Energy Matters: Combating the Fuel-

Related Challenges Facing U.S. Airlines

John Heimlich — Vice President and Chief Economist

May 4, 2006
 The Air Transport Association of America, Inc.
ATA Members Carry Over 90% of U.S. Airline Passenger and Cargo Traffic

Combination Services (13) All-Cargo Services (6) Associate Members (4)

Alaska Airlines ABX Air Aeromexico

Aloha Airlines ASTAR Air Cargo Air Canada
American Airlines Atlas Air / Polar Air Cargo Air Jamaica
ATA Airlines Evergreen Int’l Airlines Mexicana
Continental Airlines FedEx Corporation
Delta Air Lines UPS Airlines
Hawaiian Airlines
JetBlue Airways
Midwest Airlines
Northwest Airlines
Southwest Airlines
United Airlines
US Airways

© ATA May-06 -- 2
 The Word on the Street

“Geopolitical risks prevail and are not going away in

the short term. The risk to WTI* prices is therefore still
skewed to the upside and even comfortable reserves
and warm weather cannot compete against nuclear
showdowns and sabotaged pipelines.

Deutsche Bank Commodities Research

Commodities Weekly (February 3, 2006)

*West Texas Intermediate crude oil

© ATA May-06 -- 3
 Aviation Fuel Efficiency Has Tripled Since 1971
Conservation Accelerated Post-9/11, Keeping Consumption Below 2000 Peak

22.0 70.0
Jet Fuel Consumption (Billions of Gallons)*

20.0 60.0

57.1

18.0 50.0

Miles per Gallon

44.4

16.0 40.0

14.0 30.0

12.0 20.0

N/A
10.0 10.0
1971 1980 1990 1995 2000 2005

Gallons Revenue Passenger Miles Available Seat Miles

*Consumed by U.S. passenger and cargo airlines in worldwide operations
Source: Air Transport Association
© ATA May-06 -- 4
 Fuel Conservation Via Weight Reduction

ƒ In 2003, one large airline estimated over 17 gallons saved annually per pound
of weight removed per airplane after shedding in-flight phones coach ovens,
excess potable water, and some galley equipment on one of its older fleets
ƒ In removing seatback phones from its MD-80s and B737-400s, another airline
shed 200 pounds per airplane, translating into 3,400+ gallons saved annually
ƒ Alaska Airlines indicated in March 2004 that removing just five magazines per
aircraft could save $10,000 per year in fuel; also, the airline now counts the
children aboard each flight to estimate passenger weight (and thus needed
fuel) more precisely and has reduced the weight of catering supplies on its fleet
ƒ Air Canada had considered striping primer and paint from its Boeing 767s to
save 360 pounds (an estimated C$24,000 in yearly fuel expense) per airplane
ƒ JetBlue and America West have moved toward a paperless cockpit
ƒ Others have been able to remove ovens, trash compactors, or even entire
galleys, due to the elimination of hot meals on selected flights
ƒ Most have reduced excess fuel on international flights with FAA approval
thanks to more precise navigation allowed by GPS and better wind forecasts
ƒ Some even flush the lavatories more frequently during extended ground delays
© ATA May-06 -- 5
 Fuel Conservation Through Operational Means

ƒ As reported in 2004, United, JetBlue, and then-America West lowered cruise

speeds not only to reduce airborne consumption but also to avoid arriving too
early and burning extra fuel while awaiting an occupied gate
ƒ Alaska, American, Southwest, and others have added life vests on certain
domestic routes (e.g., LAX-CUN, DFW-MIA, MIA-NYC, AUS-TPA) to enable
pilots to fly over water, in cases where over-water routings are more efficient
ƒ Many airlines ferry fuel to avoid filling up in the costliest locations
ƒ AA redistributed cargo in the airplane’s belly to move the center of gravity forward
ƒ Continental, Southwest, and others have installed winglets to reduce drag or
increase range; Southwest estimated annual savings of $10 million for its Boeing
737-700s, or three percent fuel savings per mission
ƒ More recently, American, Delta, and others have pared schedules on a
temporary basis to reduce consumption in periods of sky-high prices
ƒ Several airlines taxi on one engine when conditions permit
ƒ American, Southwest, and others are using ground power to provide electricity
and ground-conditioned air, rather than the plane’s auxiliary power unit (APU)
© ATA May-06 -- 6
 What About Air Traffic Control?

