Priced Out by Oil Cheap Airlines Are Losing Altitude

Expensive oil could end up spelling the end for once-celebrated budget airlines. Increasingly, Air Berlin, easyJet and co. are running into major difficulties. And getting rid of excess ashtrays won't be enough to save them.

Last fall and winter was not a happy time for Lufthansa CEO Wolfgang Mayrhuber. But it wasn't just the uncooperative weather and series of strikes that were making his life so miserable. Mayrhuber, a 61-year-old originally from Austria, faced heavy criticism for being too hesitant and overly risk-averse, all because he passed up opportunities to acquire charter airline Condor and Italian competitor Alitalia.

Budget airlines like Condor and Air Berlin are having trouble staying aloft these days.

Budget airlines like Condor and Air Berlin are having trouble staying aloft these days.

Foto: AP

But Mayrhuber stoically ignored the criticism and sought comfort in an old bit of airline industry wisdom: Even a missed opportunity can sometimes end up being good business. At the time, the Lufthansa CEO couldn't have imagined how quickly that adage would become reality.

Six months later the airline industry, celebrated not too long ago as an engine of economic growth, has plunged into the deepest crisis in its recent history. Even worse, unlike the period following the Sept. 11, 2001 terrorist attacks on New York and Washington, when airlines, especially major US carriers, went into a dangerous tailspin, this time there is no end in sight.

More Painful than Any Other

Since the price of oil broke the barrier of $130 (€82) a barrel, it has become clear that the former beneficiaries of globalization are operating on very shaky ground. Flying high on prognoses that saw global air travel enjoying growth rates of about 5 percent a year, airline executives were ordering new aircraft at a record pace and offering flights to even the most remote spots on earth. Now the industry seems headed for an abrupt crash-landing, one that could be more painful that any other crisis it has faced since World War II.

"The rising oil price will completely transform our industry," predicts Louis Gallois, the head of Airbus parent company EADS, "certainly for aircraft and engine manufacturers, but it will also lead to serious changes for the airlines, airports and air traffic control."

Jean-Cyril Spinetta, the CEO of Air France/KLM, has an even more drastic take on the situation. "If the oil price rises above $200 (€125) a barrel, we airlines will all be dead," he warns.

Experts estimate that the industry will accumulate losses of at least €1.5 billion ($2.39 billion) this year alone. Should the price of oil level off at $135 (€85) a barrel, total industry losses could jump to just under €4 billion ($6.36 billion), according to estimates by the International Air Transport Association (IATA).

Smaller or poorly managed airlines, where kerosene costs already make up half of total expenditures, are hardly likely to survive. At least two dozen airlines have gone under in the past six months alone -- a record for such a short period of time. "After this period of consolidation, there will only be five airlines left in Europe," says John Kohlsaat, easyJet's German chief executive, "British Airways, Air France/KLM, Lufthansa, Ryanair and us."

Cutbacks of 12,000 Jobs

US carriers like American Airlines, Continental and Lufthansa partner United are already taking large numbers of older jets out of circulation and plan combined cutbacks of up to 12,000 jobs. European airlines like Air France, TUIfly and Air Berlin are also thinning out their fleets and route systems to prepare for a rough winter ahead, a time of year when air travel falls anyway relative to summer months.

But Lufthansa seems to be defying the crisis -- for now. On the one hand, Mayrhuber and his senior executives have imposed a hiring freeze for administrative jobs. And the airline could face additional challenges if ground personnel and a portion of the onboard workforce follow through with a threat to go on strike -- at the beginning of the summer vacation season, no less.

On the other hand, the German market leader could actually end up benefiting from its competitors' troubles. "The crisis is strengthening the strong and weakening the weak," says Lufthansa Chief Financial Officer Stephan Gemkow, making it clear that he counts his employer among the former.

Unlike many competitors, Lufthansa has hedged a large share of its fuel purchases for the immediate future, even as the costs of doing so are climbing as well. Plus, existing wage agreements allow the company to temporarily reduce its employees' working hours when demand declines.

Smaller airlines, including ailing niche carriers like Spain's Iberia or Austrian Airlines, which until recently had rebuffed Lufthansa's takeover overtures, are already vying for Mayrhuber's favor. But the Lufthansa CEO is in no hurry. The higher the oil price goes, the less he is likely to pay to acquire other airlines.

Shelving the Takeover Plans

If he wanted to, Mayrhuber could even snag some bigger players. Once-spurned Alitalia? It could be had cheaply today. And former subsidiary Condor? It's been on its own again since Friday of last week, after Air Berlin, hard-hit by the fuel crisis, had to shelve its takeover plans.

Mayrhuber, the supposed procrastinator, has suddenly become the main puppet master, the one holding all the strings in his hands. Under his leadership Lufthansa, together with its subsidiaries, could develop into a gigantic airline group, significantly outpacing competitors like British Airways or Air France/KLM. The Lufthansa CEO could even play a key role in the fiercely contested budget travel sector by acquiring the shares held by Condor's main shareholder, Thomas Cook, at a low price and merging its former subsidiary with its own budget carriers, Germanwings and TUIfly.

