"10 SEATS" CONSUME THE SAME OIL

A regular reader believes that the number of people flying is going to go down; because of the recession and because of the higher ticket prices. She is absolutely right. The picky point that we may escape without having an official recession is not important. The economic slowdown, recession or not, will cause a reduction in air travel. The higher ticket prices will also cause some people to "stay home".

The fact is that the cost to fly in America has dropped like a stone from 1978 to now. It was all one smooth decline as there were a number of booms and busts along the way, but the price of a ticket dropped in real terms to a tiny fraction of the ticket prices of 30 years ago. Another fact is that the bottom has been reached. SKYBUS offered "$10 seats". SKYBUS is gone and the $10 seat will not likely be seen again.

I put the $10 in quotes because only the first few passengers got the $10 rate and by the time all fees and taxes were added the total price was typically several times $10. Still, the airline business is not like the Google Advertising Business. Google has a cost to deliver an add that is so small that it is practical to call it zero. By sending out trillions of zero costs ads, Google is able to make money when only a very small percentage of ads work. The cost of the $10 seats at SKYBUS were loss leader seats even if the airline had the lowest cost structure of any. The $10 seat consumes the same amount of fuel as the $1,000 seat and it is insufficient to support the lowest salaried pilot.

My daughter and future son-in-law will leave LA tonight at 10PM and arrive back in NC at 9AM on Sunday morning. The cost per seat will be about $300. Their original plan was to leave Sunday, spend fewer hours traveling and to save almost 90%. Had they not gotten the "$10 seats" they probably would not have made this trip. So they provide anecdotal evidence that my reader is right on target. The total number of trips is going to be reduced. The total amount of fuel burned is going to be reduced. The number of used aircraft available for purchase is going to increase. The number of available landing slots is going to increase. The delays due to over crowding will be reduced. Most important of all, the ticket prices offered will be reset to more than cover the costs of service. There will be no more losses to be made up by increasing the volume.

I am writing this on a Saturday morning not because airline shares will jump on Monday morning but because the conditions for profits are almost as good as they ever get. Indeed, the over sold condition of just a week or two ago is no longer the case. The market had a very good week this past week. The average stock went up by better than 4%. If that rate were to continue for 52 weeks the total return in one year would be 208%. It ain't gonna happen, but conditions are ripe for average stock price gains of 30% or more.

With the whole world becoming more aware of the degree to which Iran is paying terrorist, there is good reason for the market to be gun-shy. It is an amazing thing that terrorist are essentially on the payroll of the Iranian government. Extremist in a number of countries (and the big problem is that we do not know just how many) are drawing "salaries" of $200 to $300 per month. Three hundred dollars per month is "good money" in the Middle East. On the other side, America is paying about that amount per month to more than 80,000 Sunnis who have joined in the fight on our side. When the Swiss recently made a deal to buy more oil from Iran, it is easy to see why the US and a number of allies were upset. The Europeans are anxiously being forced to build an anti-ballistic missile system at great cost to protect themselves against this rouge nation. Thousands of innocent people are being bombed from Lebanon to Israel to Madrid to New York to India and to Russia (just to name a few) and Iran has bombers on its payroll.

The terrorism problem is not going to quietly go away. The US is currently practicing the Elliott Ness strategy. Ness went after Al Capone by hitting his sources of revenue. He could not capture and convict all the hoodlums (including Judges and elected officials) who were on Capone's payroll but he was able to disrupt the flow of profits and to "follow the money". Ultimately he convicted Al Capone of income tax evasion. Capone did not "get what he deserved" unless you consider the syphilis he contracted an act of retribution. The US has brought the UN to the point of declaring the Iranian Central Bank the "financier of terror". The US has "followed the money" back to Iran.

Boycotts are extremely difficult to enforce. Iran is still pulling in 100's of millions of dollars per day in oil revenues. What it will take to bring a cessation to state sponsored terrorism is a difficult question. Should this rouge nation become a nuclear power, it is likely that Saudi Arabia and other neighbors will feel the necessity to respond in kind. The wisdom of Barney Fife comes to bear, we should "nip it, nip it in the bud".

The world knows that only a crazy man would use a nuclear bomb. The crazy man would die along with the rest of his countrymen. The planet might or might not survive. In America we hold TV "debates" that focus on all sorts of "important issues". We devote hours on end trying to come up with solutions for the poor in America. The fact is that the poor in America are extremely rich relative to 3 billion or so poor people around the globe. We attempt to ease our guilt for being rich by looking for ways to redistribute our wealth. As a result, the average "poor person" in America is able to spend 194% of his income year after year after year. I am not against helping the poor. I am for protecting the rich and the poor from criminals.

