John Heimlich, Chief Economist2004 ATA e-Business Forum

Atlanta, GeorgiaOctober 28, 2004

Airlines and Oil – Fuel for Thought

The Air Transport Association of America, Inc.October 2004

Combination Services

Alaska AirlinesAloha Airlines

America West AirlinesAmerican Airlines

ATA AirlinesContinental Airlines

Delta Air LinesHawaiian AirlinesJetBlue AirwaysMidwest Airlines

Northwest AirlinesSouthwest Airlines

United AirlinesUS Airways

All-Cargo Services

ABX AirASTAR Air Cargo

Atlas AirEvergreen Int’l Airlines

FedEx CorporationMenlo Worldwide Forwarding

Polar Air CargoUPS Airlines

Associate Members

AeromexicoAir CanadaAir JamaicaMexicana

The Big Picture (Stinks)

§ Massive losses, debt = poor credit ratings and job cuts

§ Soaring, sustained price of oil accelerating Chapter 11/7/18/22/29 filings

§ Widening crack spreads hurting jet fuel users (10-20% of op. cost)

§ Passenger airlines lack pricing power; some on international routes

§ Cargo operators partially recovering spikes through indices/surcharges

§ Airline finances, energy market preclude most new “hedging”

§ Roots of “hedging” in charter industry, where revenue known

§ With a 12-month strip > $50/barrel, locking in could cost millions

§ So…unprecedented conservation efforts underway in an industry already known for steady gains in fuel efficiency over time

§ But we can only do much to offset foreseeable price levels…

$5.4$2.8

($13.1)

$23.0

($23.2)

($8.0)

($30.0)

($20.0)

($10.0)

$0.0

$10.0

$20.0

$30.0

1947-78 1979-89 1990-94 1995-00 2001-03 2004F

Net

Pro

fit/L

oss

($B

illio

ns)

U.S. Airline “Earnings” = Cumulative Net Loss2004 Net Loss Will Compound 2001-03 Losses, Which Exceeded 1995-2000 Gains

Notes: 2001 and 2002 include federal compensation remitted to air carriers under P.L. 107-42 (roughly $5B pre-tax distributed over two calendar years); 2003 includes federal reimbursements (roughly $2.3B pre-tax) for security costs imposed and estimates for concessions, offset by SARS and the War in Iraq.

Source: ATA research

Includes $1.9B DAL special charge

AA

A

BB

B

B+

B

BB

+

A

BB

B

BB

B-

BB

B+

BB

B-

B+

BB

+

B

AA

A

BB

B

CC

C

DD

A

B

BB

-

B-

CC

B

CC

C-

B-

B-

BB

-

B-

AirTran

Alaska

America W

est

American ATA

Continental Delta

Indepen

dence*

JetBlue

Northwest

SouthwestUnited

US Airways

Evergree

n**

FedEx**UPS**

9/10/2001 10/22/2004

Airline Balance Sheets in Disrepair With Heavy LossesStandard & Poor’s (S&P) Corporate Credit Ratings

AAA: Extremely strong capacity to meet financial commitments. Highest rating.AA: Very strong capacity to meet financial commitments.A: Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.BBB: Adequate capacity to meet financial commitments, but more subject to adverse economic conditions. (BBB- is the lowest investment grade rating.)BB: Less vulnerable in the near-term but faces major ongoing uncertainties to adverse business, financial and economic conditions.B: More vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments.CCC: Currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments.CC: Currently highly vulnerable.C: A bankruptcy petition has been filed or similar action taken but payments or financial commitments are continued.D: Payment default on financial commitments.

