As the dual problems of global warming and peak oil become so pressing that even US politicians can no longer ignore them, they, and all Americans, will face a daunting series of public policy questions. In one way or another, all the questions raised by the need to rein in CO2 emissions and accelerate our transition away from oil as a primary energy source share one thing in common: An implicit decision about the “proper” roles of government and free markets in achieving these goals. It’s quickly becoming clear that the first of these painfully difficult decision points is already upon us, namely: What can and should the US government do about the imploding airline sector?

This is the question posed by the report “Oil Prices and the Looming U.S. Aviation
Industry Catastrophe: A Hole In The Transport Grid”[8-page, 94KB PDF], written by the Business Travel Coalition and AirlineForecasts, LLC. The report paints an stark picture, by any measure, as summarized in the press release (emphasis added):

At current oil prices, several large and small U.S. airlines will default on their obligations to creditors beginning at the end of 2008 and early 2009, according to a study issued today by AirlineForecasts, LLC and the Business Travel Coalition. The study shows that $130/barrel oil prices will increase yearly airline costs by $30 billion, while airlines will be able to generate only $4 billion in fare increases and incremental fees. The implication of this alarming trend is that several large and small airlines will ultimately end up in bankruptcy, and of those, some will be forced to liquidate.

…

“If oil prices stay anywhere near $130/barrel, all major legacy airlines will be in default on various debt covenants by the end of 2008 or early 2009,” the study conducted by AirlineForecasts for BTC states. “U.S. commercial aviation is in full blown crisis and heading toward a catastrophe.”

“Airlines are the primary source of inter-city transportation, critical to national and local economic development, the flow of human capital, movement of just-in-time parts for manufacturing, perishable food and other goods critical to our economy,” the study says. “With airlines gravely threatened, so is our economic well-being.”

Findings:

* The top 10 U.S. airlines will spend almost $25 billion in higher fuel costs this year over last year when jet fuel averaged $2.11 per gallon. Fuel hedge benefits could offset $5 to $6 billion of the increased fuel costs.

…

* Industry fares will have to increase at least 20% - across the board and on average - just to cover the dramatic gap-up in fuel costs from 2007. This is not possible given the level of uneconomic seat capacity in the system today.

* The upshot of higher fares is less traffic, and given a reasonable estimate of price elasticity, the industry will eventually be forced to shrink its seat capacity by 15% to 20%. However, there is no guarantee that a transition to a smaller, more expensive (for the consumer) airline industry would be successful and sustainable.

* Airlines have the ability to raise some cash, and moreover, suppliers such as aircraft manufacturers, leasing companies and travel management companies will have an incentive to support large airlines that provide a stream of value. Nevertheless, without a swift reduction in the price of fuel, the industry is headed toward a massive failure that will result in more bankruptcies, including liquidations.

“The U.S. airlines, and those who depend on them, are watching with growing alarm as their cash reserves fall precipitously toward zero as the price of oil, already at unsustainable levels, continuously spikes into uncharted territory,” the study says. “These airlines have never faced a darker future.”

“Brand name legacy carriers that we and American communities from coast to coast have depended upon for decades to provide us with affordable, frequent air service are running out of cash, and therefore, toward a date with bankruptcy and liquidation,” the report warns.

“Airlines can attempt to radically shrink the industry,” the study states. “But given the competitive situation they face, it’s highly unlikely that they will have the ability to reduce capacity to levels that will allow all of them to survive. Instead, absent direct policy intervention, the likelihood is several airlines will fail.”

“Stabilizing this ailing industry must become a national policy priority,” the report states. “Many Members of Congress, federal regulatory officials, state legislators and Governors have yet to fully appreciate the devastating impact an oil-crippled airline industry will wreak on our culture and our national and local economies.”

The report itself says (pages seven and eight):

To fully grasp the gravity of the current situation, it’s useful to reference some historic context. During the airline industry cyclical downturn in the early 1990s, the industry lost a cumulative $12 billion between the fourth quarter of 1990 and the first quarter of 1993. What followed were 6 years of profits
sufficient for airlines to repair damaged balance sheets. (US Airways even repurchased $2 billion of its stock.)

The most recent downturn in 2000 lasted until 2006 and reported net losses were over $44 billion. The industry only had one year of profitability, in 2007, at less than $4 billion, to begin the balance sheet repair work before it was plunged into deep losses again in 2008. Importantly, during this most recent downturn, significant costs were taken out of the industry, and for many airlines, virtually all assets were mortgaged. Most airlines have little flexibility now as they face both a slowing economy and record-setting jet fuel prices.

…

A catastrophic result for U.S. airlines can be averted if policymakers, particularly in the White House and Congress, step up purposefully to address this monumental challenge. There is still time to make a difference. This is important not only for airlines and their passengers, but also for every business that uses oil products.

In the weeks ahead, BTC will work with its allies to bring forward to Congress and the Administration some specific proposals that will help address the near and long-term implications of the aviation fuel crisis.