ƒ In early 2005, the introduction of RVSM* in U.S. airspace expanded altitude

choices, mitigating congestion and enabling pilots to select more efficient paths

ƒ Currently, ATA is advocating the following ATC measures, among others:

9 Accelerate RNAV** deployment at hub airports; delegate development of procedures
9 Reconsider rule limiting speeds below 10,000 feet to 250 knots; some aircraft may
operate more efficiently at higher speeds (especially on climb-out) but are prevented from
doing so (note: also allows controllers greater flexibility to manage air traffic)
9 Provide more timely information to flight crews to increase opportunity to avoid operating
engines when departure delays are in effect
9 Allow flights to maintain climb-and-descent profiles and “level-offs” prior to filed altitude;
decreased controller issuances of direct aka “DCT” clearances to enroute flights
9 Coordinate “HOLDING” alerts to operational degree possible and increase controller
awareness of aircraft fuel consumption when holding at low altitudes
9 Allow short ground delays or user-preferred trajectories in lieu of circuitous re-routes
9 Offer re-route options whenever multi-route options are available
* Reduced vertical separation minima (see http://www.faa.gov/ats/ato/rvsm1.htm); enables vertical separation to be reduced between flight levels 290-410
(inclusive) from 2,000 feet to 1,000 feet; first implemented in North Atlantic Airspace in 1997
** Area navigation (see http://www.faa.gov/ATpubs/AIM/Chap1/aim0102.html); developed to provide more lateral freedom and thus more complete use of
available airspace; does not require a track directly to or from any specific radio navigation aid

© ATA May-06 -- 7
 Can Airlines Hedge in this Environment?

“…Management of energy risk is an area that many carriers have neglected in

recent years…. Most of the airlines…have not hedged their exposure for 2006 and
beyond. In addition, a large percentage of the hedges were placed in crude oil as
opposed to their actual exposure, which is jet fuel…. For airlines that did not
hedge, or for those which liquidated hedges due to court-ordered instruction, the
outlook remains very severe…. The airline industry…suffers from the burden of
having to pay high prices without the flexibility of receiving higher fares.”
Testimony of Stuart R. Sokel, Director, Deutsche Bank,
before the Subcommittee on Aviation, U.S. House of Representatives, September 28, 2005

“[H]edging is a risky proposition that requires an airline to put up millions of dollars

of cash on the notion that jet fuel prices will be higher in the future. Cash-strapped
airlines, then, can end up unhedged and vulnerable to high fuel costs that they
can’t easily recoup through fare hikes.”
Keith Reed, The Boston Globe, “Hedging their jets,” June 10, 2004

“Financial problems have made it tough for some of the major carriers to make
such arrangements. Poor credit ratings make it more expensive for them to borrow
money to pay for hedge contracts.”
Harry R. Weber, Associated Press, “Lack of Hedges Hurt Airlines’ Bottom Line,” April 16, 2004

© ATA May-06 -- 8
 Significant Exposure to Fuel Marketplace in 2006
Only Three U.S. Passenger Airlines Hedged >= 30% of Consumption

$70
American
Continental
JetBlue
$65 Delta
US Airways
Frontier
Midwest
$60
Price of Hedge ($/bbl)

$55

$50 AirTran Alaska

$45

$40

Southwest
$35

$30
0% 10% 20% 30% 40% 50% 60% 70% 80%
Fraction of Consumption Hedged
Sources: ATA research, Bear Stearns and carrier reports * Weighted average for crude-equivalent prices; estimated in some cases
© ATA May-06 -- 9
 Could Oil Prices Go To Triple Digits?