The budget airlines, once considered hot commodities, have felt the brunt of exploding kerosene prices to a far greater extent than their established competitors. When the first of the low-cost carriers appeared in the skies more than 10 years ago, they were seen as the pioneers of a new era -- a day in which air travel would become as ordinary for broad segments of the population as attending a sporting event or going on a weekend family outing. With price-dumping offers starting at one euro a ticket, fees not included, they lured an entirely new clientele into planes packed tightly with as many seats as possible.

These low prices were sufficient incentive for travelers to accept the need to drive to the new budget carriers' often more remote airports. But now that fuel costs have reached dizzying heights, the business model of budget airlines is threatening to collapse. And there is no relief in sight. It could take up to 10 years before a new generation of jets running on fuel cells or biofuels is ready for takeoff. Many airlines will be long-gone by then.

Efforts to combat the fuel price pressures are underway, but many of them are merely sealing the budget carriers' own fate. Kerosene surcharges, booking and baggage fees or service fees for reserving seats, as well as additional fees for paying by credit card, have already become standard among budget airlines -- and they are scaring away their price-sensitive customers in droves.

The carriers are also desperately looking for ways to slash the weight of their airplanes to save fuel. Many carriers have recently started carrying the bare minimum of water in their onboard tanks -- making using the toilet a potentially dicey proposition. Major US carriers are thinking of imposing a surcharge on overweight passengers, even if this threatens to violate anti-discrimination laws. Air India took the concept a step further when it reassigned flight attendants whose weight significantly exceeded the ideal to ground-based jobs.

Ditching the Ashtray

For some time, carriers like TUIfly and Germanwings have been slowing down their jets. While costing travelers only a few minutes, the measure can save the company several hundred thousand euros each year.

Lufthansa subsidiary Germanwings has been especially painstaking in its search for new ways to save fuel. CEO Thomas Winkelmann recently had all moveable objects from a jet in his Airbus A-319 fleet removed and individually weighed. The results? The ashtray in the cockpit, weighing in at 230 grams (8 oz.), was removed. Pilots now use the empty recess as a place to keep their pens. Their crew manuals, weighing in at just under 10 kilograms (22 lbs.) apiece, will soon be replaced by electronic manuals. Germanwings management also discovered that it could save about 150,000 liters (40,000 gallons) of kerosene a year by removing leather headrests. But the idea was ultimately rejected -- for hygienic reasons.

Although comfort and hygiene prevailed over exaggerated frugality in this case, it is already clear that the growing scarcity of kerosene will change the world of aviation to a greater extent than the introduction of legendary Boeing 747 jumbo jet once did.

For years, the two major aircraft manufacturers, Boeing and Airbus, were locked in a constant battle to outdo each other in developing new jet models that could travel extremely long distances non-stop, such as the Bangkok-New York or Dubai-Los Angeles routes. But the flagships of the past could soon be obsolete, because transporting the additional fuel required for such nonstop flights means higher kerosene consumption.

A few carriers, like Lufthansa alliance partner Thai Airways, have already decided to discontinue these ultra-long-distance flights, which can last up to 18 hours. This could benefit Airbus in sales of its new wide-bodied aircraft, the A380, which consumes relatively little fuel per passenger and is operated from such major hubs as London and Singapore.

For elite airlines like Emirates or Singapore Airlines, the quirky practice of attracting well-heeled customers with features like comfortable Business Class beds or even completely private cabins could soon prove to be too costly. Major airlines, on the other hand, could even begin squeezing more seats into each row in tourist class, although this would also increase on-board water requirements.

Meanwhile, Lufthansa CEO Mayrhuber can sit back and relax, waiting to see which of his competitors sends out the next Mayday signal. Unlike many other players, Lufthansa faces little serious competition in its domestic market nowadays.

Pesky Domestic Competitors

Until recently Air Berlin, which swallowed pesky domestic competitors like DBA and LTU long ago, was seen as a serious competitor for Lufthansa. Today CEO Joachim Hunold is struggling for survival. His major assault on the industry leader in the long-distance market failed miserably. In fact, he can thank his lucky stars that a plunging stock price put an end to his plans to acquire Condor, which Air Berlin had hoped to position as a Lufthansa competitor on long-distance routes.

Up-and-coming Arab carriers like Emirates and Qatar Airways and, paradoxically, his own employees pose the only real risks for Mayrhuber today. Services union Ver.di, which represents a significant portion of Lufthansa's 52,000 ground staff and cabin crew members, began holding a strike vote on Tuesday, the results of which are expected to be released on July 25. Most expect union members to vote in favor of going on strike. Lufthansa employees, also affected by rising energy prices, are demanding wage increases of just under 10 percent for one year. The company is offering employees just under 7 percent, but spread out over a 21-month period.

Mayrhuber faces a difficult choice. If he stands his ground, long lines could begin forming at German airports by the end of July. Unlike business travelers, vacationers usually travel with a significant amount of luggage, and they are not accustomed to checking in online at home or at automated check-in machines.

If the Lufthansa CEO relents, he will exceed his personnel budget and spend money urgently needed elsewhere: to pay his kerosene bill.

Translated from the German by Christopher Sultan

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