Inve

stm

ent

Gra

de

(>=

BB

B-)

* Formerly Atlantic Coast Airlines** Airfreight company

Airline Headcount Down ~122,000 (16%) from 9/11Low Fares, High Fuel Prices, Productivity Gains Driving Cuts or Curbing Growth

433

75

165

74

314

81

150

80

0

100

200

300

400

500

"Big 6" PassengerAirlines*

Selected Low-CostCarriers**

Selected CargoAirlines***

Other U.S. Airlines

U.S

. Air

line

Em

plo

ymen

t (00

0s)

Aug-01 Aug-04

Sources: U.S. Department of Transportation P1a employment report; carrier reports for full-time and part-time workers

* American, Continental, Delta, Northwest, United, US Airways** AirTran, Alaska, America West, ATA (formerly American Trans Air), Frontier, JetBlue, Southwest, Spirit

*** Air Transport Int’l, ASTAR/DHL, Express.Net, Evergreen, FedEx, Gemini, Kalitta, Kitty Hawk, Polar, Ryan Int’l, Southern, Tradewinds, UPS, World

Aug-01 Aug-04747.6 625.9

TOTAL

Post-2001 Fuel Prices Soaring to Record HighsCrude Oil to Reach Record High in Nominal Terms in ’04; No Relief Seen in ’05

$19.73

$23.34

$27.14

$31.66

$41.60$41.60

$31.10

$41.65

$26.10

15

20

25

30

35

40

45

50

55

60

1992-2001 2002 2003 2004F 2005F

Ave

rag

e P

rice

of C

rud

e O

il ($

per

Bar

rel)

*

Nominal Real ($2004)

*West Texas Intermediate at Cushing, TexasSource: PIRA Energy Group and Air Transport Association

“Daniel Yergin, chairman of Cambridge Energy Research Associates, agrees that it would be a mistake to underestimate the effect high oil prices have already had on the world economy. He points out that the…losses suffered by the airlines mirror the increase in their fuel bills. ‘We are not that far behind the high prices of the early 1980s even in real terms…’”

(James Boxell, Financial Times, September 16, 2004)

Jet Fuel Crack Spread Widening in 2004

Source: Goldman Sachs

Gulf Coast $1.52/galNY Harbor $1.59/galLos Angeles $1.62/gal

Post-2001 Fuel Surging to Record HighsCrude Oil > $50/Barrel; Modest Hedging Bringing Jet Price Paid Below Spot

10

15

20

25

30

35

40

45

50

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Ave

rag

e P

rice

of C

rud

e O

il ($

/Bar

rel)

*

55

65

75

85

95

105

115

125

135

Jet Fu

el Price excl. T

axes (¢/Gallo

n)

Crude Oil (WTI)* Jet Fuel Paid (DOT) Jet Fuel Spot (EIA)

*West Texas Intermediate (WTI) at Cushing, TexasSource: DOT Monthly Fuel Cost and Consumption Report and PIRA Energy Group

Crude Oil $/bbl*

2001 $262002 $26

2003 $312004F $42

2005F $42

$425

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$1 $2 $3 $4 $5 $6 $7 $8 $9 $10 $11 $12 $13 $14 $15

Hypothetical Increase in Price of a Barrel of Oil**

Incr

emen

tal O

pera

ting

Exp

ense

s ($

Mils

)

0.0

15.0

30.0

45.0

60.0

75.0

90.0

105.0

Airlin

e FT

Es (000s)*

Expenses

Jobs

Fuel Spikes Exacerbate Losses and Threaten JobsEvery $1 Increase in Fuel is Cost of Employing 5,520 Airline Workers*

Source: ATA Airline Cost Index ($77K per worker in 1Q04)* Job equivalent not intended to establish causation** Assumes annual industry-wide consumption of 425M barrels

Weak Demand and High Fuel Prices Don’t MixAn Assessment by Standard & Poor’s

"Fuel prices are an external factor that airlines cannot control. What can they do to react and minimize the damage? A comparison with other modes of transportation is revealing. Fuel represents a roughly comparable proportion of expenses for railroads and many trucking companies (in the mid-teens percent range), but they have not been hurt by higher fuel prices to nearly the same degree.