“[A]s long as incremental supplies of oil continue to come from countries

where availability is an issue, the potential for prices to stay high or go higher
is, itself, very high.... After several years of very strong global economic
growth and rising oil demand and a decade of under-investment in oil
infrastructure, there is virtually no spare oil production capacity left in the
world. In such circumstances, a sudden shortage in the markets can only
be rebalanced through an extraordinary rise in prices.”
Commodities Weekly, Adam Sieminski, Deutsche Bank (April 28, 2006)

“Unforeseen disruptions to global oil supplies are becoming an increasing

danger to world energy markets. Iraq, Iran, Nigeria and Venezuela threaten to
heighten the markets’ concerns towards the ability of other oil producers…to
respond to any negative supply shocks.”
“Bottoms Up,” John Kilduff, Fimat Energy Risk Management Group (January 27, 2006)

© ATA May-06 -- 10
 Jet Fuel Cost Poised to Reach New Record in 2006
Crude Oil Average Expected to Approach $70-per-Barrel

$100

$90

Jet Fuel Crack Spread

18.85
$80
Benchmark Crude Oil*
Average Price ($ per Barrel)

14.24
$70

15.84
$60

$50

9.28
$40

69.44
7.49

5.90

63.27
56.48
$30

5.56
7.42

3.63
4.91
4.80

4.34
4.18

41.44
5.10

3.13
3.67
4.69

$20

31.14
3.55

30.30

25.92

26.10
24.50

22.15
21.48

20.56

20.60

19.25
18.46

18.43
17.19

$10
14.40

$0
1990 91 92 93 94 95 96 97 98 99 2000 01 02 03 04 05 1Q06 Apr-
06
Source: ATA analysis of Energy Information Administration data * West Texas Intermediate (WTI)
© ATA May-06 -- 11
 High Fuel Prices “Eating the Upcycle”
“On a non-fuel basis, operating profitability…is as good as it was in the late 1990s.”

“…it would be a mistake to underestimate the effect high oil prices have already
had on the world economy. [T]he…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…’”
Daniel Yergin, Cambridge Energy Research Associates, Financial Times (Sept. 16, 2004)

“If fuel prices average $50 for 2005, the debt burden on…network airlines will
grow by a number that rivals the[ir] entire combined market capitalization...”
Gary Chase, Lehman Brothers, “Fuel Eating the Upcycle” (Oct. 19, 2004)

“The airline industry has moved aggressively to reduce costs in the face of
unprecedented challenges… On a non-fuel basis, operating profitability…is as
good as it was in the late 1990s. While these facts are exciting…, they may also
be totally moot if oil prices do not return to [historical norms]… [W]e see a
materially greater chance for oil prices above $50 than below $40 over the next
several years. Unfortunately, high fuel prices are consuming what would
otherwise be an upcycle for the industry.”
Gary Chase, Lehman Brothers, “Industry Update” (Mar. 15, 2005)

© ATA May-06 -- 12
 Jet Fuel Prices Outpacing Crude Over Last Few Years
Crack Spread Down from $30/bbl Peak, But Still Far Above $5 Historical Norm

$100

$90 Crack Spread

Jet Average
$80 Crude Oil
Average Monthly Price per Barrel

$70

$60

$50

$40

$30

$20

$10

$0
Jul

Jul

Jul

Jul

Jul

Jul

Jul

Jul

Jul

Jul

Jul

Jul

Jul

Jul

Jul

Jul

Jul
Jan-90

Jan-91

Jan-92

Jan-93

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07
Sources: U.S. Energy Information Administration and the Air Transport Association of America
© ATA May-06 -- 13
 Jet Fuel Approaching $100/bbl on Rising Crude
Crude Oil Broke $70 on April 17; Crack Spread Eclipsed $20

$55 $140
Crack Spread
$50 $130
NY Harbor
Average Daily Crack Spread ($ per Barrel)

Spot Price (Right)

Average Daily Spot Price ($ per Barrel)

