietly whisked at 200 mph across the picturesque countryside. Regular service walked up and down the aisles, asking if I’d like anything to eat or drink. Or I could get up and stretch my legs and walk down to the café car if I wanted something-like a decent sandwich on a nice baguette, not some nasty air "snack." Door to door, it was a little cheaper than an air ticket, and took less time because trains go from city center to city center, not to some godforsaken outpost 20 miles outside of town.
Compared to the cattle car experience of discount air travel, it’s bliss.
Comfort aside though, rail is bound to gain market share in the coming decades as the airline industry contracts. This is because rail is by far the cheapest and most fuel-efficient form of transport, requiring about a third less fuel than air for personal travel, and as little as 3% of the energy for freight.
Rail can also run on renewably generated electricity, making it a true transportation alternative for the future.
Now, I realize that the only long-distance passenger carrier in the country, Amtrak, is terminally broken and underfunded and suffering from decades of neglect. But as the rail resurgence in freight travel picks up speed, I have no doubt that passenger rail will follow.
Simon Fraser University professor Anthony Perl, author of the new book Transport Revolutions, predicts that in 2025, no more than 25 airports will be functional. Electric powered transportation and rail will be the standard transport options.
Very simply, in a post-peak oil world, rail is a no-brainer. It’s probably the longest safe bet one could possibly make.
That would explain why the sector has attracted large investments from some of the wealthiest investors in the country over the last several years.
Bill Gates has become the largest investor in Canadian National Railway (NYSE: CNI). Warren Buffett and George Soros have taken large positions in both Union Pacific (NYSE: UNP) and Norfolk Southern (NYSE: NSC). And Carl Icahn has taken a $122 million stake in CSX Corporation (NYSE: CSX).
Their investments have already paid off handsomely. Consider this chart of a few of the top airlines against their rail counterparts over the last year and a half:
What else need we say?
Until next time,
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