[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]





    CURRENT SITUATION AND FUTURE OUTLOOK OF U.S. COMMERCIAL AIRLINE 
                                INDUSTRY

=======================================================================

                                (109-32)

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                                AVIATION

                                 OF THE

                              COMMITTEE ON
                   TRANSPORTATION AND INFRASTRUCTURE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                           SEPTEMBER 28, 2005

                               __________

                       Printed for the use of the
             Committee on Transportation and Infrastructure


                                 _____

                    U.S. GOVERNMENT PRINTING OFFICE
                           WASHINGTON : 2006 
25-912 PDF

For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512-1800  
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001


             COMMITTEE ON TRANSPORTATION AND INFRASTRUCTURE

                      DON YOUNG, Alaska, Chairman

THOMAS E. PETRI, Wisconsin, Vice-    JAMES L. OBERSTAR, Minnesota
Chair                                NICK J. RAHALL, II, West Virginia
SHERWOOD L. BOEHLERT, New York       PETER A. DeFAZIO, Oregon
HOWARD COBLE, North Carolina         JERRY F. COSTELLO, Illinois
JOHN J. DUNCAN, Jr., Tennessee       ELEANOR HOLMES NORTON, District of 
WAYNE T. GILCHREST, Maryland         Columbia
JOHN L. MICA, Florida                JERROLD NADLER, New York
PETER HOEKSTRA, Michigan             CORRINE BROWN, Florida
VERNON J. EHLERS, Michigan           BOB FILNER, California
SPENCER BACHUS, Alabama              EDDIE BERNICE JOHNSON, Texas
STEVEN C. LaTOURETTE, Ohio           GENE TAYLOR, Mississippi
SUE W. KELLY, New York               JUANITA MILLENDER-McDONALD, 
RICHARD H. BAKER, Louisiana          California
ROBERT W. NEY, Ohio                  ELIJAH E. CUMMINGS, Maryland
FRANK A. LoBIONDO, New Jersey        EARL BLUMENAUER, Oregon
JERRY MORAN, Kansas                  ELLEN O. TAUSCHER, California
GARY G. MILLER, California           BILL PASCRELL, Jr., New Jersey
ROBIN HAYES, North Carolina          LEONARD L. BOSWELL, Iowa
ROB SIMMONS, Connecticut             TIM HOLDEN, Pennsylvania
HENRY E. BROWN, Jr., South Carolina  BRIAN BAIRD, Washington
TIMOTHY V. JOHNSON, Illinois         SHELLEY BERKLEY, Nevada
TODD RUSSELL PLATTS, Pennsylvania    JIM MATHESON, Utah
SAM GRAVES, Missouri                 MICHAEL M. HONDA, California
MARK R. KENNEDY, Minnesota           RICK LARSEN, Washington
BILL SHUSTER, Pennsylvania           MICHAEL E. CAPUANO, Massachusetts
JOHN BOOZMAN, Arkansas               ANTHONY D. WEINER, New York
JIM GERLACH, Pennsylvania            JULIA CARSON, Indiana
MARIO DIAZ-BALART, Florida           TIMOTHY H. BISHOP, New York
JON C. PORTER, Nevada                MICHAEL H. MICHAUD, Maine
TOM OSBORNE, Nebraska                LINCOLN DAVIS, Tennessee
KENNY MARCHANT, Texas                BEN CHANDLER, Kentucky
MICHAEL E. SODREL, Indiana           BRIAN HIGGINS, New York
CHARLES W. DENT, Pennsylvania        RUSS CARNAHAN, Missouri
TED POE, Texas                       ALLYSON Y. SCHWARTZ, Pennsylvania
DAVID G. REICHERT, Washington        JOHN T. SALAZAR, Colorado
CONNIE MACK, Florida                 JOHN BARROW, Georgia
JOHN R. `RANDY' KUHL, Jr., New York
LUIS G. FORTUNO, Puerto Rico
LYNN A. WESTMORELAND, Georgia
CHARLES W. BOUSTANY, Jr., Louisiana
JEAN SCHMIDT, Ohio

                                  (ii)



                        SUBCOMMITTEE ON AVIATION

                    JOHN L. MICA, Florida, Chairman

THOMAS E. PETRI, Wisconsin           JERRY F. COSTELLO, Illinois
HOWARD COBLE, North Carolina         LEONARD L. BOSWELL, Iowa
JOHN J. DUNCAN, Jr., Tennessee       PETER A. DeFAZIO, Oregon
VERNON J. EHLERS, Michigan           ELEANOR HOLMES NORTON, District of 
SPENCER BACHUS, Alabama              Columbia
SUE W. KELLY, New York               CORRINE BROWN, Florida
RICHARD H. BAKER, Louisiana          EDDIE BERNICE JOHNSON, Texas
ROBERT W. NEY, Ohio                  JUANITA MILLENDER-McDONALD, 
FRANK A. LoBIONDO, New Jersey        California
JERRY MORAN, Kansas                  ELLEN O. TAUSCHER, California
ROBIN HAYES, North Carolina          BILL PASCRELL, JR., New Jersey
HENRY E. BROWN, Jr., South Carolina  TIM HOLDEN, Pennsylvania
TIMOTHY V. JOHNSON, Illinois         SHELLEY BERKLEY, Nevada
SAM GRAVES, Missouri                 JIM MATHESON, Utah
MARK R. KENNEDY, Minnesota           MICHAEL M. HONDA, California
JOHN BOOZMAN, Arkansas               RICK LARSEN, Washington
JIM GERLACH, Pennsylvania            MICHAEL E. CAPUANO, Massachusetts
MARIO DIAZ-BALART, Florida           ANTHONY D. WEINER, New York
JON C. PORTER, Nevada                BEN CHANDLER, Kentucky
KENNY MARCHANT, Texas                RUSS CARNAHAN, Missouri
CHARLES W. DENT, Pennsylvania        JOHN T. SALAZAR, Colorado
TED POE, Texas                       NICK J. RAHALL II, West Virginia
JOHN R. `RANDY' KUHL, Jr., New       BOB FILNER, California
York, Vice-Chair                     JAMES L. OBERSTAR, Minnesota
LYNN A. WESTMORELAND, Georgia          (Ex Officio)
DON YOUNG, Alaska
  (Ex Officio)

                                 (iii)

                                CONTENTS

                               TESTIMONY

                                                                   Page
 Baggaley, Philip, Managing Director, Corporate and Government 
  Ratings, Standard and Poor's Ratings Service...................    11
 Kiefer, Mark, Associate Principal, CRA International, Inc.......    11
 Matesanz, Maria, Senior Vice President and Team Leader, 
  Infrastructure Finance Team, Public Finance Group, Moody's 
  Investors Service..............................................    11
 Morrison, Steve, Professor and Chair, Department of Economics, 
  Northeastern University........................................    11
 Sokel, Stuart R., Director, Deutsche Bank Commodities Group.....    11

          PREPARED STATEMENTS SUBMITTED BY MEMBERS OF CONGRESS

Carnahan, Hon. Russ, of Missouri.................................    48
Costello, Hon. Jerry F., of Illinois.............................    49
Oberstar, Hon. James L., of Minnesota............................    70
Porter, Hon. Jon, of Nevada......................................    72

               PREPARED STATEMENTS SUBMITTED BY WITNESSES

 Baggaley, Philip................................................    37
 Kiefer, Mark....................................................    51
 Matesanz, Maria.................................................    58
 Morrison, Steve.................................................    63
 Sokel, Stuart R.................................................    00

                         ADDITION TO THE RECORD

Air Carrier Association of America, Edward P. Faberman, Executive 
  Director, statement............................................    75