Part of the difference is due to more active hedging programs by these freight transportation companies, but most is due to the fact that many of their contracts with corporate customers allow them to pass through higher fuel costs in the form of surcharges. Airlines have tried repeatedly to raise fares in response to high fuel costs, but with little success. [T]he problem comes back to a lack of pricing power in a very competitive market.”

Philip Baggaley – Managing Director, Standard & Poor’s (June 3, 2004)

Testimony before the U.S. House of Representatives Committee on Transportation and Infrastructure

Since 2000, Breakeven Load Factor Well Above ActualPrices, Less Cargo, Higher Costs = More Seats Must be Filled

67.2%

69.4%70.5% 70.8% 71.1%

72.4%

70.0%

71.8%

73.4%

71.5%

77.7%

79.6%

66.0%64.9% 64.9%

80.9%

84.1%

69.3%

66.5%

64.3%

60%

65%

70%

75%

80%

85%

1995 1996 1997 1998 1999 2000 2001 2002 2003 1Q04

Pas

sen

ger

Lo

ad F

acto

r (%

) — M

ajo

rs a

nd

Nat

ion

als

Actual Breakeven

Source: ATA research

0

100

200

300

400

500

600

700

800

900

1,000

46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03

Pri

ce In

dex

(194

6=10

0)

CPI Yield-Domestic Yield-International

Airfares Have Not Kept Pace With U.S. InflationEven Adjusting for Increasing Trip Length, Yields Have Fallen Flat

Sources: U.S. Department of Transportation Form 41 reports; U.S. Bureau of Labor Statistics

Nominal Yield (Fare Paid per Mile) Below 1988 Levels

Pricing Power Remains ElusiveDomestic Fares (Excl. Taxes) Down Sharply From 2000; International Recovering

Source: ATA research

“Internet pricing, low-cost carrier growth and higher taxation of airline revenue remain as obstacles to an airline recovery. [I]t may be years before we experience a return to the late 1990's absolute level of revenue….” (William Greene, Morgan Stanley — September 24, 2004)

(30%)

(25%)

(20%)

(15%)

(10%)

(5%)

0%

5%

10%

Jan-01

Apr Jul Oct Jan-02

Apr Jul Oct Jan-03

Apr Jul Oct Jan-04

Apr Jul Oct Jan-05

% C

han

ge

in M

ain

line

Psg

r. Y

ield

(¢/R

PM

) vs.

200

0

Domestic International

Passenger Unit Revenue Weak at Home; Strong AbroadDomestically, Record Load Factors Insufficient to Offset Sharply Lower Fares

6.00

6.50

7.00

7.50

8.00

8.50

9.00

9.50

10.00

10.50

11.00

Dec-00 Mar Jun Sep Dec-01 Mar Jun Sep Dec-02 Mar Jun Sep Dec-03 Mar Jun Sep Dec-04

12-M

on

th R

olli

ng

Psg

r. R

even

ue

per

AS

M (¢

)*

Domestic Atlantic Latin Pacific

* ATA research of Alaska, American, America West, Continental, Delta, Northwest, United, US Airways

“[T]he industry continues to face a demand curve characterized by very accentuated price elasticity and thus the needed objective to achieve simultaneously capacity and traffic growth as well as improved price realization continues to be a very elusive task.” (Citigroup — October 24, 2004)

VolatilityHighest for Crude!

-

30

60

90

120

150

180

Dec-89 Dec-90 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03

Gold

Euro

Deutsche

3-Month Treasury Bill

Crude Oil

To Hedge or Not to Hedge?It Depends, Sherlock

§ Doing nothing could be considered speculation

§ Reduce cash flow volatility

§ Respond to competitive pressures

§ Improve financial planning capability

Market Terms

Fuel “hedging” is participating in a forward contract for a fuel commodity. It is not truly hedging in the conventional sense, more of a gamble than arbitrage.

