$130 Oil Leads to Irrational Moves at American Airlines

With oil prices surpassing $132 per barrel today for the first time ever, American Airlines (AMR) has reacted by raising prices. Most notably the airline will charge travelers $15 to check a bag. The company calls this a “revenue growth initiative” in their press release, but it is really just silly. When high fuel prices are pressuring an already bloated cost structure and a weak economy is reducing air travel, price increases are not going to help AMR. It simply does not address the problem.

In such a competitive industry, weak players increasing fees will only result in more people going to discount airlines, which are run far better than their larger counterparts. There is a reason Southwest Airlines (LUV) has been taking market share and has never lost money in any year since its founding more than three decades ago and it is not because they started to charge their customers for things like checking baggage. In fact, they have used those boneheaded ideas in their brilliant marketing campaigns:

The problem for AMR and the rest of the airlines that go bankrupt every five or ten years (this time will be no different) is that they rarely directly tackle the problems that are causing them to bleed red ink. Raising prices in a price sensitive industry reduces revenue and does nothing to address bloated costs. The airlines need to get their costs in line with their revenues. It is not rocket science; Southwest and JetBlue (JBLU) have done wonderfully over the years.

The AMR story is not very much different than the management of our federal government lately. Gas prices are crippling lower class Americans? Okay, then we will give them tax rebate checks and tell them to go out and spend that money on $4 gasoline. How does that solve the problem? As Dr. Phil would say, “money problems are not solved with more money.”

All the government is doing is paying us to buy gas when buying gas is exactly what is causing fuel prices to be so high in the first place. We are sending money straight to the oil executives and the nations who export their oil to us. This transfer of wealth, both from poor to rich and from the U.S. to the oil producing nations, doesn’t even begin to address the energy problems we face. As 5% of the world’s population using 25% of the world’s oil, paying our citizens to buy gas is the last thing we need.

As long as these are the things that AMR and the government are doing about sky-high oil prices, the investment strategy is not very difficult to pin down: stay long oil producers, foreign currencies, and the rich and stay short the airlines, the dollar, and the poor.

Full Disclosure: No positions in the companies mentioned at the time of writing

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5 Thoughts on “$130 Oil Leads to Irrational Moves at American Airlines

  1. JaaJoe on May 21, 2008 at 1:30 PM said:

    It’s so called Environmentalist who have put us in this position of rising energy costs. Any solution has been shot down by propaganda. Check out this article don’t drill for oil and no nuclear power. It’s ridiculous what there doing to us.

  2. bobby on May 21, 2008 at 2:15 PM said:

    Not that they don’t have their issues, but blaming enviormentalists for the high oil prices seems to me as nearsighted as thinking that a $15 luggage check-in fee will fix the AA balance problems.

    I can hardly pinpoing the single biggest reason, but I can surely think of a few that are far more important than eviormentalists and one of them is the oil companies themselves.

  3. Rubens on May 22, 2008 at 7:17 AM said:

    Can you give some specific advice to the big airlines on how they can cut costs and become profitable? I don’t think you really understand their situation. To compare the big airlines with the budget ones is like comparing a Ford and GM plant with a Toyota one. Ford and GM has massive legacy costs of high salaries and benefits, and so do the big airlines. American is one of the few (or is it the only one?) of the big airlines that hasn’t filed for Chapter 11 in recent years, which would have let them reduce costs and renegotiate legacy employee agreements.

  4. Chad Brand on May 22, 2008 at 8:00 AM said:

    jaajoe – The ridiculous amount of energy that our country consumes is what has put us in this mess. We use 25% of the world’s oil in the U.S. alone. The solution is reduced oil use (25% of cars in this country are SUVs) and alternative energy. The former hasn’t happened yet and the latter is just starting to take form.

    Rubens – I decided to address your point in a new post so I had a bit more room to elaborate.

  5. bobby on May 24, 2008 at 10:18 AM said:

    Just to chip in – I am not so sure that energy consumption alone is to blame.

    US would have been consuming nuclear power, for example, if it was offerred, like France does.

    And, let me repeat, the problem in my opinion aren’t the enviornmentalists.

    Oil and ore companies – the so called “energy” companies – has simply set foot and invested heavily in an oil and ore industry and have very heavily suppressed the possible alternatives, includin subsidizing the automobile industry to focus on gasoline driven cars.

    Just my 2c.

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