After six profitable years, airline managers claim to be a happy bunch, but with a nervous undertone. After all, how long can this last? Through an Asian downturn, a European slump and a fuel price shock most continued to prosper and profit. Surely this can’t go on forever.

Probably not, but most signs say 2001 will be the seventh consecutive year of profits for the world airline industry despite a softening of the global economy. And if fuel prices start the gradual decline expected last year, this year could produce stunning financial results as airlines, geared down for higher prices, watch energy cost savings drop straight to the bottom line.

Naturally this rosy view comes with the standard caveats about unanticipated events and is not a universal prescription. There will be some pockets of pain, some airlines will lose money, and a very few may lose a lot. And a yearend US stock slump, driven by the fantastic discovery that even new economy" tech and Internet companies need profits, threatens to become a wider economic downturn.

For the most part, however, airline profits should be as good as or better than in 2000, and that’s saying something at this stage of the cycle or what should be "this stage" of the cycle. Aside from an increasing trend to park airplanes that may be just retirements temporarily disguised as aircraft for sale, the key indicators are more typical of an early or mid-cycle stance. World economic activity continues to be buoyant and fuel prices, while not yet trending down as hoped last year, present stability as a worst case scenario.

World economic activity is expected to slow somewhat, pulling down traffic in a proportional manner. According to the International Monetary Fund, global economic growth of 4.7% in 2000 will be followed by a 4.2% expansion this year. The US may cool from 5.2% to 3.2% but Europe will remain steady at around 3.5%. The key Asian economies outside of Japan will continue their recovery, expanding from 6% last year to 6.5% this year, while the largest Asian economy will continue with its modest recovery, growing from 1.4% to 1.8%. Korea, says LG Economic Research Institute, will continue to expand at 6% annually through 2002 before taking a two-year breather.

The US economy, slowing in the last quarter of 2000, is expected to be sufficiently under control that the Federal Reserve Board will reverse its recent trend and begin easing interest rates, with analysts forecasting two such cuts this year.

Traffic growth in mature markets— North America and Europe—tends to follow economic growth at approximately equal levels, while in developing markets traffic increase percentages can be a multiple of the general economic expansion. Despite the fact that the world’s airlines during 2001 are scheduled to receive 677 airliners seating more than 100, according to Forecast International/DMS projections, most believe that capacity will be in line with demand, a bit under or over but very close (A TW 12/00).

Airlines will do "quite well" in 2001, says Jon Ash, managing partner of Global Aviation Associates in Washington, D.C., with only 2%3% capacity coming on line in the US and on US-Asia and US-Europe routes. The net fleet addition worldwide is not much above 3%, he says. The capacity constraint is "partly through retirements, partly because airlines are not in capacity wars any more," and will enable profitability growth. "Load factors have become so high the airlines have been able to yield-manage out the low-end stuff so they can boost RASM," he says.

Also, reduction of seating density— fleetwide at American Airlines and some at United Airlines—holds down capacity growth.

"The only caveat is United sat down so much capacity [last] year it will be interesting to see how quickly they can bring that on," says Continental Airlines President and COO Greg Brenneman. Indeed, United’s growth plans seem to stand out from the rest of US carriers. VP Resource Planning Kevin Knight says UAL’s capacity rose "in the upper teens" in 2000 and will slow slightly to "the mid-teen level" this year.

"Europe," says Scott C. Gibson, VP at consultancy SH&E, "is not bad, but some people are growing like crazy and capturing traffic so we have an imbalance of demand and capacity. The winners are Air France and Lufthansa more than just about anybody else," using their strong hub feed to build business.

Lufthansa CEO Jiirgen Weber sees "potential over-capacity on some routes—the North Atlantic, possibly to Asia—but altogether European airlines have exercised cautious growth, with RTKs outbalancing ATKs. This situation is likely to prevail."

In Asia, self-generating traffic is expected to add to growing business traffic as more and more of the region’s inhabitants have the income and their govemments’ permission to travel, says the World Tourism Organization. But Peter Harbison, MD of the Centre for Asia Pacific Aviation, points out that while load factors are up, economies an growing again, forecasts are healthy anc freight traffic especially is very healthy, the prospect of continued high fuel prices is hurting carriers’ ability to boost effective yields.

