Wednesday, August 22, 2007


This past quarter, CAL earned almost as much as it did in the same quarter of 2000. This is no small accomplishment, given that fuel costs were up about 400%. The story is told well by looking at the unrestricted cash on hand. CAL spent 8 of the last years with unrestricted cash of close to 1 billion dollars. In the past three years, cash has soared to almost 3 billion dollars.


During the current quarter, fuel costs have fallen significantly. Most of the drop has happened in the past few days but, as you may recall, gasoline prices peaked in late May and have been on a downward trend all summer. Based on current wholesale prices, gasoline should be selling for around $2.46 retail in just a few days. Jet fuel prices are more difficult to follow but each decline of 1 cent lowers CAL's annual cost by $18,000,000.

Last fall, we went through a similar swoon in prices only to see prices of crude oil bounce all the way back to the prior peak by July. What is different this time? Many things! What a difference a year can make!

What is not different is the breaking of all prior traffic records. Month after month the old records fall. Based on the record for the first 21 days of August, the airlines are about to set another all time record for full seats. Full seats, lower cost and higher fares is a formula for PROFITS, PROFITS AND MORE PROFITS!


I had another good laugh yesterday when yet another good politician said "so and so should have known" about three times in one paragraph. One of the "should have knowns" was that Ben Bernanke should have taken action long ago to prevent the sub prime mess and another one was that companies should have hedged their fuel costs.

Hindsight is always a powerful tool in hindsight. Foresight is nothing more than a powerful gamble. In other words, it cost money to hedge fuel expenses. If you hedge an expense and you are wrong, you just wasted the money you spent on the hedge. CAL takes the right approach.

CAL works day after day to make its fleet the most fuel efficient in the industry. The company recently sold 10 of its older planes and finished the installation of wing tips on many more. It will take delivery of 30 new planes next year. The company has decreased fuel consumed per available passenger mile by more than 35% in the past 4 years. In other words, the best way to hedge a fuel expense is to eliminate it.

To the extent that CAL has pre-sold tickets, it has purchased fuel hedges. CAL management philosophy is one of simple elegance, there is no need to hedge prices next year as ticket prices will be forced to rise if fuel prices rise. To the extent that seats have been sold forward, fuel must be purchased forward to "lock-in" a profit. There is that word again, PROFITS, PROFITS AND MORE PROFITS!


Last year, I wrote that the 5.25% fed funds rate was starting to BITE, BITE, BITE. Because the USA is a smaller portion of the total world economy now-a-days, the BITE of the FOMC is not as powerful as in the old days. The US economy was slowed by the higher rates but the economies of the rest of the world continued to soar. In the year after the FOMC stopped raising rates, other nations played a slow game of catch up. Rates were raised numerous times from Canada to Australia to Europe and to most points in between. The BITE of higher rates has finally had a slowing effect on the European economy while resource rich nations like Canada and Australia have seen their currencies rise and rise some more. Strong currencies are good but they also impose huge costs. The price of goods produced in Canada and Australia are now very expensive to the rest of the world and tourist to these areas also pay dearly. Because the US dollar has been weak relative to all major currencies with the exception of the Japanese Yen, the current cost for Americans to travel over seas is very high.


The amazing economic reality is that even the weak dollar has not caused the average cost of manufactured goods to rise. YES, there is still DISINFLATION of goods prices. WAL-MART continues to lower the price of goods sold! The people of the world are enjoying a better life as they continue to be able to spend more on "the good things" because their basic needs can be covered with a smaller and smaller portion of their disposable income. Put another way, the cost of a college education continues to soar because more and more people willingly "buy the product".

All the while, the Chinese economy has soared. Even though yesterday's increase in interest rates was the fourth one China has made this year. No one knows when these rate increases in China will start to BITE, BITE, BITE but the odds are that at least a modest slow down in growth is on the horizon.


In some ways, China has more economic tools available than fully democratic nations. Two examples of recent moves, the government recently put a moratorium on new airline companies. No matter how much money a business or individual has available and no matter what the supply demand story, a new airline simply cannot be started in China. China has also taken a page out of the American play book from the 1970's. It has instituted an odd-even day for driving cars. If your license plate ends in an odd number, you are not allowed to put your car on the road on an even numbered day and vice versa.