 
    CURRENT SITUATION AND FUTURE OUTLOOK OF U.S. COMMERCIAL AIRLINE 
                                INDUSTRY

                              ----------                              


                     Wednesday, September 28, 2005,

        U.S. House of Representatives, Committee on 
            Transportation and Infrastructure, Subcommittee 
            on Aviation, Washington, D.C.
    The committee met, pursuant to notice, at 2:00 p.m., in 
room 2167, Rayburn House Office Building, Hon. John L. Mica 
[chairman of the subcommittee], presiding.
    Mr. Mica. I would like to call this hearing of the House 
Aviation Subcommittee to order.
    Welcome everyone today.
    The topic of today's hearing centers on an important 
subject: the current situation and future outlook of the United 
States commercial airline industry. We only have one panel 
today so I am going to let the panelists go a little bit longer 
and talk about eight minutes. We have assembled hopefully some 
of our Country's best minds on the subject and we will hear 
what the professionals have to say.
    The order of business will be opening statements by 
members. I will start and then we will hear from the panelists.
    I do have a request. We have Ms. Schmidt, a member who has 
requested to participate in our hearings. The normal procedure 
is I will ask for unanimous consent for you to participate and 
in doing so, also you will be the last to be heard or last to 
offer questions. So, welcome. I ask unanimous consent to allow 
Ms. Schmidt to participate in today's hearing.
    Mr. Costello. Without objection.
    Mr. Mica. So ordered. Thank you and welcome.
    We will start with my opening statement. Today's hearing 
will focus on the current situation and future outlook of the 
United States commercial airline industry. Looming changes in 
our Federal bankruptcy law and fuel prices helped send Delta 
and Northwest into bankruptcy earlier this month. 
Unfortunately, this is just the tip of an iceberg of challenges 
that America's airline industry has experienced over the past 
four years.
    The airline industry in the United States lost some $32 
billion during this time period and it may face an additional 
$9-$10 billion loss which is projected for this year, 2005. An 
economic slowdown, declining business travel, increased 
competition from low cost carriers, the 9/11 terrorist attacks, 
the SARS epidemic and rising fuel costs have all contributed to 
the industry's unprecedented losses. After surviving all of 
these challenges, despite these great obstacles, in the last 
quarter, American, Continental, United and several discount 
carriers reported small operating profits.
    Until yesterday, when US Airways emerged from bankruptcy to 
merge with America West, almost half the capacity of the 
airline industry was flying in bankruptcy. Most legacy carriers 
have made cuts in labor, operational and also their 
administrative costs. Unfortunately, their only other option to 
bring about further reforms has been bankruptcy.
    While the airline industry is no stranger to bankruptcy, 
having so many major carriers in bankruptcy certainly does get 
everyone's attention and it has. Historically, airlines have 
failed at a much higher rate than most other types of 
businesses. The airline industry has the worst financial 
performance of any of our major business sectors. While the 
industry has enjoyed some profitable years, airline operators 
as a whole have lost money since deregulation in 1978.
    This instability has been attributed to the highly cyclical 
demand for air travel as well as the structure of the industry, 
which has very high fixed costs and few barriers to entry. Some 
argue that the industry's current problem is over-capacity and 
the bankruptcies, to the extent that they reduce capacity, will 
help solve the problem. While such capacity reductions may 
offer temporary relief, history has shown that the growth of 
airline industry capacity has continued unaffected even by 
major liquidations.
    According to the Government Accountability Office, only 
recessions, which curtail the demand for air travel, and the 
September 11 terrorist attacks appear to have caused the 
airline industry to reduce its capacity. This indicates that 
other airlines quickly replenish capacity to meet demand. Low 
cost carriers, in particular, are continuing to take delivery 
of new aircraft and expand their capacity. For example, 
Southwest Airlines continues to grow at an 8 to 10 percent 
annual rate and Jet Blue at almost 30 percent annually. In 
addition, there are 17 new entrant airlines currently awaiting 
certification by the Department of Transportation.
    One bright spot for legacy carriers is the continued 
profitability of international routes where there is less 
competition from low cost carriers. In adjusting to their new 
economic realities, legacy carriers have made flying abroad a 
priority and sometimes they shift aircraft from domestic to 
international flights and start new service to foreign 
destinations as we have seen. For example, Delta's plan for 
recovery included reducing mainline capacity by 15 to 20 
percent and increasing their international flying by 25 
percent.
    Under President Bush, negotiators from the Department State 
and Transportation have reached agreements with countries such 
as India, Vietnam and Mexico as well as others to open 
international routes to U.S. carriers. These efforts are 
important and hopefully will be of assistance to our legacy 
carriers.
    The airlines' financial woes may also impact our airports. 
Sometimes their financial problems do go beyond just the legacy 
carriers. Airports that serve as secondary hubs for financially 
weak airlines are particularly at risk because reductions in 
connecting passenger traffic can end up leaving a void too 
large for other carriers to fill. For example, flight schedules 
have been reduced by US Airways at its Pittsburgh hub and more 
recently by Delta at its Cincinnati/Northern Kentucky hub, 
leaving these airports with decreased revenues.
    An airline's withdrawal from a hub can also leave an 
airport over-extended relative to its remaining passenger and 
revenue base. They take on pretty significant obligations and 
we see the results for these airports. For example, when US 
Airways withdrew from Pittsburgh, that airport was left with a 
financial responsibility for the new terminal building that it 
had built specifically for US Airways operations. In addition, 
Fitch Ratings recently revised its outlooks for the Detroit, 
Minneapolis and Memphis Airport bond ratings from stable to 
negative based on their concerns that the risk to financing at 
those airports may increase during Northwest's bankruptcy.
    I think this also poses an issue for this Subcommittee and 
our efforts to improve infrastructure at various airports 
across the United States and we are putting hundreds of 
millions and some billions of dollars in improving the 
facilities and airports themselves. This does raise some 
serious issues that our Subcommittee needs to address.
    For our hearing today, we have assembled a panel of airline 
industry, financial experts and academic professionals. I look 
forward to hearing the views of our witnesses. We don't have 
any associations here. I do welcome any associations that want 
to submit for the record. We will leave the record open for a 
period of two weeks so they may submit commentary on this 
important hearing and their recommendations.
    With those lengthy but necessary comments and caveats, I 
would now recognize the outstanding Ranking Member of this 
subcommittee, the gentleman from Illinois, Mr. Costello.
    Mr. Costello. Mr. Chairman, thank you and thank you for 
calling this hearing today. I also welcome the witnesses that 
are here. I will submit my statement for the record and 
summarize it.
    As you indicated, since the terrorist attacks of 2001, we 
have seen the airline industry lose about $32 billion, 
staggering fuel prices, thousands of people have lost their 
pensions and health care and in the last two weeks, Northwest 
and Delta both have filed bankruptcy. I have no doubt that 
thousands more will lose their pensions and health care in this 
coming round of the bankruptcies that were just filed. With 
close to 50 percent of our domestic aviation capacity in 
bankruptcy up until yesterday, we need a frank assessment of 
the short and long term condition of the industry.
    It is difficult to gauge how much the industry's current 
conditions can be attributed to September 11. We all know that 
legacy carriers were in trouble before September 11. The legacy 
carriers, in my judgment, failed to adjust their business plans 
to economic trends that began long before September 11, 
including business models that depended on extracting a premium 
fare from business travelers.
    In fact, the premium fare for business travelers amounted 
to a significant amount of revenue for the legacy carriers. 
When the economy started to tighten in 2000, the business 
traveler shifted and went from the legacy carriers to the low 
cost airlines. Indeed, low cost carriers are a significant 
force in the aviation industry today with a combined domestic 
Origin and Destination (O&D) market share of about 30 percent 
up from 23 percent just a few years ago.
    In addition, the aviation industry and the Nation as a 
whole is faced with record high fuel cost which has stymied 
growth. According to the ATA, the Air Transport Association, 
the industry's jet fuel expenses could increase by $9.2 billion 
in 2005 alone. The ATA also projects industry-wide net losses 
this year of approximately $9-$10 billion.
    Some have suggested ways to save the airline industry. ATA 
has called for a repeal or the suspension of certain taxes and 
fees, a move, in my opinion, that would wreak havoc on our 
Aviation Trust Fund and does not take into account the fact 
that other modes of transportation and consumers are also 
suffering from high fuel prices. In fact, the amount paid in 
fuel taxes for 2005 is expected to be $600 million, well short 
of the $10 billion projected net industry losses. We should not 
make such policy decisions in a vacuum.
    Some current and former airline CEOs and others have 
suggested other ways to save the industry. Robert Crandall, the 
former Chairman of American Airlines, wrote an op ed recently 
in the Wall Street Journal suggesting that the bankruptcy laws 
need to be changed. He suggested, ``You say, look, if you fail, 
you liquidate.''
    In addition, Mr. Crandall and others have suggested that we 
have too much capacity in the system. Crandall states, ``The 
