Follies

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May 16, 2012

Airline Follies

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By Paul Bertorelli

Just as I thought I'd seen everything, along comes Spirit Airlines suing the government for the right to engage in bait-and-switch advertising. You probably saw the story this week.

Spirit has taken the idea of unbundling—that is, unbundling everything from the seat except the upholstery (and maybe even that)-- and charging extra for it to absolutely artistic levels.

Now Spirit is steamed that the government is requiring that its advertised fares include not just the fare itself, but also the taxes and relevant fees.

And what fees! By this fall, Spirit will charge $30 for a carry-on bag, $28 for a checked bag, between $1 and $50 for a reserved seat, up to $15 for drinks and snacks, $12 to $199 for an extra-wide seat and, my favorite, an unintended consequences of DOT regulations fee of $2, which everyone pays each way.

These fees are almost comically absurd, but they're also American capitalism at its best. The cheapest possible prices and plenty of choices so that the customer can tailor his or her airline experience from absolutely horrid to sort of tolerable. Spirit is suing on the grounds that its first amendment rights are being trampled. Good luck with that one. It will be an interesting head butt between the commercial code and the Constitution.

I flew Spirit once, but wouldn't again. The service was adequate, but they have so many fees now that I'd be afraid of more being added while I drove to the airport.

Higher Fares
And speaking of fares, you may have noticed they're up--as much as 25 percent. There are two reasons for this. One is higher fuel prices and the other is reduced capacity--the airlines have cut back on flight frequency and, in some cases, switched to smaller airplanes on some routes. United, for instance, has chopped up to 16 percent of its flights; Southwest about 6 percent.

Supply and demand does the rest, so fares rise. While I don't like paying the higher fares, I'd rather pay and have airlines run as profitable businesses than be niggled to death by ancillary fees. So I'm willing to suck it up and just pay.

The downside is airplanes filled to the gills with passengers as load factors sustain above 80 percent. In the name of efficiency, that's the way it goes. Another downside, unfortunately, is less flexibility in scheduling and a much higher probability of the airline re-routing or re-scheduling you whether you like it or not. Supply and demand again. I suspect the airlines will have to add back a little capacity once the curve reaches bottom. We'll see.

Delta Makes Its Own Gas
I'd like have lunch with the MBA who came up with this idea: Delta bought an oil refinery near Philadelphia in order to makes its own jet fuel. ConocoPhillips unloaded the thing for a fire sale price.

Now I'm no expert on oil refining but I have the phone numbers of people who are. If you fancied yourself wanting to find a fortune in the oil business, the last aspect you'd want to get into is refining. All the money is on the upstream side and refiners, which are typically structured as independent business units, often lose money. It's just a tough, thankless business that requires gobs of capital for little, if any, return. And it's not like Delta can convert all of the barrels of oil it will have to buy into Jet A. Refining doesn't work that way. You have to make a range of products or get someone else to.

It makes me wonder if Delta's board was awake when this proposal floated by. Maybe the losses will sweeten their tax position. Only in the airline business could you seek more losses to make money. I give it five years before they'll be trying to get out of the refinery business in a hurry. Carry-on bag fees, anyone?

Virgin's New Cell Service
Meanwhile, Virgin Atlantic is introducing a new service that lifts the ban on in-cabin use of cellphones. Beginning this year on its London-New York routes, Virgin will offer a service which appears to provide a local cell network inside the cabin through a satellite link. It will be available to six users at a time and, evidently, only in business class. (Imagine the fights over divvying up that limited service to the road warriors in the biz section.)

This could end up being an interesting sociological experiment over the wilds of the North Atlantic. Even though passengers will be asked to keep usage to a minimum, we all know that 3.6 percent of the population are loud, obnoxious cellphone users or obsessive texters. Personally, on a long international flight, I'm perfectly happy having the cellphone silent and pray that whoever is in the seat next to me feels the same.

Comments

I honestly believe that the people who come up with these bright ideas will seek out any aspect of flying that is even remotely pleasurable or convenient and find a way to charge for it. My pet idea is that if you encounter a check-in or flight attendant that is nicer than most or goes a little out of his or her way to help you, you should pay extra. I see a day when staff receive "niceness certifications", maybe indicated with an attractive, Chinese-made, label pin, and you would pay a fee to talk to them. If you don't pay up, you would be directed to a gruff, angry, over-worked, and under-paid employee and you would have to stand there and listen to him or her complain about the poor state of the airline industry. You would then have to pay extra to stop listening and board the plane. It's American Capitalism at its best - any perceived increase in value should be supported with money.

posted by James Freal on May 17, 2012 [report abuse]

It seems fitting that Delta, a company in the most regulated business in America, would want to venture into petroleum refining which is probably the second most regulated business. Of course there is nothing in common between the airline business and refining except for the common practice of operating both of these difficult businesses at a loss.