Odd - Even Days is just one of many steps that are being taken to drive down the cost of fuel. One of the more interesting technologies being deployed is electric power generation by wave turbines. In Portugal, massive floating tubes generate electricity when powerful ocean waves lift the sections. This system reminds me of the ram pump my Dad put on a creek to water his garden. He was able to pump water more than 1,000 feet while using no electricity. He converted water pressure into mechanical energy to divert a small portion of the creek up a big hill and all the way to his house.

I have never been a fan of windmill power as the total amount of concrete and steel used per kilowatt of electricity is huge and, since the wind is unreliable, the cost of back up generation power must be factored into the total cost of windmill generation. Also, wind mills must be widely dispersed which means that high transmissions costs must be included.

On the other hand, water power is typically much more reliable and much less costly. Some of the cheapest electricity in the world is hydro-electric power. Ocean waves are also reliable and water flowing through a turbine is much more powerful than wind. A ram pump is a simple device. If a turbine is fixed to turn only one way, then with each wave, water flows backward to no effect but then powers the turbine on the "down hill" stroke. In a long set up, the motion becomes similar to that of a piston engine where one cylinder fires while the next one spits out its exhaust. In the soon to be completed first phase, Portugal will be supplying 1,500 homes with wave generated electricity. The second phase will take the level to 15,000 homes. Wave power will not eliminate the need for oil but it easily supply as much as 10% of the total power needs.


Another innovation comes to us through a company called ZipCar. Many a city dweller has found that they do not need to own a car. The number who do not has recently been jumped in the cities serviced by ZipCar. ZipCar places cars of various sizes and styles all around a city. After signing-up, customers can go online to find cars parked nearby. They can order the car for an hour or more online and then use their personal id card to unlock the vehicle. The car will not start unless the driver is in possession of a valid "company card". In major cities, many folk use mass transit for their daily commute to and from work. Many folk own a car just for occasional errands or the week end trip. Scores of folk are finding that they can "rent for less". Many are excited because they rent the size and style vehicle they need for each occasion for a total cost that is far below the cost of ownership.

The fuel saved by the increased use of ZipCar may not be obvious but it is real and potentially huge. The big difference is in the marginal cost of usage. A person who has already invested 30K in a car, pays only the operating costs to drive across town. While the total cost to the ZipCar user might be dramatically less, the margin cost are dramatically higher. Given the option to walk a couple of blocks to the subway or to pay the rental cost for an hour, many a trip by car will be avoided.

As more and more of us become constantly connected to the Internet through mobile devices, the practicality of ZipCars becomes all the more real. If you are on one side of town and realize you need to be home in a hurry, you simply call up the location of a nearby vehicle on your mobile device. The code to unlock the car might even be sent to your mobile device.


Marilyn and I will be making our "move to town" in about 6 months. Winston-Salem does not have much to brag about in regard to mass transportation but, even so, our total mileage should decline sharply. With restaurants, parks, libraries, banks, the YWCA and many more places and services close, we will drive less. The city has made plans for a new electric trolley that will include a stop at our new home. As residents of big cities know, new homes and apartments will be built near subway stations and trolley lines. This is the old chicken or egg coming first story. High energy prices will encourage some to move to town, others will move after the new population is sufficient to support new services. The downtown crowds encourage festivals, events, restaurants, art shows, museums and more crowds. Suburbanites who enjoy these new events and services will consider moving to be close. Once started, demographers say such cycles last about 40 years. In Winston-Salem, the "big move out of town" started around 1964. The "big move back" started around 2004. "Big moves" start slow, like a train, but then pick up unstoppable steam. The current mortgage crunch has slowed the "big move" like a train moving up a hill but the crest of the hill is in sight! It took 40 years for America to become a land of suburbia, over the next 40 years, the center cities of suburbia and the old "down towns" will see the big growth.


City dwellers who do not own cars will likely vacation in resort towns where cars are not needed. Getting to the resort will likely be by air. Again, the marginal cost of driving a car will demonstrate that most airfares are cheap. Yes, the process of globalization is a decades long event. The airlines will see good times and bad times within this long term cycle. The good news is that we have entered the "good part" of the business cycle. Over the next few years, business travelers will pay big bucks to go to points here and yon. CAL grew revenues 17% last year. In any business, if you grow your capacity by only 5% but your revenues by 17%, then you are racking in the dough. The difference is in more sales volume or a higher price per sale or a combination of both. Generally volumes lead prices. Therefore, much of the 17% increase last year was an increase in full seats. With virtually every day time seat flying full, the next big move is in price. CAL could easily increase revenues 17% for many years in a row without increasing capacity by much. Let the good times roll!