capacity never comes out. It takes all the guys that haven't 
gone bankrupt and drives them into bankruptcy.'' He and others 
have suggested that in addition to changing the bankruptcy 
laws, we should remove perceived barriers to consolidation. In 
fact, ATA agrees that consolidation and capacity reductions are 
needed. Yet, it is still not clear to me that any one of these 
proposals or all of them together will provide the much needed 
fix for this ailing industry.
    I hope that our witnesses today will address those issues. 
In addition, I hope that the witnesses will talk to us about 
what this subcommittee or what the Congress should be doing in 
the future for the industry. When we get into questions, I will 
be interested in knowing not only how you feel about the 
proposal from ATA about the temporary suspension of the fuel 
tax, about the capacity issue and also interested in knowing if 
the Congress did nothing substantial for the industry, what 
would happen in the long and short term.
    Last, in addressing all of these issues, the suspension of 
the current fees and taxes, current bankruptcy laws and 
capacity issue, I hope to hear what solutions you provide and 
will suggest to this subcommittee.
    Mr. Chairman, again, I appreciate you calling this hearing. 
I welcome the witnesses and look forward to hearing from them.
    Mr. Mica. I thank the gentleman.
    Mr. Coble?
    Mr. Coble. Thank you, Mr. Chairman. I will not take the 
five minutes.
    I commend you and the gentleman from Illinois for having 
scheduled this hearing and express appreciation to the 
panelists for their attendance.
    The future outlook of the United States commercial airline 
industry is an area of our commerce that needs thorough 
examination. I like to avoid use of the word ``crisis'' because 
it is so obviously laced with pessimism. There are many people 
and colleagues who believe that the U.S. commercial airline 
industry is standing in the shadow of a critical situation.
    Someone said to me the other day airports are what bus 
stations were four decades ago, 45 years ago. By that, I think 
he meant the obvious overcrowding, wall to wall people. 
Oftentimes when you go to an airport today, and I am not 
pointing accusatory fingers at anyone, but a cancellation or a 
delay in flight almost becomes the rule rather than the 
exception.
    I appreciate your scheduling this, as I said, because we 
need to examine this before it does become a crisis.
    I yield, Mr. Chairman.
    Mr. Mica. I thank the gentleman.
    Ms. Norton?
    Ms. Norton. Thank you, Mr. Chairman, for trying to stay 
ahead of the curve on the airlines and it is very difficult to 
do but I appreciate the hearings, and this is not the first, on 
the state of our commercial airline industry. It is kind of 
like a physical exam, only the airline industry has had to take 
these physical exams often.
    When two major airlines, not the ones most traditionally 
troubled, now find themselves in bankruptcy, it is very hard to 
know where to go from here or what to think of the industry as 
a whole. This much we know. This industry, even more than every 
other industry in the Country as a whole, did not need two 
hurricanes, Katrina and Rita, and especially not Rita which has 
put very special pressure on all of our resources, gas and fuel 
resources.
    I am concerned that the fuel crisis which does not seem to 
abate is putting great pressure even on the lower cost 
airlines. You remember at our last hearing there was particular 
interest in whether all of them would become low cost and maybe 
somehow the industry would be saved that way. I heard the 
President say people should not take trips they don't need to 
take. Of course the airline industry wants you to take as many 
trips as you can.
    It is one indication of how the airline industry, every 
economic change appears to negatively affect the airline 
industry. Conservation, for example, does not appear to be any 
kind of solution there, although there is much to be said for 
why the Country ought to have an explicit conservation policy 
which might then free up some energy for industries like our 
airline industry which certainly can't do that.
    I just think we need to talk to folks out there and notice 
that these are not Government witnesses, so that we can get the 
best information and the best thinking we can at this time.
    Again, I thank you, Mr. Chairman, and yield back.
    Mr. Mica. I thank you.
    Mr. Ehlers?
    Mr. Ehlers. Thank you, Mr. Chairman, and thank you for 
having this hearing.
    I would just like to comment. Everyone knows the airlines 
are in trouble and are having serious problems. It is perhaps 
no an appropriate business model as it has been traditionally 
practiced, but I encourage us also to look on the positive side 
and what a tremendously positive impact the airline industry 
has had upon this Nation over the past half century.
    I recall my first flight in a jet airplane, a 707, in the 
late 1950s, early 1960s, and that was an incredible experience. 
Little did I realize that the first of over a million miles of 
travel I would perform on jet airplanes. It has transformed 
American life, it has brought families closer together with 
more frequent visits, it has changed the very nature of the 
Congress.
    When I first took office, one of my predecessors, former 
President Ford, commented to me that when he was elected in 
1948, he moved to Washington with his family and they went home 
twice a year, the August recess and the Christmas recess. 
Today, most members of Congress go back to their districts 
every week and have maintained much closer ties with the public 
and I think have been much more responsive to the public as a 
result of that.
    Air travel has been a very positive thing for the 
integration of this Nation, of bringing people together, 
developing better understanding and we have to make sure 
whatever we do as we discuss these issues we recognize what a 
strong, positive effect that has been and that we work together 
to maintain a strong airline industry which can continue to 
keep the bonds of our Nation firm, but not only that, but give 
us opportunity to visit other lands frequently and become 
better acquainted with other countries and therefore, make us a 
better country in dealing with the problems of the world.
    I yield back the balance of my time.
    Mr. Mica. I thank the gentleman.
    Mr. DeFazio?
    Mr. DeFazio. Thank you, Mr. Chairman. Thank you for the 
timely hearing on this issue.
    My goal in debating this issue over the years has been to 
see that we continue to have a system of universal air 
transport which serves not only major hubs or profit centers in 
the United States' large urban areas, but also medium and 
smaller sized cities. I am concerned about whether continuing 
total deregulation, a hands-off attitude with perhaps some 
liquidations in the industry of so-called legacy carriers, is 
going to provide that sort of service to the traveling public, 
not only to leisure travelers who seem to be the target model 
of many airlines, but to the business travelers.
    We are moving toward a very inefficient system where more 
and more corporate travel is being done on fractional 
ownership. I was riding with a fellow from a not particularly 
large company out of Eugene last week, crammed into a 50 seater 
from Phoenix to Eugene. He was waxing about how as soon as they 
could justify it on the books, which he thought would be real 
soon, they were buying a private jet.
    So it is that desire to drive out all the people who used 
to pay or were willing to pay a premium for access to that kind 
of a system and just run a low budget system which may or may 
not have international links of any good significance for 
leisure travelers who don't quite pay for their cost of 
transport. That doesn't seem like a sustainable model.
    There are other issues raised or touched on by the 
testimony. It seems that the so-called rents attributable to 
the refiners have tripled in a year. That is interesting. 
People are wondering why is jet fuel so expensive. Well, 
because our refinery capacity has been squeezed down to the 
point where it is just about adequate to demand and the 
slightest burp allows an Exxon-like jacking up of the prices 
saying oh, my gosh, we just can't meet the demand, we will have 
to jack up prices. The head of the largest refinery in America, 
Valero, said the system was working real well for them. Their 
stock is up 263 percent a year.
    We want to blame the environmentalists and the regulatory 
system. It wasn't the environmentalists or the regulatory 
system. It was the lack of a regulatory system that allowed the 
mergers, the closures and the downgrading in refining capacity 
and nothing has been built. Even when George Bush offered to 
make military bases available with no environmental 
restrictions, the industry said no, we are not really 
interested. We are doing well where we are. So we have to look 
at those sorts of things.
    I am concerned about the idea that somehow we should let 
the market squeeze and squeeze and squeeze and squeeze until we 
get all the costs out of the system. I think the recent Jet 
Blue incident points to the problems there when planes are 
maintained in El Salvador by people who may or may not be 
qualified mechanics, who may or may not be using approved 
parts, who may or may not be enlisted in terrorist networks 
because we can save money by maintaining planes in El Salvador. 
Meanwhile, mechanics here are put out of work who are doing a 
good job, who were regulated, who were overseen, that is good 
for the system. That is squeezing out the inefficiencies.
    That is pretty essential, your plane can land and you will 
live, your plane can't land and you won't live. Most Americans 
are willing to pay a slight bit more to know their pilot and 
the mechanic are trained and qualified and the plane doesn't 
have unapproved parts on it.
    I am concerned about how we are squeezing and pushing the 
system. I am not sure that cutthroat competition will give us 
the service the American people need, particularly many small 
and medium sized cities, and it is not going to give us the 
safety that we need, particularly with an Administration that 
is so derogatory of government and regulation that led us to 
the point where we no longer even have a functional Federal 
Emergency Management Agency let alone an FAA that has enough 
people to oversee the maintenance work being farmed out more 
and more.
    I think there are a lot of questions raised by this model 
and I hope the panel can respond to some of these points and 
