Airline Industry CEOs Hoping You’re As Ignorant About Economics As Everyone Thinks You Are
Um, Guys? Speculators Aren’t Your Problem
By blackhedd Posted in Airlines | CEOs | Economy | Oil Prices | regulation | speculation — Comments (19) / Email this page » / Leave a comment »
I’m going to avoid linking to this because you can find it yourself, and because I don’t know who the original authoritative source is. But you’ve certainly heard that a dozen CEOs of major US airlines, including all the big names, have put out a letter urging you, their customer, to agitate for more regulation of the commodities-futures markets.
Unfortunately time is too short to fully consider the issues raised in this carefully-written letter. The basic idea is something you’ve heard me discuss several times now: speculation in crude-oil futures and derivatives is raising the price.
That’s true enough, as I’ve said before. It’s also true that the airline industry is under as much pressure from high oil prices as anyone else (more on that in a moment).
What’s not true is that speculative pressure (or more precisely, buying pressure originating ultimately from institutional investors) is a permanent support for the price of oil. Thus, the conclusions reached by the airline CEOs are wrong, but they’re wrong in ways you wouldn’t expect from experienced business people.
We have a few regular commenters on this board who know a lot about the airline business, and I do hope they chime in with comments. For now, I’ll say that airlines are an extremely capital-intensive business. They have very high labor costs, and high capital costs (which they manage partly by leasing equipment). But as the price of jet fuel has increased along with crude oil, fuel has become the dominant aspect of their variable-cost equation.
Because airlines compete in an environment that is only semi-deregulated, they aren’t necessarily going to rationalize their own operations in response to high fuel prices as you might expect. Airlines have a hard time raising prices unless they do it in a de facto coordinated way, because otherwise they’ll lose market share against each other. I’m glossing over a lot of interesting detail, but let’s get to the point.
The major-airline CEOs have gotten together to request a regulatory response to their biggest business problem. Because of the semi-regulated environment they operate in already, this isn’t altogether inappropriate.
But for them to explain that speculative trading in oil futures and derivatives adds “$30 to $60 per barrel in unnecessary speculative costs” and that “consumers pick up the final tab” is begging the question.
The ordinary speculative activity in futures markets is what makes those markets function smoothly. As major participants in those very same futures markets, airline CEOs certainly know that speculators provide the liquidity needed for producers and consumers to perform the hedging operations that allow them to manage risk and plan their businesses. Why are these people trying to sell us something they know is a lie?
The CEOs are also looking for increased “disclosure, transparency and sound market oversight.” I’ve already written here about how challenging these objectives are. It’s no longer the case that crude oil (and jet fuel for that matter) are traded exclusively in open pits in lower Manhattan, on an exchange that is fully regulated by the CFTC. Things are a lot more complicated than that, these days. The regulatory environment does need to be improved, but doing so will take far more time than the airlines have before they start facing a serious risk of bankruptcy.
The real reason that oil prices are high is that oil prices are high.
What the heck do I mean by that? I mean that the global supply/demand picture for oil means that the stuff will have at least some stable long-term value in any plausible forecast.
But in a deflating and de-leveraging financial world, that means that oil itself is an attractive asset for investors to hold. Because the price is high, they want to own it. And that makes the price higher.
So we’re not really talking about speculators in the traditional sense. We’re talking about the hedge funds that institutional investors buy into. And these people will keep buying oil as long as they have few good alternative investments.
Two points: first, you might as well try to boil the ocean as tell the world’s investors what they may or may not buy. And second, they’re going to drop the oil markets like a hot potato as soon as the price momentum in oil reverses, which it inevitably will do someday.
Enlarging the point somewhat: we need to face the fact that commercial aviation in the US may not be long-term viable in its current form. The CEOs are scrambling madly to buy a bit more time to keep operating as they always have. But they’re facing a losing battle.
This industry can’t survive with its current cost structures, which are extremely union-bound at most of the major carriers. But in addition to that, the construction of new capacity (which this country badly needs) is curtailed by a raft of outdated regulations left over from the Civil Aeronautics Board era. These include restrictions on new landing slots at airports, and an inability to modernize the air-traffic control system.
We need to make a decision one way or the other: either bring back full-on regulation as it existed before 1977, or de-regulate the industry completely. I almost don’t care which choice we make, but let’s make one.