With the US industry consolidated, we would expect at least a short term discipline as the oligopoly finds its “natural” equilibrium.  As we have said before over the long term, there is always going to be a breakdown because of cheating.  Look at any oligopoly (i.e. OPEC) and we see that sooner or later the natural equilibrium isn’t enough.  Greed sets in and once one player cheats – and cheating is defined not by that player, but by the others – the system breaks down.

Take a looks at air fares. 2015-06-08_9-38-31They have been steadily climbing. Never mind the cost in real dollars as the industry likes to point out – we are in a period of low inflation and prices feel higher because they are.  The oligopoly has managed to show extraordinary discipline in pricing.  This is important because better pricing is the siren song that drives the first phase of greed.  All that juicy revenue beckons.

The next thing to look at is load factors.  For the 12 months through February, traffic is up 3.1% to 666 million.  Departures were down 1.6% and load factor up 0.7%.  Industry load factor was at 84.4%, meaning the aircraft could not get much fuller.  There is no margin for cancelled flights and these are tough to clear which means potentially lots of people stuck at airports for long times trying to get away.  The industry reaction has been to steadily move to larger aircraft.

When looking at the top US domestic markets, we note that aircraft range is not the biggest issue facing airlines. The bars show the of traffic and the numbers are the nautical miles ranges for that city pair. 2015-06-08_10-03-54The LAX-NYC route ranks third and is a thick route that requires considerable range capabilities. But today’s single aisle aircraft can typically accomplish this provided there is no massive jet stream disrupting flights going west. Over the year, this route handles an average of just under 10,000 passengers per day.  It is the most competitive market in the US and almost is certainly among the most competitive in the world.  By comparison Chicago-NYC has over 10,600 people per day but the route is less than one third the distance and easily handled even by regional jets, enabling lots of frequencies.

How does the market look at the current time? The chart shows some names may be showing up you did not expect to see.  Southwest is #2 -which is why its decision to move to 737-800s is so upsetting to the “natural” order.  The network carriers don’t like this at all and can be expected to fight back.  Southwest has now softened its plans to increase because it does not want a fare war. A fare war only makes consumers happy and that does not suit the industry at all.

2015-06-08_10-24-50 Note you need to add the numbers for American and to get its real value.  As the #1 carrier American will not give up its share (and power) without a fight.  Hence media interest in its CEO speaking at the IATA AGM. The big four airlines can be expected to be careful not to tip the natural balance too much for fear of causing a financial pain on the entire industry where none win.

It is interesting to see that is now a bigger airline than much older Alaska.  Next, adding SkyWest and Expressjet (both owned by the same firm) gives a much better indication of its heft – it is also bigger than Alaska but only flies regional jets.

American’s CEO was vocal about competitors growing capacity (code for Southwest) and saying they would respond, Southwest responded to the signal as received and understood.  For now it looks like the oligopoly is holding to its natural order.

But it will be tested again.  And we expect it to be Southwest that will do the testing because it is the only one that can afford to.  We think it the cost/benefit for Southwest makes the bet worthwhile.  It has the ability to connect communities more easily because it is not a legacy. It can increase frequencies and other little things easily unnoticed.  The legacies have to watch the rest of the world, where, for example, the ME3 are keeping things unsettled.  So Southwest can grow incrementally across the borders where its aircraft can reach easily at low risk.  So while CEO Gary Kelly says “We don’t want to grow 8 percent, we’re not going to grow 8 percent and we can easily trim the schedule to stick to 7 percent” – it may not reach 8% but it could easily go over 7%.

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