tell us why it is so great that most carriers are flying full 
and still losing money.
    Thank you, Mr. Chairman.
    Mr. Mica. I thank the gentleman.
    Mr. Ney?
    Mr. Ney. Thank you, Mr. Chairman and the Ranking Member. I 
will be brief.
    I want to thank you for the hearing. I think it is 
important. The airline industry is important. We have seen that 
through Katrina. I have to credit the brave pilots of Jet Blue 
last week and the plane they safely landed with 140 people on 
there.
    Also mentioned before were the bankruptcies and an issue I 
would like to know about is if some of the bankruptcies occur, 
what happens with the pensions versus those who didn't go into 
bankruptcy. Is there a level playing field? Does that have 
future repercussions? I think that is important.
    Also the airlines are being asked to have cost saving 
measures or to increase customer service which I know they want 
to do, I still think that has to be analyzed. There are delays, 
baggage lost. On a personal note, and I am not going to say the 
airlines but I will take it up privately, but our office books 
my flights through CATO, the service we have, and then I had to 
change it so I called myself and had a lengthy conversation, 
about 20-25 minutes.
    I arrived at the airport where they asked me to produce my 
employee ID because I was booked employee rate. Thank goodness 
I didn't accidentally travel on employee rate, and that would 
have given people things to look at of, how did you get the 
employee rate traveling to Washington. I didn't have an 
employee badge, obviously, and then I asked, where did I call. 
I can't remember whether it was India or Ecuador but I called 
somewhere overseas. The past couple of times I have called 
there.
    If you talk to the employees, they will tell you that this 
may be cost saving to outsource to India or Ecuador or wherever 
it was outsourced to but at the end of the day, they said there 
are hundreds of mistakes they see coming in as a result of this 
outsourcing.
    I would like to know has anybody ever looked, in the quest 
to save money, does outsourcing overseas come back to haunt the 
very airlines that are trying to save money? I don't know if 
small issues like that are looked at or not but I think it 
should be because saving a dollar but costing the airlines a 
lot may not be good for them.
    Again, would the bankruptcies result in reduction in 
services, cities served and the fate of the thousands of 
airline employees? I think it is a topic of utmost importance 
to the citizens of the United States.
    Again, I want to thank the Chair and the Ranking Member for 
the hearing.
    Mr. Mica. I thank the gentleman.
    Ms. Millender-McDonald?
    Ms. Millender-McDonald. Thank you, Mr. Chairman and the 
Ranking Member, for holding this very important hearing.
    I would like to say to the committee, Mr. Ehlers, a 
physicist, after his positive stand on this hearing today, it 
was very enlightening, however, the issues facing the U.S. 
airline industry are indicative of the challenges that face all 
of us. Many of the issues that we will be discussing today, 
hopefully, will be issues confronting our national economy in 
some capacity and that would be pension reform, bankruptcy 
reform, rising fuel costs and a changing and evolving 
marketplace.
    So I would like to commend our leaders, both the Chairman 
and the Ranking Member, today for putting in front of us such a 
distinguished and focused panel. The panelists before us now 
are not industry representatives, but I am told from leading 
financial institutions that offer an outside perspective with 
an investor's eye, and that is good.
    As we prepare to reauthorize the aviation bill, this 
hearing is an excellent first step and I commend the Chairman 
and the Ranking Member and look forward to hearing from these 
experts on what the next step for the airline industry could 
be. Of course I would like to know what the impact of the most 
recent wave of bankruptcies will have on the airline industry 
as a whole, to what point it will bring us and there are 
arguments made that major network carriers are unprofitable now 
because their business models are no longer functional.
    These are some of the issues that I would like to hear from 
you regarding our airline industry. As the Chairman and the 
Ranking Member have stated, the industry has lost over $32 
billion and it is projected they will lose an additional $9 
billion to $10 billion. This is astounding. We do understand 
our airline industry is flying in bankruptcy, so it is not a 
healthy industry.
    I look forward to hearing from all of you today, outside of 
the bronchitis that I have. Thank you, Mr. Chairman and Ranking 
Member.
    Mr. Mica. Thank you.
    Mr. Kennedy?
    Mr. Kennedy. Mr. Chairman, Ranking Member, I want to thank 
you for holding this hearing today and I want to thank all the 
witnesses for attending.
    We are currently experiencing a time of financial crisis 
with the commercial airline industry. As a representative from 
Minnesota's Sixth District, this concerns me. As you know, 
Northwest Airlines based in my home State of Minnesota declared 
bankruptcy two weeks ago. The airline industry is an enormous 
economic engine in Minnesota. Northwest Airlines represents 
approximately 80 percent of the flights to of the Minneapolis-
St. Paul Airport, they employ thousands of Minnesotans and tens 
of millions of passengers fly into and out of Minnesota each 
year.
    The pensions of tens of thousands of Minnesotans are 
foremost on my mind. Over the past four years, U.S. commercial 
airlines have lost over $32 billion collectively and it is 
estimated that the industry will experience another $10 billion 
in loss in 2005.
    We all know that skyrocketing fuel prices have become a 
burden on everybody, individuals, families and businesses. 
Northwest Airlines is no exception. In 2003, Northwest spent 
$1.6 billion on fuel. It is estimated that the airline will 
spend $3.3 billion on fuel in 2005. When fuel costs are 
combined with the climbing cost of pension plans, the results 
are a perfect storm. Over the next three years, Northwest must 
contribute $3.3 billion to its pensions plans in order to meet 
their obligations. The airline has already missed a $65 million 
payment to the fund.
    Northwest is only the latest of a string of airlines which 
have sought bankruptcy protection for these same reasons. 
United Airlines and USAir's decisions to terminate their 
pension plans gave those airlines an enormous competitive 
advantage as they plot to emerge from bankruptcy protection. 
United's shortfall of $9.8 billion and USAir's shifting of 
further billions in liabilities not only puts the Pension 
Benefit Guarantee Corporation at risk, but cuts the guaranteed 
benefits for thousands of employees and retirees. Statistics 
like this explain why until yesterday almost half the capacity 
of U.S. airlines is flying under bankruptcy protection.
    Mr. Chairman, we must continue to work with the airline 
industry, its workers and retirees to find solutions to this 
crisis. I look forward to the testimony of the witnesses today 
and I am hopeful that we can determine how to go forward to 
protect the ticket buying public, workers, retirees and the 
airline industry as a whole.
    I yield back the balance of my time.
    Mr. Mica. Thank you.
    Any other members of the Subcommittee seek recognition? If 
no other members of the Subcommittee seek recognition, we will 
recognize Ms. Schmidt from Ohio.
    Ms. Schmidt. Thank you, Mr. Chairman, for allowing me to 
participate in this important review and outlook of our 
Nation's commercial airline industry.
    I know I am not the only member of Congress with 
constituents who have been directly affected by the serious 
difficulties facing many of our commercial airlines. Delta 
Airlines, which filed for Chapter 11 bankruptcy on September 
14, has its second largest hub in my local area at the 
Cincinnati-Northern Kentucky International Airport.
    According to a 2005 study by the University of Cincinnati, 
the airport contributes $4.52 billion annually to the Ohio-
Kentucky-Indiana tri-state economy and supports more than 
55,000 jobs through the region. Delta accounts for about 83 
percent of the passengers at the airport annually.
    When I was sworn in on September 6, I was notified by Delta 
of its intention to accelerate its overall transformation plan 
which includes realignment of Delta and its subsidiary, 
ComAir's services at the Cincinnati-Northern Kentucky 
International Airport. Locally, this will result in the loss of 
nearly 1,100 jobs in my area. A week later, as I mentioned, 
Delta and its subsidiaries filed for Chapter 11 bankruptcy.
    I am a strong believer in competition and free enterprise. 
I am also concerned at what appears to be difficult economic 
conditions including pension costs and the rising cost of fuel 
that confront virtually every airline in our Nation. A vibrant, 
safe and reliable airline industry is vitally important to our 
Country.
    I look forward to learning more about the outlook of our 
airlines at today's hearing.
    On a personal note, as I flew up here yesterday morning, 
one of the flight attendants came to me and thanked me for 
serving and said that she loved working with Delta, was willing 
to take another pay cut in order to keep her job and was very, 
very worried about her pension, and asked for my consideration 
on that. I am just bringing that to this committee's attention.
    Thank you once again, Mr. Chairman, for the opportunity to 
participate and for holding this most important hearing.
    Mr. Mica. I thank the gentlelady.
    If there are no further opening statements, we will 
recognize our panel of witnesses today. As I said, we have 
assembled some of hopefully the Country's leading experts on 
this topic. We have Mr. Mark Kiefer, Associate Principal, CRA 
International, Inc.; Mr. Philip Baggaley, Managing Director, 
Corporate and Government Ratings, Standard and Poor's Ratings 
Service; Mr. Steve Morrison, Professor and Chair, Department of 
Economics, Northeastern University; Mr. Stuart R. Sokel, 
Director, Deutsche Bank Commodities Group and Ms. Maria 
Matesanz, Senior Vice President and Team Leader, Infrastructure 
Finance Team, Public Finance Group, Moody's Investors Service. 
Welcome to all of you.
    As I said, normally we go five minutes. We won't run the 
clock in the normal fashion. We will let you go seven or eight 
minutes. We want to leave time for questions. We will start 
with Mr. Mark Kiefer of CRA International, Inc. Welcome and you 
are recognized.