Who knows . . . maybe next year you will be able to buy Delta gas for your car or airplane. Of course you will need to order diesel fuel if you want full octane gas and if you want to use a pump to fill your vehicle instead of a siphon you will need to pay an extra 50 cents per gallon. And don't even consider ordering first class service (you know, getting to skip waiting in line at the gas pump. Delta can't provide that on airplanes and won't do any better in the gasoline business.

I heard a rumor that Delta will be lobbying congress for a merging of aviation and petroleum rules. They want the government to require 2nd class medical certificates for people who pump gas and first class medicals for those who drive gas trucks. They realize the medical certificates will be just as worthless for the petroleum business as they are for aviation but they hope to reduce their personnel monitoring costs by making the requirements match.

posted by Paul Mulwitz on May 17, 2012 [report abuse]

I agree that with refineries shutting left, right and center, it does seem a bit strange for Delta to enter the business. But some crude oil is better suited for aviation fuel than others, and refinery processes can be tweeked to make more kerosene and diesel and less gasoline. Even if they save just 1 or 2 percent on their normal price it might be worth it -- a 747 uses six litres of fuel a second in cruise, which is a hell of a lot.

posted by Brian McCulloch on May 17, 2012 [report abuse]

Talking about budget airliners and their cost structures reminds me of when I first went to a budget restaurant where you ordered your meal and then have to pay extra for the condiments. Only problem with both is that one losses track of what you are buying and you get an awful bill at the end. Most of the budget flights in England use this technique and when one compares the final cost with an airline that is straight up about it prices there is very little difference. Whose to blame are the marketing Directors and gullible flyers.

Regarding Delta it seems someone from the Board of Directors went to the auction and forgot to stay still when the Auctioneer was doing their bit. Silly person.

Why not just set an alarm on you cell and when it goes off answer it like you would normally and then just continue chatting to thin air. Just imagine the looks of jealously you get from those around you. A comedian once suggest this for the London underground and got a lot of laughs for it. Personally the less I can get to use the dam phone the better and if someone wants to make out they are better than me because they can talk on their's good luck to them.

posted by Bruce Savage on May 17, 2012 [report abuse]

"May you live in interesting times"

This has become my favorite feature of avweb.

The nice thing is we get to watch and see how it all plays out without losing any money(unless you own airplane stock, in which case you need a new financial adviser).

posted by Roy Zesch on May 17, 2012 [report abuse]

Paul, Do you know whether or not Spirit's fee structure minimizes their payment to the FAA for services? I'm under the impression that the FAA bases the fees for airlines on the "fare" price which I doubt includes additional fees for baggage, food, and drinks. If that's true, Spirit may have found a way to avoid paying their "fair share" of the FAA budget.

posted by Lance Fisher on May 17, 2012 [report abuse]

That's a good question, Lance. I don't know. Of course, they have to pay the pax facility fees and other enplanement-related taxes. They often advertise really low fares, like $25 or $9. The new rules force them to list all the add on fees that a customer would have to pay.

Brian, you're right about the 1 or 2 percent. It's not inconceivable that it could work. But it's just as possible for it go 1 or 2 percent the wrong way, oil prices tank and they end up refining their own fuel at a price much higher than anyone else is paying.

Southwest came at the problem by buying long term contracts. They went long on oil as a hedge and won. Delta's risk, it seems, is a little like setting up a hedge to go short on their own stock. Given the history of oil refining, I wonder if the risk isn't much different.

posted by Paul Bertorelli on May 17, 2012 [report abuse]

I think y'all may be too quick to dismiss Delta's refinery play. They're modifying the refinery to improve its jet fuel output (up to ~32% vice the 15% or so it currently produces), which will help a lot. They can sell all of the gasoline and other light fractions they can make from that refinery, and in fact have already entered into agreements to do so. DL will swap gasoline and diesel 1:1 for jet fuel in other locations, e.g. they'll deliver a gallon of mogas to BP from the refinery and pick up a gallon of Jet-A in SFO (or wherever).

DL is claiming that the refinery plus the swaps will cover 80% of their jet fuel needs. Given the trouble that DL (and pretty much everyone else, except LUV) has had with long-term fuel hedging, I think this will prove to be a smart move for DL.

posted by Paul Robichaux on May 17, 2012 [report abuse]

Is there some airline executive stupidity disease? Paul B is right, Delta is not smarter than Conoco when it comes to the oil business. COP decided to sell the refinery primarily due to a lack of reliable or cheap crude available to that location. Shell has closed one in California for the same reason. This helps validate my reasons for owning BP, Chevron and Royal Dutch Shell instead of airline stocks.

posted by Jim Lo Bue on May 17, 2012 [report abuse]

I didn't bother to research the details, but Lance Fisher is correct that a major component of the "unbundling" craze is that by shifting money out of the base fare the airline lowers its per-passenger Federal tax (or fee, or whatever the Feds prefer to call it).