However, Richard Stirland, DG of the Assn. of Asia Pacific Airlines, says last year’s traffic growth in the face of constrained capacity "has absorbed most of the slack in the system and load factors are touching new highs. This could be extremely good news for yield improvement and profitability" (see story, p. 59).

From Latin America, Varig Chief Executive Ozires Silva is "very optimistic." After 10 years of [Brazilian] economic stagnation, when the economy starts to grow it is tremendous good news. We are planning that domestic market revenue will grow 12% over 2000. Since our load factor now is 75% domestic and international, we clearly must offer additional capacity."

From a profit point of view, US carriers had their peak operating profit in 1998, says David A. Swierenga, ATA chief economist. "Beginning in 1999 earnings began to decline, and except for the sale of some assets— Priceline.com and some of the CRS systems—I’m sure the net would have fallen in that year. Industry earnings have been in decline since 1999 [due to] sky-rocketing fuel prices. It looks like [2000] will probably come in somewhere around $3-$3.5 billion."

But he is optimistic about key trends turning around this year, although "if the economy continues to slow or if airlines continue to raise prices, demand is definitely going to slip back a bit— maybe we’ll see 3%3.5% growth. We’re not back yet to the [profit] levels that we achieved in ‘98’99 but I think we have a decent chance of heading in the right direction in 2001."

The price of fuel is on everyone’s mind, with Brenneman pointing up its impact: "Commodity jet fuel price in February 1999 was 35 cents; now it’s $1.15. That’s $100 million a month to us.

Merrill Lynch analyst Michael Linenberg says the fuel price drop will arrive in a modest way this year for US carriers, declining 10% during the year and producing for Majors an operating profit boost of $8.1 billion, a 20% jump. Mark Korol of National Bank said his Canadian firm’s Oil & Gas Research Team has projected a drop from the late2000 cost of $30/bbl "to an average of $26/bbl in 2001."

American Airlines Comptroller Doug Herring says his airline’s annual fuel costs will be up in 2001. "We started in 2000 low and tripled [in price] over the course of the year. Now we’re going into 2001 at a higher level, so even if we stay flat the average price would be greater. We don’t expect fuel prices to go significantly down from today," a comment echoed by UA officials.

Whatever happens to fuel prices this year, the effect will be felt more universally as the number of airlines significantly hedged is much lower than last year. In the US Southwest is 80% hedged, Delta and Continental around 40% and America West at 23%.

As seen by Robert Milton, Air Canada CEO, "If the US economy continues to operate as the global economic engine, and I think it will, then we are in for a difficult fuel price environment." Silva, a former president of Brazilian oil company Petrobas, says, "yang is not planning on the price of oil going down. We’re planning on living with the new price. If we’re right, we’ll be the leaders in that direction; if we’re wrong, we’ll be even more strongly positioned for profits."

The new year may be full of the usual threats, but for US carriers the major cost challenge was created when United last year agreed to a generous pilot contract that reset the bar for future pacts to the level of, as one economist says, "United plus 1%." So generous was the deal, in fact, that it activated some labor groups far in advance of the amendable dates of their contracts, motivated by a desire to get their fair share. "Labor," says one VP at a Major, "is a can of worms." UAL’s Knight says that simply finding labor "is a bigger issue not only for all airlines but for all companies, struggling to find skilled labor or even general labor, especially when you’re growing at the pace we are.