      TESTIMONY OF MARK KIEFER, ASSOCIATE PRINCIPAL, CRA 
   INTERNATIONAL, INC.; PHILIP BAGGALEY, MANAGING DIRECTOR, 
 CORPORATE AND GOVERNMENT RATINGS, STANDARD AND POOR'S RATINGS 
  SERVICE; STEVE MORRISON, PROFESSOR AND CHAIR, DEPARTMENT OF 
ECONOMICS, NORTHEASTERN UNIVERSITY; STUART R. SOKEL, DIRECTOR, 
  DEUTSCHE BANK COMMODITIES GROUP; AND MARIA MATESANZ, SENIOR 
 VICE PRESIDENT AND TEAM LEADER, INFRASTRUCTURE FINANCE TEAM, 
        PUBLIC FINANCE GROUP, MOODY'S INVESTORS SERVICE

    Mr. Kiefer. Thank you, for the opportunity to appear before 
you today to hear my comments on this very important subject.
    I have a Power Point presentation for you although I would 
ask that my prepared statement be made a part of the record.
    Mr. Mica. Without objection, the entire statement will be 
made a part of the record.
    Mr. Kiefer. I will speak directly to the issues that 
brought us all here today, namely the current situation facing 
the U.S. commercial airline industry, the impact of the recent 
bankruptcies and high fuel costs, and also the outlook for the 
future of this industry.
    I do believe it is fair to characterize the current 
situation in this industry as the greatest crisis it has faced 
in its nearly 100 year history. We have heard from several 
members of the Subcommittee the number, $32 billion in losses 
since 2000 and I agree with the assessment, that loss is 
expected to reach $40 billion by the end of this year.
    At the same time, the millions of shareholders among the 
American public that own these publicly traded companies have 
experienced over $24 billion in losses in the market value 
because of the steep declines in the prices of their shares. We 
have also heard that five of the ten largest airlines in the 
industry have entered Chapter 11 to this point since the year 
2000.
    At the same time, well over 100,000 jobs have been lost in 
this industry since that time and just recently, in concert 
with their announced bankruptcies, Delta and Northwest have 
announced the likelihood of additional layoffs. Pay and 
benefits have been cut very substantially. You may recall 
before their bankruptcy, Delta pilots negotiated pay cuts of 
over one-third, and significant cuts in benefits. The failure 
of the pensions at United and USAirways have resulted in the 
largest pension default in U.S. history. Those airlines that 
continue to have pension plans now have unfunded liabilities of 
over $14 billion.
    The effect of this crisis is felt not just in the airline 
industry itself, but in other sectors of the economy. Those 
institutions engaged in aircraft finance are having to accept 
less favorable terms just to have any business from the airline 
industry, aircraft manufacturers and parts suppliers are facing 
canceled or foregone orders or delayed orders for their 
equipment, and as mentioned, the current environment has caused 
a potential funding shortfall in supporting the FAA and its 
infrastructure because that system is funded through taxes and 
fees paid by the carriers, a large portion of which are based 
on air fares.
    Not all of the news is bad. I would share the optimism of 
Mr. Coble in this regard. The low cost carriers are very 
profitable and growing. Southwest has had 57 consecutive 
quarters of profit, Jet Blue has had 18. They have weathered 
this storm remarkably. In fact, the resulting low fare 
environment has produced tremendous benefits to consumers 
because they are paying lower prices as a result.
    I would like to talk a bit about how we got here and add to 
the comments that have gone before. I think there are three 
basic factors that have contributed to the current situation. 
Business travel has undergone a fundamental reorientation since 
2000. At that time, a weakening economy had already begun to 
dampen travel and business travelers were becoming increasingly 
intolerant of very expensive tickets.
    After September 11, 2001, there was a disproportionate drop 
in business travel as many corporate travel departments 
restricted travel altogether. As a result, there is much more 
cost consciousness among the traveling public but among 
business travelers as well.
    We have heard there have been an unprecedented combination 
of challenges that have buffeted the industry since the year 
2000, the economic slowdown, the events of September 11, the 
outbreak of SARS, the war in Iraq and the dramatic increase in 
fuel prices now at a historic high at least in nominal terms.
    At the same time, advances in technology have reshaped the 
demand for travel. Improvements in teleconferencing and related 
facilities have made it less necessary for business people to 
travel. At the same time, the growth in online ticket sales has 
created much greater, really unprecedented price transparency 
so that business travelers are more easily able to seek and 
find lower cost alternatives to the traditional legacy carrier 
business model of charging much higher fares. At present, low 
fares are not the exception but really the rule.
    The other important contributing factor in that regard is 
that low cost carriers have become an integral and significant 
part of the industry. Their market share has almost tripled in 
the last ten years and is expected to constitute about one-
fourth of the domestic industry by the end of this year.
    The largest domestic airline in the United States is 
Southwest Airlines at this point. Jet Blue and Air Tran are now 
classified as major carriers by the Department of 
Transportation, earning more than $1 billion in annual revenue. 
Most of the cities served by legacy carriers are served by at 
least one low cost carrier. At the same time, legacy fare 
carriers face low cost competition in most of their city fare 
markets.
    As a result of this significant market penetration, low 
cost carriers are now able to dictate price in many markets. It 
is important to point out the low cost carrier business model 
is not really predicated so much on low cost, but on low fares. 
These carriers were designed from the beginning to charge low 
prices and their low cost structure is a result of that 
imperative.
    At the low cost carrier prices, legacy carriers simply 
cannot make money with their higher cost structure. The chart 
you see before you reflects a measure of the operating 
profitability of Southwest and Jet Blue compared to the major 
legacy carriers. You can see in the last calendar year, there 
was a remarkable difference in that regard.
    I would submit to you that deregulation of the industry in 
1978 has finally caught up as it were with the legacy carriers. 
The legacy carrier cost structure is even today to a 
significant extent, a remnant of the regulated era where routes 
and fares were regulated by the Civil Aeronautics Board and in 
effect, cost increases could be passed on to customers through 
higher fares. This made possible higher wages and lucrative 
benefits such as pension plans. In effect, there was to some 
extent a disincentive to reduce costs because the profits were 
in effect a function of costs.
    Until recently, legacy carriers faced only limited price 
and route competition on a national scale. The legacy carriers 
competed mostly with other legacy carriers and hub dominance 
and limited competition for nonstop service are a feature of 
the hub and spoke networks that the legacy carriers employ. In 
the current market environment, the high labor costs which were 
possible under the regulated environment have become 
unsustainable such that the unfunded pension liabilities now 
exceed $14 billion.
    You can see from this chart just how much they have grown 
in the last four years. That is a reflection in part of the 
poor investment performance of these plans. At the same time, 
the rising cost of health care, which we have talked and heard 
so much about, has produced large unfunded liabilities in the 
post-retirement insurance benefits offered by many of the 
legacy carriers.
    I would submit that conversely, low cost carriers are 
ostensibly post-deregulation carriers. They have been designed 
from the ground up to compete on price and their cost structure 
is fundamentally different, fundamentally lower and their 
operating model likewise is designed for low cost.
    I would quickly add that I think with respect to the impact 
of the recent bankruptcies, I think we will see further wage 
reductions at Delta and Northwest, elimination of the pension 
plans are likely. Going forward, I think the other legacy 
carriers that have not yet gone into bankruptcy will have no 
choice but to eliminate their pension plans as well should 
Delta and Northwest do so.
    I think the low cost carriers are indeed vulnerable because 
of higher fuel prices but finally, I would say new aircraft on 
the horizon promise greater increases in fuel efficiency and 
significant growth in air travel is forecast which I think will 
return this industry to financial health in the long term. I 
think the prospects are very good in the long term.
    Thank you very much for the opportunity to appear before 
you today.
    Mr. Mica. Thank you.
    We will wait until we have heard from all the panelists to 
start questions.
    Mr. Baggaley with Standard and Poor's Ratings Services, 
welcome, and you are recognized.
    Mr. Baggaley. Thank you.
    Good afternoon. Thank you for the opportunity to testify 
today.
    I am the Managing Director with Standard and Poor's Ratings 
Services and Senior Credit Analyst for the airline industry. 
Please see my written testimony which I ask be included in the 
record.
    Mr. Mica. Without objection, so ordered.
    Mr. Baggaley. This afternoon I hope to provide some 
perspective on the airline industry's problems by addressing 
three related topics: first, what are the principal causes of 
the U.S. airlines' current financial problems; second, how are 
airlines responding to that situation; and third, what broader 
changes might improve the industry's prospects.
    First, why are most airlines reporting losses and bleeding 
cash in a strong economic environment? Numerous factors have 
contributed to the problem and Mr. Kiefer mentioned some of 
them. I would say that three stand out in the current 
environment: very high jet fuel prices, intense price 
competition in the domestic market; and heavy debt and pension 
burdens.
    Fuel prices are the most serious concern at the moment. Oil 
prices have increased sharply over the past year and the future 
outlook is for an extended period of high prices. Added to that 
is limited refining capacity which has widened the normal price 
difference between oil and jet fuel. Exhibit 1 of my written 
testimony shows the movement of oil and jet fuel prices this 
year with the levels of January 1st set to equal 100. You can 
see the heavier line, jet fuel prices, jump above the lighter 
crude oil line over the past month due to damage to refineries 
in the wake of Hurricane Katrina.
    The Air Transport Association estimated recently that the 
U.S. airlines will spend $30.6 billion on fuel in 2005 compared 
to $21.4 billion in 2004 and double 2003's $15.2 billion. These 
and other years are shown in my Exhibit 2.
    Even low cost airlines are under pressure. Southwest 
Airlines would be operating around break even without its fuel 
hedges and Jet Blue recently warned that it could report 
losses. Standard and Poor's last week placed our ratings on Jet 
Blue on credit watch for a possible down grade.
    Most airlines don't have the credit profile that would 
allow them to hedge fuel prices without putting up cash 
collateral, thereby depleting their reserves of cash. In any 
case, hedges cannot undo current price levels, only protect 
against further increases. Airlines are trying to raise fares 
in response. However, unlike railroads, trucking companies and 
shipping lines, airlines don't have corporate contracts that 
allow for automatic fuel surcharges. Rather, they must try to 
raise fares, a move that requires all the major players to go 
along or the attempted fare increase will fail.
    The second major cause of the airlines' financial problems 
is intense price competition, particularly in the domestic 
market. Exhibit 3 in my remarks shows domestic yield and 
revenue per available seat mile. Both measures turned sharply 
downwards starting in 2001 and have improved little despite 
several years of economic recovery. The rapid spread of low 
cost airlines and excess seat capacity have prolonged the 
pricing weakness.
    Over the past year, airlines have managed to raise their 
fares somewhat in response to high fuel costs. However, if high 
oil prices cause the U.S. economy to slow, that momentum 
towards higher fares will likely stall.
    The third big financial problem for the airlines currently 
is debt and pension deficits. Airlines tend to operate at 
higher leverage than manufacturing companies even in the best 
of times. Starting in 2001, the legacy carriers had to borrow 
heavily to fund losses and maintain adequate cash reserves even 
with Federal aid. On top of that, pension plans that were fully 
funded in the stock market boom of the late 1990s fell into 
deficits when share prices and interest rates fell. Exhibit 4 