$45 Gulf Coast $120
Los Angeles
$40 $110
Crude Oil

$35 $100

$30 $90

$25 $80

$20 $70

$15 $60

$10 $50

$5 Crack Spread (Left) $40

$0 $30
9-Nov-05

29-Nov-05
7-Feb-05

24-Feb-05

18-Apr-05

4-May-05

20-May-05

16-Aug-05

8-Feb-06
15-Dec-05

27-Feb-06

19-Apr-06

5-May-06
3-Jan-05

8-Jun-05

13-Jul-05

29-Jul-05

1-Sep-05

6-Oct-05

24-Oct-05

4-Jan-06
20-Jan-05

14-Mar-05

31-Mar-05

24-Jun-05

20-Sep-05

23-Jan-06

15-Mar-06

31-Mar-06
Sources: U.S. Energy Information Administration and the Air Transport Association of America © ATA May-06 -- 14
 Higher Energy Prices: A Double-Edged Sword
Lower Disposal Income for Consumers Compounds Higher Fuel Cost

“The widening gaps between the price of crude oil and various types of fuel…are dealing a
one-two punch to an industry that can ill afford it…. To a reeling airline industry, the widening
crack spread couldn’t come at a worse time.”
“Ouch! Jet-Fuel Prices Outpace Crude,” Wall Street Journal (Aug. 9, 2005)

“Mother Nature often has a cruel way of delivering her fury at some of the worst times for the
airline industry, and the devastation Hurricane Katrina caused…is no different as it will lead
to millions of dollars of lost revenue for both the strongest and weakest major carriers.”
Steve Lott, Aviation Daily, and Aaron Taylor, Éclat Consulting, Aviation Daily (Sept. 7, 2005)

“As a rather poignant example of the strain airlines are under from the combination of cheap
fares and high oil prices, we note that the gasoline costs of driving from NY to LA now
surpass air fares for the same trip, in stark contrast to the parity we calculated early last
year…. We believe these economics are unsustainable.”
David Strine and Frank Boroch, Bear Stearns, Oil Things Reconsidered–Where Do We Go From Here? (Sept. 12, 2005)

“If oil prices remain above $50/bbl, we will undoubtedly see further capacity cutbacks,
bankruptcies and/or liquidations.”
Michael Linenberg and Lily Ng, Merrill Lynch, “Air Mail” Research Note (Sept. 16, 2005)

© ATA May-06 -- 15
 Industry Fuel Expense Rose $10.4B in 2005
Higher Crude, Crack, Consumption All Responsible for Year-Over-Year Increase

$40
$36.0

$35 $33.1
Fuel Expense ($Billions)—U.S. Airlines

$30

$25
$22.7

$20
$16.4
$14.8 $15.2
$15
$12.7

$10

$5

$0
2000 ($0.81) 2001 ($0.78) 2002 ($0.71) 2003 ($0.85) 2004 ($1.16) 2005 ($1.66) 2006F
Sources: Air Transport Association, Energy Information Administration, Department of Transportation
© ATA May-06 -- 16
Fuel Surging Just as Labor Restructuring Showing Results
Work Rules, Operations, Downsizing, and Compensation Changes Kicking In

4.50

3.99
Unit Operating Cost (¢ per Available Seat Mile)

4.00

3.50

2.95
3.00

2.88
2.50 Labor

2.00 Fuel

1.50

1.00
1.23

0.50

0.00
1990 1992 1994 1996 1998 2000 2002 2004 2Q05 4Q05

© ATA May-06 -- 17
 Low Fares and High Fuel Prices Don’t Mix
An 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

© ATA May-06 -- 18
 Since 2000, Breakeven Load Factor Well Above Actual
Lower Prices, Less Cargo, Higher Costs = More Seats Must be Filled

85
Passenger Load Factor (%)—Majors and Nationals

84.1
Actual Breakeven 82.4
81.4 81.3
80
79.6

76.3
75.4
75
73.7
72.4
71.8
70.8 71.1
70.5 70.0
70
69.4

67.2 69.3

66.0 66.4
65
64.3 64.9 64.9

60
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 YE 3Q05

Source: ATA research

© ATA May-06 -- 19
www.airlines.org