Douglas M. Steenland, executive VP and chief corporate officer at Northwest Airlines, says this year will bring "upward wage pressure," apparent in Northwest’s yearend battles with its mechanics. Labor’s tendency to use its power to disrupt service will increase if consolidation continues in the US, says Mike Conway, founder, chairman, president and CEO of newentrant National Airlines. "You saw the effect of the labor disruption at United.., what would the impact have been if it affected a much larger United?" Consultant Mike Boyd says 2001 "will be the year of labor— whether it’s labor peace or labor unrest or labor war I don’t know." Additionally, Regionals "are going to find that unions are saying wait a minute, we’re not worth less." Barbara Beyer, president of consultancy Avmark, says, "Labor is totally out of control. Productivity is down, wages are up, everybody is trying to outdo each other in terms of their compensation packages and, there’s no way it’s sustainable. The costs are going to dictate that the industry’s going to be even more aggressive about pay cuts and divestitures than previously." Herring says, "Over the next year or two you’re going to see labor rates in this industry ratchet up quite significantly."

The problem is less severe in Europe, but Weber lists labor as one of his airline’s biggest problems, noting that this year Lufthansa’s general work contracts are up for renegotiation. "Will unions demonstrate maturity of judgment and ask for moderate wage increases?" he asks rhetorically.

"The only way industry can pay for" the elevated labor expenses, says Gibson, "is to keep capacity growth very very tight. This is a US phenomenon. They need to continue to increase RASM. You can’t do it that much more with load factor so you’ve got to start shutting down lowerend buckets and force traffic upward."

Initial US carrier reports of flat traffic growth in October were colored by a average yield increase of 6.5% as reported by ATA, the highest yearoveryear increase recorded in 2000. Coach fares rose 5.4% while firstclass fares climbed 10.6%. This combination of stagnant traffic growth but strong yield expansion may mean that the effort to reduce the lower fare buckets already is underway and is having the intended results.

The major threat to US yields, and to a lesser extent those in Europe, is the lowfare airlines that are thriving and setting the price. Ash points out: "Southwest in a couple of years will have more passengers than any other airline, growing at 15% per year compared to an industry growth of 3%. Southwest’s impact on fares will become more widespread; already you can see the fare effect spreading beyond specific markets."

Gary Kelly, Southwest VPfinance and CFO, says, "We feel competitively as strong as we ever have. Our route system has never been stronger, our balance sheet is in great shape, service levels are in great shape and our cost advantage is only widening. We’ve got a good hedge in place and right now it looks like that will give us an even better cost advantage for 2001." Southwest will grow capacity about 10.5% this year.

Few airlines outside of Southwest or Ryanair can afford to look at a future without links to other carriers, and the importance of a good alliance system to many international airlines is undiminished in the new year. However, a basic attribute of these arrangements continues to be their impermanence. Alliance churn will continue, it is agreed, especially around the edges but occasionally at the core. Ash says, "There’s more tal than action. They’re blowing in eve one’s ears but it’s not clear if it produce any weddings."

The strongest of the allies remain the Northwest/KLM core artnership, now with antitrust exempti s extended to Malaysia Airlines, and the Star Alliance. SkyTeam core partners Delta and Air France also seem happy with their arrangement.

While one world appears formidable on paper, the dedication of key members American and British Airways seems limited to lip service. Herring admits the relationship has been "stymied by the US/UK talks" that have failed to achieve an open skies agreement. ‘We are working to strengthen and develop our relationship with BA," he says. One observer sees the relationship differently: "oneworld I think is dead, but BA hasn’t found an alter native and American doesn’t want to be the one to pull the plug."

Continental, although linked to Northwest domestically and through Tokyo, remains outside the alliance mainstream, which is fine with Brenneman. "It is less important for us to have an alliance network in Europe than nearly anybody else," he says. "With our hub in Newark we essentially have a European hub; it just happens to be in New York, getting to 2530 destinations out of Europe." Eventually, "we’ll end up with great alliance partners mainly because we control New York."

Consolidation continues to be a concern, with European carriers trying to find the combination to create a viable merger and the US government considering the controversial US Airways/United merger. Herring points out, "The airline business is not one airline versus another but one network versus another. If another has a bigger spread, you lose that business. You can’t allow a competitor to be twice your size." Opinions differ on the outcome of the US/UA merger except that if allowed it would, one, come with conditions that might be too painful for UA to accept and two, trigger further consolidation attempts.

Weber says that "consolidation will accelerate in 2001 with regard to strategies and structures. Realism will predominate and lead to consolidation in anti cooperations.