in my remarks shows the effect for Delta Airlines.
    What have airlines been doing in response to all these 
problems? First, airline employees have been asked to take 
substantial pay cuts, trim their benefits and in some cases, 
lose their jobs. Exhibit 5 in my remarks shows broad expense 
categories for AMR, parent of American Airlines, in 2002 and in 
the second quarter of 2005. Over that period labor costs 
declined from 41 percent of total expenses to 32 percent. 
Exhibit 6 shows the dollar value of the labor concessions and 
of significant other cost initiatives and the large negative 
effect of higher fuel costs that offset much of that progress.
    The final question that I posed at the outset of my remarks 
is perhaps the most important one. Are there broader trends or 
changes that could provide an answer to the industry's 
financial problems? I will consider three such possibilities: 
bankruptcies, mergers and reductions in capacity. Obviously, 
bankruptcy signals financial failure but it also gives an 
airline tools to correct that situation. Exhibit 7 shows 
selected financial data for United Airlines in 2002 when they 
entered bankruptcy and from the forecast in their 
reorganization plan.
    Three items are shown. First, there is some reduction in 
debt, mostly through canceling unsecured obligations. The scope 
for cutting secured debt and leases is rather less unless 
United wants to turn back planes to their creditors, some of 
which they have done. Second, the pension deficit was 
eliminated by terminating the defined benefit plans. Lastly, 
United's forecast shows much lower labor costs by 2006. 
Bankruptcy makes it easier for an airline to secure labor 
concessions because ultimately the Bankruptcy Court can impose 
them.
    Delta and Northwest will face similar opportunities and 
constraints as they proceed through Chapter 11. Bankruptcy can 
help an airline improve its financial prospects, but the 
struggles and continued losses of United and the fact that 
USAirways paid a second visit to the Bankruptcy Court shows 
this is no panacea.
    Mergers are a second change often suggested as a cure for 
airline problems. Such combinations do allow the merged airline 
to capture more passengers but diversion of traffic is by its 
nature a zero sum game. What the merged airlines gain, others 
lose. Furthermore, these mergers have tended to drive up labor 
costs because union cooperation is needed for smooth 
integration.
    For example, United's proposed acquisition of USAirways in 
2000 led management to negotiate an expensive pilot contract 
that later helped push the airline into bankruptcy. For these 
and other reasons, the track record of airline mergers has been 
discouraging.
    Fortunately, mergers in the current environment may fare 
better, particularly if the acquired company is in bankruptcy. 
Consider America West acquisition of USAirways just completed 
yesterday. USAirways had already lowered its operating costs to 
levels approaching those of America West. As a bankrupt 
company, USAirways had the flexibility to rid itself of 
aircraft and facilities not needed in the combined airline, and 
America West managed to attract significant outside investment 
and loans to bolster its cash reserves.
    The merged company will still face difficulties in 
integrating its two labor forces over the next several years. 
Also, outside forces such as high fuel costs could certainly 
cause a renewed financial crisis. Even so, acquiring a bankrupt 
but potentially viable airline appears to avoid some of the 
pitfalls that have plagued previous mergers.
    From the perspective of the airline industry as a whole, 
the main benefit of airline bankruptcies and mergers is that 
they can reduce overall capacity. This should is often 
suggested improve the balance of supply and demand and allow 
for increased fares to cover added fuel expense. One of the 
most frequent criticisms of the bankruptcy process is it has 
allowed struggling airlines to survive to the detriment of 
their solvent competitors.
    There is no doubt that liquidation of a major airline in 
bankruptcy would allow the survivors to raise prices somewhat, 
however, whether that revenue gain is sustainable would depend 
on where the parked aircraft end up and whether the surviving 
legacy airlines have competitive cost structures. If the 
liquidated airline's planes simply change hands or if low cost 
airlines still have a huge cost advantage, then the revenue 
benefits would likely erode over time. In other words, 
consolidation, whether through bankruptcy, liquidations or 
mergers, will help the industry only if accompanied by 
withdrawal of planes from the U.S. market and by competitive 
cost structures at the survivors.
    To conclude, let me summarize my answers to the questions 
posed at the beginning of my testimony. First, the dire 
financial condition of most U.S. airlines is due principally to 
high fuel costs, intense price competition in the domestic 
market and heavy debt and pension burdens.
    Second, legacy airlines have undertaken significant steps 
to trim their losses but these have so far been insufficient to 
restore profitability, largely because of the fuel prices. 
Lastly, bankruptcy, restructuring and mergers have the 
potential to improve the industry's financial health, but only 
if accompanied by reduced capacity and most important, by lower 
operating costs.
    Thank you for your attention.
    Mr. Mica. Thank you for your testimony.
    We will now hear from Dr. Steve Morrison, Professor and 
Chair, Department of Economics, Northeastern University.
    Mr. Morrison. Thank you. It is my pleasure to be here 
today.
    I should note that the statement I submitted was co-
authored with my longtime collaborator, Cliff Winston. When I 
say ``we'' in the testimony, I am referring to he and I.
    Mr. Mica. Thank you, and we will include the entire 
statement in the record without objection.
    Mr. Morrison. The airline industry has always been a 
cyclical one because the demand for air travel is sensitive to 
the level of economic activity and carriers must invest in 
capacity well before they know the level of economic activity 
and demand. In the current down turn from 2001 to 2004, the 
U.S. airline industry lost $13 for each of the nearly 3 billion 
passengers it flew resulting in the $32 billion number we have 
heard several times here today but the causes of the current 
financial state of the airline industry are more complicated 
than mere cyclicity.
    What the industry is experiencing is unprecedented and is 
due to a confluence of factors which have exacerbated the 
longstanding and underlying challenge that carriers have of 
aligning capacity with demand over the business cycle. To 
understand the current situation better, we need to look at 
what has happened during the last several years to some of the 
key components that determine an airline's profitability, the 
number of travelers, the fares those travelers pay, the price 
of fuel, wages and salaries of employees being of particular 
interest.
    As far as the number of passengers goes, the good news is 
the traffic in 2004 exceeded its previous peak in 2000 before 
the down turn began. I should note that month to month traffic 
turned down in February 2001 before the recession began in 
March 2001. The recession ended in November 2001 so this 
situation goes well beyond cyclicity as I said.
    Although the industry is cyclical, year over year traffic 
declines are relatively rare and the latest down turn is 
unprecedented in that it took four years for traffic to 
rebound, but traffic did rebound. The question there is why. 
One is the GDP is growing, about 3 percent a year since the end 
of the recession.
    Another reason is more travelers are feeling that flying is 
safe enough for them to travel by air, but perhaps most 
important, is that airlines responded to the drop in traffic by 
significantly reducing fares. That is good news for travelers 
and bad news for airlines. Fares have fallen by 25 percent from 
2000 to 2004 after adjusting for inflation. This substantial 
decline in fares has only occurred one other time in the U.S., 
namely right after World War II when capacity restrictions were 
eased.
    Because of the dramatic decline in fares, the rebound in 
traffic masks underlying changes in passengers demand for air 
travel. Our back of the envelope calculations suggest that air 
fares in 2004 generated 17 percent less traffic than those same 
low fares would have generated in 2000. Demand has changed. 
This raises the question of what has caused this change in 
passengers underlying willingness to pay for air travel.
    Plausible reasons are that the airlines product has 
changed. Increased security leads to earlier arrival at 
airports and longer trip times. To quantify this with another 
back of envelope calculation, if passengers now arrive at the 
origin airport one half hour earlier than previously, then 
under plausible assumptions, travel would decline by 7 percent.
    Fuller planes, now over 75 percent full on average, the 
highest since right after World War II, make travel more 
unpleasant. An alternatives to air travel, teleconferencing and 
rail travel at least in the northeast corridor, have become 
more attractive options. In addition to these considerations, 
the traveling public, especially the formerly lucrative 
business travelers are less willing to pay fares many times 
higher than their fellow leisure travelers.
    Fuel, we have heard a lot about fuel. In addition to 
unanticipated reductions in travel demand, the industry is 
vulnerable to unanticipated increases in costs. Jet fuel makes 
up 10 to 30 percent of airlines costs and its price can 
fluctuate widely which can have a significant effect on airline 
profits.
    Relative to the price of jet fuel that prevailed in 2000, 
the last so-called good financial year for the airline industry 
and one in which the price of fuel was relatively high by 
previous historical standards, in 2003 and 2004, the industry 
lost an estimated $8 billion due to the higher price of jet 
fuel. Given the higher prices in 2005, especially the post 
Hurricane Katrina price spike, the industry is estimated to 
lose even more.
    Before discussing labor costs, it is important to note the 
change in the competitive environment of the industry. Since 
deregulation low cost carriers have expanded more or less 
steadily to the point where in 2004 low cost carriers competed 
on routes between metropolitan areas that accounted for over 50 
percent of the Nation's domestic air travel. This increased 
competitive presence by low cost carriers has put increased 
pressure on legacy airlines to reduce their fares and costs.
    I should add here that the surprise here is that it has 
taken so long for low cost carriers to have this role. 
Advocates of deregulation looked at the performance of 
Southwest Airlines in Texas and PSA in California and saw that 
as the model that would prevail in the Country and it may well 
be the case but it has taken 27 years for that to happen.
    Labor represents the biggest single category of airline 
costs, about 28 percent. Legacy airlines were, by definition, 
those that existed during the period when airlines were 
regulated. In the regulated environment, there was what 
economists call rent sharing as unionized workers and others 
sought and received a share of the profits that the regulated 
firms earned. Low cost carriers adopted a different style of 
labor relations that resulted in lower pay and/or higher worker 
productivity than legacy carriers were able to achieve with 
their work force.
    Legacy carriers have been cutting costs where they can and 
since labor is the largest category of airline costs, it has 
been the target of cost cutting and enhanced productivity 
through negotiation as well as in bankruptcy as the legacy 
carriers seek to reduce costs to compete with low cost 
carriers.
    As a result of these demand and cost shocks, the U.S. 
airline industry finds itself with more capacity, high cost 
capacity in particular than can be profitably supported at the 
fares passengers are willing to pay. This problem will be 
rectified if when demand increases, costs are reduced or high 
cost capacity leaves the industry. Competition among carriers 
will reduce such capacity and may well lead to at least one if 
not more carriers to contract, undergo liquidation or be 
absorbed by another carrier.
    Successful carriers, those that are cost efficient and 
responsive to passenger preferences, will be poised to pick up 
any slack. Indeed, travelers will gain if legacy carriers make 
the required changes to be effective competitors in the new 
environment or are replaced by lower cost carriers.
    We looked at competition between carriers through the year 
2000 that low cost carriers tended to enhance traveler welfare 
much more than legacy carriers. That sounds obvious but there 
are factors other than fares that affect traveler welfare like 
frequency of service. This is an important finding because it 
indicates airline markets are working in the sense that those 