We urgently need a new energy policy that will give the airlines a fighting chance to survive and recover — and serve all members of the traveling public for many years to come.

Even if you want to apply a fudge factor to these claims–it’s a business sector claiming times are tough and asking for government help, not a condition that historically tends to result in understatement–it’s hard not to agree with the conclusions of this paper. We’ve already seen several airlines increasing fees, retiring less fuel efficient airplanes, laying off workers, and even flying slower. As I’ve pointed out in some detail (e.g. Airlines, Apocalypticons, and the rest of us), the essential problem is that airlines have no where to turn; they’re tied to the cost of jet fuel, with no substitutes in sight.

So, if you wake up tomorrow morning and find out you’re the US president (with far more time in office remaining than George Bush) or the Senate Majority Leader or Speaker of the House, say, what policy fixes for this quickly unfolding mess would you propose?[1] I’m not talking about blue sky, magic wand notion that we can talk about on a blog and then blithely ignore, but real world, honest-to-Orville-and-Wilbur solutions that must (1) pass through the legislative process intact, (2) actually address the problem to an acceptable degree, and (3) do so at an acceptable cost to the taxpayer at a time when the US Treasury is geysering red ink and the US has an astronomically high national debt.

The first step, clearly, is to define what “acceptable” in (2) above means. Do you try to save all airlines over a certain size? Or do you determine a minimal size for the overall airline sector and try to save just enough carriers to meet that level of service (meaning coverage and number of flights), regardless of which companies that means saving or throwing to the wolves of the marketplace? My gut feeling is that the latter is the best approach, since our goal is to save the country from the pain of an airline sector collapse, not save individual companies.

Once we have some sort of metric for “acceptable”, then what do we do? I think the only viable approaches are to subsidize tickets or subsidize fuel costs. Subsidizing tickets would quickly turn into a infinite mess, I suspect, as the sheer volume of tickets and the resulting logistics would outstrip the government’s management skills, especially in the short run. If we were to subsidize fuel, however, it would be orders of magnitude simpler to administrate and adjust the program, and we would be directly addressing the problem: Fuel costs.

So, we decide to subsidize all airlines to a set fuel cost. What’s the magic number, and how much does it cost? The above report has a table (page 5) that provides various oil prices and their effects on the airline industry. This table says oil at $130/barrel equates to jet fuel at $3.80/gallon, and $100 oil translates to jet fuel at $3.10/gallon. For the sake of example, assume we’re aiming for the $100/barrel oil, $3.10/gallon fuel price point, although I’m not sure that the airlines would agree that this is enough help.

The US uses about 1.6 million barrels of jet fuel/day, or 67.2 million gallons/day, according to the current TWIP report, and oil is just a bit over $130/barrel. So we’re talking about the government underwriting 70 cents of ever gallon of jet fuel, at a daily cost of about $47 million, which is $17.1 billion/year. Given that the US is spending about $12 billion every month in Iraq, an endeavor which should end sometime within the life of at least some people reading this, this doesn’t seem too bad.

There are some very serious issues here, obviously:

• How long do you subsidize jet fuel? Until oil prices come down on their own? Lots of luck on that front. Until airlines shrink enough that they can survive without subsidies, i.e. the conversion to a boutique industry that serves only the wealthy? That’s what we’re trying to avoid in the first place, so that’s out of the question unless your goal is merely to slow the collapse of the airlines enough to let the rest of the economy adjust and soften the shock.
• Lower fuel prices means you’ll have more people flying than if you hadn’t created the subsidies, so that means more oil diverted to jet fuel and less to gasoline, diesel fuel, and home heating oil, as well as more CO2 emissions that we have to deal with as part of that other growling monster under our bed.
• How do you pay for the subsidies? Do you generate some other revenue stream–windfall profits tax on oil companies, anyone?–or do you simply pile it on the mountain that is our yearly deficit?
• What do you do if the crazy people on the Internet, like, well, me, are right and we hit peak oil in just a few years and oil becomes much more expensive, pushing up the cost of your subsidies? Do you maintain your commitment to subsidize jet fuel at $X/gallon, or is your commitment to subsidize by Y cents per gallon? Even if you stick to the Y cents/gallon formula, how many other, equally dire demands on the government will materialize once we get into the age of truly expensive oil?

I often say that one of the things I’m thankful for on a daily basis when I wake up is that I’m not the president of the US, and this airline situation is a prime example why that observation is less amusing on some days than others. In light of the range of current and developing issues facing the US, all industrialized countries, and essentially the entire human race, I honestly have no idea what I would do about this.

See also:

• Airlines, Apocalypticons, and the rest of us
• Airline Armageddon
• Aviation articles on the TCOE discussion board

[1] I’m assuming that you agree that this is a very big problem that should be addressed if at all possible. If you think it’s either not a problem for the country to have the airline sector implode, or you think we should just let it “sort itself out” as the free marketeers like to say, then consider the rest of this post as an exercise in fantasy.