posted by John Wilson on May 17, 2012 [report abuse]

The information from the oil industry indicates that ConocoPhillips was losing $1M per day on that refinery which is why it was closed. Delta is not just going to have to be as smart as ConocoPhillips to make it pay, but a lot smarter. On top of that this refinery was closed and mothballed, so there will be some serious start-up costs involved. This is going to be very interesting to watch and the oil industry analysts are doing just that. Not one of them has said they think it is a good idea yet.

posted by Adam Hunt on May 17, 2012 [report abuse]

DL's business interests aren't the same as COP's. They don't have to worry about the low-margin gasoline market since they're swapping mogas for Jet-A. The crack spread for gasoline and Jet-A move in opposite directions, too, so there's some benefit for DL that COP couldn't take advantage of.

The bigger advantage is one I hadn't thought of: if DL is successful in doing this they put more cost pressure on their competitors in the TATL market. AvWeek estimated $4000-5000 per flight, which, while not huge for a single flight, adds up quickly for a large TATL market like metro NYC. That means either DL makes an extra $4k per flight or cuts their fares, thus making AA, et al, have to work even harder for cost containment.

In AvWeek, Anderson was quoted as saying that the refinery purchase + improvements cost about the same as list price for a single 777, but that it would cost DL about $2.5 billion to make fleet upgrades that would net the same cost savings due to efficiency. That seems like a pretty decent bet to me.

posted by Paul Robichaux on May 17, 2012 [report abuse]

Without question, the notion of an airline operating its own refinery is novel. Being novel, though, you can bet someone made a pretty convincing business case for it.

Let's hope it pans out for them, and who knows, maybe more vertical integration is the wave of the future.

posted by John Wilson on May 17, 2012 [report abuse]

Making petroleum products is like making, well, sausage. Just because you eat it, dosen't mean you should try to make it ... things don't get smellier or dirtier than making oil (or sausage) ... but the "brain trust" at Delta will be sure to assign the dirty job to some exec they don't like ... upon which they will lose their shirt from lack of adequate manufacturing oversight and mismanagement, or outright theft.

posted by Phil Derosier on May 18, 2012 [report abuse]

I have no problem with Spirit unbundling as long as they post the various charges so a customer can easily figure out the total cost. The bait and switch plan is just plain dishonest.

As to Delta, what the hell, it is pretty well proven that airline "business as usual" is simply a plan for losing large sums of money. Somebody needs to come up with a better plan and just maybe Delta has worked this refinery idea out. If not, they would lose the money anyway. I wish them well. If nothing else, it will be an interesting exercise and an opertunity for Paul to say "I told you so."

posted by Richard Montague on May 18, 2012 [report abuse]

The truth is, I'd rather say..."I'm glad you got that to work."

But before breakfast every morning, I have a warm cup of reality.

posted by Paul Bertorelli on May 18, 2012 [report abuse]

For me, and perhaps tens of thousands of other principled Americans who agree with "Freedom to Travel USA", the only airlines we would voluntarily fly on, are those avoiding the TSA regs, e.g. SeaPort, PlaneRed, etc. Until the major airlines start being part of the solution, they are the problem. If the majors all go bankrupt, so be it.

posted by Bruce Liddel on May 18, 2012 [report abuse]

I am glad that I don't have to ride the airlines anymore.

I hope Delta's gamble succeeds.

Have a good weekend.

posted by Richard Sinnott on May 18, 2012 [report abuse]

Paul, the reference to SouthWest came as a surprise : I like to present SW as proof-in-case that hedging is like playing with fire. Not because they won, but because they seriously burnt their fingers. In late 2008 they had to report their first quarterly loss thanks to some hedging gone awry.

posted by Peter De Ceulaer on May 20, 2012 [report abuse]

Wait a minute! Who gets to the head of the line for jet fuel at the Delta refinery? Who gets to set the price that they charge themselves? Who gets to do the math at tax time? Who wouldn't like to have their own power plant/gas station/brewery/whatever? I'm not running the Delta Fan Club and haven't seen any of the articles, but this is pretty clever.

posted by Randall Wilhite on May 21, 2012 [report abuse]

Correct me if I'm wrong here, Peter, but Southwest's long term fuel contracts made it more competitive in the 2008 to 2011 time frame. This is what the trade press reported.

What hedge are you referring to?

posted by Paul Bertorelli on May 21, 2012 [report abuse]

The airline biz is just crazy. It's a classic conversation subject. Some airline genius figures out that a change could make two cents a passenger. A decision maker says, "That's crazy, but it might just work". Next thing you know all the passengers and employees are saying the same thing, only they rightly stop at "crazy".

Then, another genius, Branson, agrees with the customers and employees and ignores what all the other airlines are doing and gets people to pay to avoid the nuttiness.

Except in this case. He needs to put one of those cool London phone boxes on the plane.

posted by Eric Warren on May 21, 2012 [report abuse]