carriers that enhance traveler welfare are rewarded with higher 
profits.
    Some have argued that our bankruptcy laws need reforming 
because carriers operating under Chapter 11 are able to 
artificially reduce their costs and thus drag down healthier 
carriers. In previous work, we found the effect of bankrupt 
carriers competing against healthy carriers was mixed. For some 
bankruptcies competing against bankrupt carriers were helped, 
competing against a weakened competitor and others, healthy 
carriers were hurt by such competition. On net, the effects did 
not merit reevaluation of current policy.
    The current situation with nearly 50 percent of carriers in 
bankruptcy could well be different but analysis that we have 
done so far suggests that is not an area in which to look for a 
solution.
    Thank you.
    Mr. Mica. Thank you for your testimony.
    Now we will hear from Mr. Sokel, Director of Deutsche Bank 
Commodities Group. Welcome and you are recognized.
    Mr. Sokel. Good afternoon.
    My name is Stuart Sokel. I am a Director at Deutsche Bank 
in New York City. Having spent the last 14 years in the oil 
trading industry, my testimony today will attempt to provide 
insight into the logistical and economic forces currently in 
place today.
    Without a doubt, high energy prices are having a major 
impact on the Nation's economy and it is imperative to 
understand the core issues which are significantly affecting 
the United States' commercial airline industry. I invite 
questions and comments at any point should further clarity be 
required.
    In brief, the oil market today reflects a composite view of 
global macro economic strength, environmental concerns and 
demographic changes, all of which have contributed to 
dramatically higher energy prices over the past year. Most 
Americans are keenly aware of how limited refinery capacity in 
the United States, a point that has been pronounced due to the 
damage wrought by the hurricanes in the Gulf Coast region has 
meant higher refined product prices. This point only gives a 
partial explanation and I believe it needs greater scrutiny.
    To start, let us remember what has taken place in the world 
since 1998. At precisely the same time that a number of 
emerging market countries, for example, India and Thailand, 
were rapidly expanding domestic refinery capacity, a financial 
crisis in Asia coupled with over capacity from OPEC pushed oil 
prices to levels that seem like a mere memory today. Ten dollar 
oil was just another session away and many respected 
journalists and pundits alike predicted the end of reliance on 
oil, Middle Eastern or otherwise. Thus, there was no perceived 
financial pressure for airlines to change their operating 
procedures.
    In retrospect though, this period was a mere blip on the 
trend line of growth that has taken place in the world today. 
Today, the major United States airlines are competing for the 
same marginal barrel of jet fuel that Singapore Airlines, 
Quantas and British Airways need for their own fleets.
    Seven years ago, domestic passenger demand in India and 
China alone was a mere pittance compared to today. In addition, 
the environmental regulations of lower sulfur gasoline and 
diesel fuel in Europe and the United States have only served to 
take the jet fuel market into further deficit given the 
continuing difficulty of refiners to adopt to changes in 
product specification. In short, the situation would appear to 
be dire and it becomes critical to develop a strategy that 
serves the industry in the coming years while addressing the 
immediate need to remain solvent.
    To start, we have to acknowledge that the lack of 
investment in refiner and terminal capacity over the past 30 
years will not likely suffice for the next 30 years. To be 
critical of the oil industry, however, neglects a very 
important point. I would like to address one of Congressman 
DeFazio's points. The logistical hurdles of building a new 
refinery coupled with the questionable return on investment 
given history poor margins did not exactly provide the 
integrated companies with any major incentives.
    It is true that the stock of Valero, for example, has risen 
260 percent though I forget the precise number. However, from 
1985 to 2000, if you had been managing an equity portfolio, 
similar returns would not have been made. So it is a recent 
phenomenon that the oil and gas sector in terms of the equity 
market has rewarded the sort of returns we have seen over the 
last one to two years.
    This point may be small consolation for the aviation 
industry but it does provide a bit of historical context to the 
current dilemma. In order to remedy the supply bottlenecks, the 
coastal areas of the United States will need investment in the 
downstream sector. By that, I mean the refinery sector and will 
also need support from the Congress in order to educate an 
electorate which seems very comfortable with the notion of 
affordable oil as long as the infrastructure is not in their 
specific backyard.
    Storage facilities need to be in close proximity to high 
volume airports and major markets. Such projects will need to 
be environmentally and economically sound but without a 
reasonable commitment from all interested parties, the burden 
of supplying jet fuel will fall exclusively into the hands of 
market forces which will lead to a continuation of higher 
prices in years ahead.
    I should point out currently it is very likely that a 
carrier flying into LAX airport is utilizing jet fuel supplied 
from a Korean refiner given the nature of the physical 
arbitrage that we see in the oil industry today.
    Management of energy risks is an area that many carriers 
have neglected in recent years and unfortunately the blame may 
be spread around in no short order. Most of the airlines which 
did hedge for the current fiscal year 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. In trading jargon, this differential is commonly referred 
to as basis risk. Given the potential for jet fuel to out pace 
the rise in crude oil prices, in effect, that is precisely what 
has happened this year and the market expectation is that this 
will continue.
    Anecdotally today, the price of jet fuel has risen by seven 
cents a gallon and by virtue of the Air Transport Association's 
statistics, each penny increase in the price of a gallon of jet 
fuel drives an additional $190 million in annual fuel costs for 
the United States airlines.
    For airlines that did not hedge or for those which 
liquidated hedges due to court ordered instruction, the outlook 
remains very severe given the current forward price of 
approximately $2 per gallon for 2006. I understand that the 
forecast by United Airlines for their 2006 jet fuel costs is 
roughly $1.50 per gallon.
    It is fair to say that Wall Street can be critical of 
hedging activity which is unprofitable or deemed to be 
speculative as exemplified by certain refiner activity. 
However, the incremental cost of fuel and labor will continue 
to play the largest role in the future outcome of the industry. 
While labor costs cannot be hedged, oil prices certainly can be 
managed in the same manner in which companies monitor their 
foreign exchange, interest rate and credit exposure.
    There is an adage in financial markets which states the 
only thing that can cure high prices is high prices. The 
airline industry however suffers from the burden of having to 
pay high prices without the flexibility of necessarily 
receiving higher fares. Historically, carriers have been loathe 
to pass on higher fuel costs in the form of any additional 
tariff for fear of being undercut by competition. This has led 
to a vicious cycle within the industry, an important matter 
left for an airline industry expert to discuss as opposed to an 
oil trader.
    From my perspective, however, the potential solutions 
aforementioned are sound and will allow the forces of supply 
and demand to act to the advantage of consumer and industry 
alike.
    Thank you very much.
    Mr. Mica. Thank you.
    Now we will hear from Maria Matesanz, Senior Vice President 
and Team Leader, Public Finance Group of Moody's Investor 
Service. Welcome, Ms. Matesanz. You are recognized.
    Ms. Matesanz. Good afternoon. I am Maria Matesanz and I 
manage the team at Moody's that rates debt issued by U.S. 
airports. Thank you for inviting me to speak today.
    Moody's Investors Service is the oldest bond rating agency 
in the world. We have been rating bonds since 1909. Today we 
have more than 1,000 analysts in 19 countries around the world. 
Our ratings and analysis cover approximately 10,000 
corporations and financial institutions, more than 20,000 
municipal debt issuers, over 12,000 structured finance 
transactions and 100 solvent issuers.
    In Moody's view, the main and proper role of credit ratings 
is to help enhance transparency and efficiency in debt capital 
markets by reducing information asymmetry between borrowers and 
lenders. We believe that this benefits the market by enhancing 
investor confidence and allowing borrowers to have broader 
access to funds.
    Moody's does this by publishing forward-looking rating 
opinions publicly, freely and broadly and by publishing credit 
research about debt securities and their issuers. Our credit 
ratings are opinions about the future probability of full and 
timely repayment of debt obligations such as bonds, notes and 
commercial paper. Our opinions are communicated to the market 
through a symbol system originated almost 100 years ago which 
rank orders relative credit risk on a scale with nine broad 
categories ranging from AAA to C.
    My comments today will focus on the impact of airline 
bankruptcies on U.S. airports. Moody's has ratings on 166 debt 
issues at 114 publicly owned U.S. airports. The median airport 
rating is A2. This contrasts sharply with the median rating of 
B3 for airlines.
    Airlines have had a very unprofitable number of years as a 
result of extremely low air fares, high labor costs and 
increasing fuel costs. The combination of low fares and the 
growth in capacity by both the legacy airlines and the low cost 
carriers has resulted in very strong passenger and revenue 
growth at airports and stable outlook for airport sector 
issuers. In most markets, passenger volumes have now exceeded 
pre-9/11 peak levels and many airports are experiencing flight 
delays due to capacity constraints.
    In Moody's opinion, credit quality in the airport sector 
has stabilized due to the maintenance of solid liquidity 
levels, growth in non-airline concession revenues, management 
control over operating and capital budgets and the strength of 
the underlying origin and destination service area economies. 
Moody's analysis focuses on these factors as key explanatory 
variables for the increasing gap between the median airport and 
the median airline rating.
    Air transportation remains an essential service in our 
economy and Moody's believes that because of the difficulty in 
building new airports and the long lead time needed for 
environmental approvals, existing airports will generally be 
able to pass justifiable operating and capital costs on to 
airlines and passengers despite financial turmoil in the 
airline industry. Given the strategic importance of hub 
facilities for legacy carriers and their large investment in 
local facilities, certain hubs may even benefit from route 
restructuring by their dominant carrier.
    For example, when Delta chose to de-emphasize its Dallas-
Ft. Worth hub last year, Atlanta Hartsfield Jackson saw 
significant increases in its connecting traffic. Likewise, when 
American scaled back its hub at Lambert St. Louis, Chicago 
O'Hare saw an increase in connecting traffic. We define a hub 
as having more than 30 percent connecting passengers.
    With three of the six legacy airlines in the U.S. now 
operating in bankruptcy, our focus is on identifying those 
airports that may suffer financial stress as a result of cuts 
in service, reductions in passengers and revenues as well as 
those airports that may suffer a rejection of key airline 
leases. Airlines operating in bankruptcy generally continue to 
pay airport rates and charges and in most cases do not 
radically downsize their operations. These are two important 
offsetting factors that help buffer the impact of an airline 
bankruptcy on the ability to generate revenue at an airport.
    Our analysis will continue to weigh the credit impact of 
the bankruptcy filing of an airline on the ratings of its hub 
airports. We will also consider such credit fundamentals as the 
size and economic health of the origin and destination base, 
the financial strength of the airport and the operating 
agreements for airlines at each facility.
    Hub airports served by airlines in bankruptcy often have 
agreements that allow the airport to charge the airlines fees 
to recover all operating and debt expenses. The so-called 
residual agreements often include a credit for all non-airline 
revenue such as parking and rental car fees and food and 
beverage concessions as an offset to airline charges. While 
some airlines may not wish to pay increased fees, Moody's 