Commodity is any useful thing that is bought/sold as an article of commerce.

Futures or forward contract is a contract for purchasing or selling a commodity in the future at set pricing.

a cap or call option is paying a premium to lock in a price ceiling for a future time period

a swap* is locking in a price for a future time period

a collar* is locking in a price range for a future time period

Each day, billions of dollars worth of energy products, metals, and other commodities are bought and sold on the trading floor of the New York Mercantile Exchange. Shortly after the trading floor closes, overnight electronic trading picks up, because night and day, minute by minute, the value of these strategic commodities changes.

*A swap or collar may involve paying a premium depending on the price set for the time period.

Industry “Hedge” Program ComparisonExcept Southwest, Minimal “Hedges” in Place -- @ Legacy or LCCs

Source: Goldman Sachs

44.2

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

1975 1980 1985 1990 1995 2000 1Q2004

Rev

enu

e P

asse

ng

er M

iles

per

Gal

lon

Aviation Fuel Efficiency Has Risen SteadilyPassenger Throughput — RPMs per Gallon

Source: U.S. Department of Transportation

Policy Considerations/Options

§ Slow down Strategic Petroleum Reserve.

§ Eliminate Federal Jet Fuel Tax.

§ Modify state jet fuel taxes – especially those tied to price!

§ Ease construction/enhancement of refineries.

§ Improve air traffic control system and runways to ease congestion.

§ Liquidate.

Customer Service Metrics Show StrengthLow Fares and Steady On-Time Performance Lead to Fewer Complaints

Source: U.S. Department of Transportation Air Travel Consumer Report

0.750.711.222.102.982.47Customer Complaints(per 100,000 passengers)

4.584.194.914.965.295.08Mishandled Bags(per 1,000 passengers)

79.4%76.0%78.3%80.2%62.8%78.0%On-Time Arrivals(within 00:15 of schedule)

0.970.860.720.821.040.88Denied Boardings(per 10,000 passengers)

1.5%2.1%1.7%1.0%5.9%n/aFlight Cancellations(per 100,000 passengers)

YTD0420032002200120001999

Ope

ratio

nal P

erfo

rman

ce

500

600

700

800

900

1,000

1,100

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Fiscal Year

Rev

enu

e P

asse

ng

er E

np

lan

emen

ts (M

illio

ns)

* FAA Forecast FY01

FAA Forecast FY02

FAA Forecast FY03

FAA Forecast FY04

As of Mar-04, FAA Still Projecting Long-Term GrowthFAA Expects Demand to Exceed a Billion Passengers in Fiscal Year 2014

*Scheduled Revenue Passenger Enplanements (Millions), Certificated U.S. Carriers; Source: FAA Aerospace Forecasts, based on DOT Forms 41 and 298-C

Consumer/CEO OutlookCEO Confidence Hit 20-Year High in 1Q04, but Deteriorating Rapidly

25

30

35

40

45

50

55

60

65

70

75D

ec-9

8

Mar

Jun

Sep

Dec

-99

Mar

Jun

Sep

Dec

-00

Mar

Jun

Sep

Dec

-01

Mar

Jun

Sep

Dec

-02

Mar

Jun

Sep

Dec

-03

Mar

Jun

Sep

Dec

-04

CE

O B

usi

nes

s C

on

fid

ence

Ind

ex (Q

uar

terl

y)

75

80

85

90

95

100

105

110

115

120

125

Co

nsu

mer S

entim

ent In

dex (M

on

thly)

CEO Consumer

Sources: Conference Board and University of Michigan

May it Please the Court…Bankruptcy Protection (or Equivalent) Sought by Many in 2001-03

Atlas/Polar

Arrow

ATA

Great Plains

Hawaiian

Midway

National

Sun Country

TWA

Vanguard

United

US Airways

Air Canada

ACES

Aeris

AOM-Air Liberté

Avianca

Sabena

Swissair

www.airlines.org