The terrorism problem is far more important than all the "poor versus rich" problems combined. On the other hand, the world is well aware that Iran is sponsoring terrorism and the UN Security Council has voted several times to impose economic sanctions and to offer incentives to Iran for abandoning its nuclear ambitions. Iran is holding firm to its nuclear course because the only way it can continue to dream about taking back the lands it once controlled (all the way through Spain) is to have the nuclear weapons as the back up threat. While the reality is that Iran has little chance of even wiping out the tiny little country of Israel even after acquiring nuclear weapons, it makes no sense to let them get in the position to try.

The Iranian threat is so obvious that it has brought together the US, Russia, China, Europe and Japan. A couple of weeks back, China turned over intelligence materials to the UN showing the degree to which Iran has worked on nuclear weapons. During War War II, it took the cooperation of Russia and the US to squeeze Germany. Today, all the major powers are cooperating. The bottom line is that the threat is very real, that it must be dealt with and that with a lot of determination and persistence, Iran will ultimately be forced to reach a peaceful accord (by the current government or a new one).

So, there are problems in the world. No news in that. The real and to some degree rational fear of conflict has resulted in the use of gold and oil as a hedge. The US dollar has sunk to extreme lows as a result of this fear, but a coiled spring can only be pushed so far. This spring has been pushed to the point that a break out of conflict would cause a relief rally in the dollar. As always, the fear is worse than the pain. If you were ever naughty as a child and were told to wait while the teacher went for his or her paddle, you know how terrible the fear that rises up into your inner being. Getting the whipping over turns out to be a great relief. The US dollar is so cheap that American companies are bringing back jobs from over seas. The big decline in profits that comes near the end of an economic slow down are upon us. Earnings announcements in April will cause all those who invest based on volatile short term estimates and PE ratios to whine and moan but the value of the US dollar is so low that business after business is going to see profits soar over the next 4 years or so.

I do not think there will be a direct conflict with Iran. When the Iraqi soldiers moved into Basra last week, the response of the rouge militias was strong, but the fight was called off quickly. The Iranian supported militias have no interest in taking on the US forces. Iran certainly does not want to give the US the excuse to invade and the US certainly does not have the political support to or the reason to invade for as long as the terrorism is "contained" and the economic and political pressure is pushing Iran toward compromise.

WHAT DOES THIS ALL HAVE TO DO WITH $10 SEAT PRICES?

Everything and nothing.

Thirty years into deregulation, the airline industry has finally rationalized its pricing structure. There is no longer room for low cost start ups to pick off lucrative routes from bloated, high cost, mainline carriers. As a result, business is back to "normal". Airplanes are only being flown when they can be flown profitably. Nothing that happens in Iran will cause domestic operators to turn the clock back. In the days before globalization, bombs killing children and innocents in the Middle East were no big deal to Americans. Going back a few hundred years, Native Americans did not know about the invention of gun power and did not care. Today, we must care. Unchecked, the terrorist will strike in cities and towns across America. Unchecked, Iran has ambitious not too different than those of Hitler. Hundreds of millions of Islamic people believe in a spiritual jihad. It is only a radical few that believe in killing all infidels. International air traffic has doubled and doubled again in recent years. The growth path is set for another quick doubling. It has been many years since the TWA flight was blown up and even many years since 9/11/2001. The terrorist have not surrendered. Many came out of hiding to die in Iraq. Many others, some on the Iranian payroll and some not, are hiding out in the mountains of Pakistan and Afghanistan, some in Lebanon, some in Gaza, some in Bahrain, some in Egypt, some in Germany, some in America, etc.

Even Obama has backed off on the idea of pulling all troops out of Iraq. No matter who the president, the war on terrorism must continue until all state sponsorship is gone. The Bush doctrine that those who harbor terrorism are against us must be pushed until all states go after outlaw groups. Criminals will always be in our midst but it is immoral to not protect ourselves as best we can.

By fighting the fight, we deter crimes. The terrorist know that if a bomb blows up an airplane, building or rail station anywhere in the world and if it can be shown that that bomb was purchased with state money or if it can be shown that the perpetrators were trained by a state, that state is at risk of becoming the next Iraq. Because the risk of take over is real, the probability of bombings has been dramatically reduced. Companies such as CAL and DAL can thus continue to dramatically expand international, highly profitable, routes. The rationalization of the US domestic market will allow companies like CAL and DAL to fly profitable routes within the US and to feed the international routes with highly profitable traffic. The most successful of discount airlines, LUV, has thrown in the towel and has joined the ranks of the "big boys".

It is a new day in the airline business. It only took about 10,950 days to reach. Actually, probably more than double that number as the pricing structure was way out of whack during many years of regulated markets.

Yes, the train business got there first. The transportation index is up 26% in recent weeks. The trains were deregulated about the same time as the airlines. The airlines are many times more levered and many times more volatile. The trains will continue to do well but they do not have nearly as tight a coiled spring. INVESTMENT OPPORTUNITIES LIKE THIS ONE DO NOT COME ALONG OFTEN!