believes that the opportunity to serve many of the larger local 
markets and the higher fares in some of these markets would be 
an incentive for the remaining or new carriers to increase 
service and continue to pay the agreed upon rates and charges.
    While the bankruptcy filings of Delta and Northwest are 
partly the result of certain pressures common to all airlines 
such as high fuel costs, rising labor costs, low yields in the 
aftermath of Hurricane Katrina, the circumstances surrounding 
each filing differ significantly and the resulting impact on 
airports may be different. Both airlines will look to regain 
their long term business viability by seeking to lower their 
costs in a variety of areas. Some of these, for example, labor 
costs, are neutral to airports. Strategic decisions about route 
structure and capacity reductions on the other hand can have a 
significant operational and financial impact on airport credit.
    Airports may also be affected by the legal strategy the 
airlines adopt regarding their airport leases. Airlines may 
choose to reject comparatively expensive or older leases, 
especially at airports they are also considering for service 
cuts. On the other hand, and as we have seen time and again, 
airlines are likely to affirm other leases at airports they 
deem strategically vital to their network.
    In conclusion, we continue to focus on those airports that 
in our view lack one or more of the credit strengths that 
support the divergence in credit quality of airports and 
airlines. In Moody's opinion, the increased risk that the 
airline restructuring process implies will be borne by those 
airports with less favorable routes, a high reliance on 
airline-derived revenues, a service area that is below the 
median in terms of generating demand for air travel, below 
average liquidity levels and limited ability to cut airport 
operating costs and/or scaled back capital programs.
    Thank you again for the invitation to testify. I would be 
happy to respond to any questions.
    Mr. Mica. Thank you and thank all the panelists. It took a 
little time to get through but we don't have any other 
witnesses today and we wanted to hear from each of you involved 
in looking at the industry and give you an opportunity to make 
presentations.
    I have a few questions. Unfortunately, there is a 
conference going on so we have lost at least half of the 
membership but I want to go ahead since you have been patient 
and continue with the hearing.
    My question for each of you, first of all, is do you expect 
additional bankruptcies in the short or the near term and the 
long term? Mr. Kiefer?
    Mr. Kiefer. I would have to say I am optimistic at the 
prospect of American and Continental, the two major legacy 
carriers that have thus far avoided bankruptcy. I am optimistic 
at the prospect of them avoiding bankruptcy. Certainly in the 
near term, there is not a likelihood of that. Their cast 
positions are such that it is not likely in the near term.
    I think in the long term, American was among the first of 
the major legacy carriers to negotiate major concessions with 
their union early on in this crisis. Continental has probably 
the reputation as the best labor relations among the legacy 
carriers and I think the combination of those two things 
implies they are likely to be able to negotiate further 
concessions in order to avoid bankruptcy.
    However, as I mentioned, should Delta and Northwest elect 
to terminate their pension plans or convert them to defined 
contribution plans, American and Continental will find 
themselves to be ostensibly the only major legacy carriers 
remaining that offer pension benefits. I think those costs will 
prove unsustainable to those carriers in the long term. So 
their ability to negotiate those potential reductions in 
benefits and costs will be a key factor in their avoiding 
bankruptcy in the long term.
    Mr. Mica. You answered part of my next question. Let me 
give Mr. Baggaley a chance.
    Mr. Baggaley. In the near term, I think the most likely 
bankruptcy candidate is an airline you are familiar with in 
this area, Independence Air. I don't expect that American or 
Continental are likely to file unless there are further shocks 
to the system such as a further major increase in fuel prices 
or terrorism.
    Over the longer term, I think I would agree with Mr. Kiefer 
that the pressure of the benefits and pensions might cause them 
to file for bankruptcy. I would expect what they would try to 
do is negotiate outside of bankruptcy to at least reduce those 
benefits. Their pension deficits are not nearly as large as 
those of Delta and Northwest, so they are not under quite as 
much pressure.
    Mr. Mica. Dr. Morrison?
    Mr. Morrison. I should add that my study of the industry is 
not at the firm level and my fellow panelists may be much 
better informed than I am, but I will say it wouldn't surprise 
me to see another bankruptcy.
    Mr. Mica. Mr. Sokel?
    Mr. Sokel. I think if the situation in terms of high jet 
fuel prices continues in the next fiscal year, it is difficult 
to see how you wouldn't have additional bankruptcies unless the 
additional costs of operation were passed on to the flyer 
because at this point, it strikes me that most of the major 
carriers have very little sense of what the outlook really is 
in the sense that if they had to hedge at this precise moment. 
I don't think any increases in refinery capacity are going to 
meet the short term needs of the industry.
    Mr. Mica. Ms. Matesanz?
    Ms. Matesanz. I would defer answering that question to our 
airline analyst at Moody's and I would be happy to report back 
his views.
    Mr. Mica. I have a question for you and you are sort of our 
airport expert. Did you say the airport bonds were at what 
rating?
    Ms. Matesanz. The median rating for airport bonds is A2.
    Mr. Mica. And airlines were B2?
    Ms. Matesanz. B3.
    Mr. Mica. Do you see any change in that rating for airports 
as a result of the current bankruptcies or financial problems 
that we have seen over the most recent period of time?
    Ms. Matesanz. The median rating is something that moves 
very, very slowly.
    Mr. Mica. So it would take a while to impact that?
    Ms. Matesanz. Exactly, and we don't see any radical changes 
in the profile of the sector. We have a stable outlook on the 
airport sector as a whole.
    Mr. Mica. What should Congress do and Mr. Kiefer, you said 
the pension was the big enchilada.
    Mr. Kiefer. I think with respect to the question what 
should Congress do, with respect to the pension benefits I 
suppose one piece of guidance I would offer is that I think it 
is likely if not certain in the long term that pensions will no 
longer be a feature of the U.S. airline industry. The low cost 
carriers have never had them and never will. I think any 
efforts at pension reform ought to be aimed at preserving 
benefits for existing employees rather than trying to maintain 
them for potential future employees because I think they are 
likely to go away in that regard.
    Mr. Mica. Mr. Baggaley?
    Mr. Baggaley. Standard and Poor's has a policy of not 
recommending for or against any public policies. I would just 
make a note as to the pensions.
    Mr. Mica. You have also provided the charts on AMR that 
reflect also industry. They cut labor.
    Mr. Baggaley. That was $1.8 billion.
    Mr. Mica. Right. They are getting hit in the shorts here 
with the fuel and they have cut some of their overhead.
    Mr. Baggaley. There were various other cost reductions on 
the order of $2.2 billion, so one can see just how much of 
their progress has been wiped out by the rise in fuel prices.
    Mr. Mica. Again, pensions would still be sort of the big 
enchilada in obligations and fuel?
    Mr. Baggaley. Actually, the largest portion of American and 
other airlines' obligations are secured debt and leases. 
Pension deficits are significant but they are a minority of the 
total.
    Mr. Mica. The only way you can restructure those would be 
through bankruptcy or negotiation?
    Mr. Baggaley. Yes.
    Mr. Mica. Dr. Morrison?
    Mr. Morrison. I mentioned in my testimony that an extra 
half hour early arrival at the airport is estimated at 7 
percent.
    Mr. Mica. Seven percent. That was interesting. I am going 
to use that because I am trying to get them to do in-line 
systems and some other things, faster screening.
    Mr. Morrison. That is my suggestion precisely. It seems to 
me that in the scheme of suggestions, it is relatively 
uncontroversial.
    Mr. Sokel. I am not entirely sure what can be done in the 
short term and the longer term. The Congress should look into 
the initiative offered by the Kuwaitis with regards to their 
offer to build a refinery within the United States because it 
would seem it is a bit of robbing Peter to pay Paul at the 
moment.
    Mr. Mica. Interesting. Ms. Matesanz?
    Ms. Matesanz. Again, I would limit my remarks to the impact 
on airport credit and would be happy to provide an answer.
    Mr. Mica. So you don't see a big problem and you don't see 
that Congress has to step in at this point?
    Ms. Matesanz. Again, with respect to the airlines, I would 
defer answering that question.
    Mr. Mica. Right, but I meant airports.
    Ms. Matesanz. As far as airport credit, again, our outlook 
is stable for the sector. While airline bankruptcies are 
something that we look at closely, particularly for hub 
airports, we look at a whole host of other factors that 
airports have under their control such as the ability to offset 
airline revenues with other sources of revenue, the ability to 
cut their operating and capital budgets, their ability to 
attract other carriers to those markets through efficiencies in 
their own operations as offsets to the credit impact of an 
airline bankruptcy on their own operations.
    Mr. Mica. I thank all of you for your comments. We don't 
have jurisdiction over fuel prices, we don't have jurisdiction 
over the four cent jet fuel tax and we don't have jurisdiction 
over pensions, but I think it is important that we review the 
impact of all of these on the airline industry and if 
necessary, take steps where we can assist, but don't underwrite 
a failing business operation or model. I have been sort of the 
tough guy on the block on this because I think that subsidies 
would only temporarily delay the inevitable as far as the 
airline business is concerned.
    Last, I thought we were doing a pretty good job in 
increasing fares and the airlines have increased fares from 
February to some time this summer about eight times. That has 
helped some of them see at least a minimal operating positive. 
I think one of you said all failed to institute price increases 
as a competitive area they won't touch. They have done that. 
Does anyone want to comment? I just don't see any other way for 
them to survive if they don't increase their fares.
    Mr. Kiefer. I think one thing that is important to point 
out is if we observe any recent fare increases that in addition 
to being very cyclical, this business is also quite seasonal. 
Fares typically, both for domestic travel and international 
travel, will increase in the summer because that is a higher 
demand season. That may be something we are observing there.
    I would offer one other further comment to the prior 
question. I think it is important when Congress looks into this 
issue and when you are thinking of what you may do about it, to 
think of this issue in the broader industry context which is to 
say that some of the same factors that are causing the large 
financial losses in the industry, the low cost competition and 
so forth, are also affecting the ability of the system to fund 
its future infrastructure needs.
    I think issues like the proposed fuel tax holiday or 
proposals that may soon be on the table to restructure the 
Federal Aviation Administration and so forth need to take into 
account not only the current but the long term financial health 
of this industry. Those proposals that might threaten that 
should be considered in that light.
    Mr. Mica. Thank you. I agree with that.
    Mr. Baggaley? Anyone else?
    Mr. Baggaley. Historically, it has been very difficult to 
pass through fare increases in the domestic market but this 
year the pattern has changed somewhat. As you said starting in 
February, there have been a series of increases. I think the 
level of fuel prices reached the pain threshold even for the 
low cost carriers and they went along with these fare 
increases.
    The bankruptcies of Delta and Northwest will probably 
result in some further withdrawal of capacity and probably out 
of the Country because there are other areas where there is 
strong demand and that should help that a bit further.
    Mr. Morrison. It is safe to say that fares over the longer 
term have to rise but it is hard for them to rise in the 
current environment with the capacity that is there. Unilateral 
action by one carrier won't do it and we generally frown on 
collusive behavior which might be in their collective interest 
but not in the interest of passengers.
    Mr. Mica. Mr. Sokel?
    Mr. Sokel. I suspect the problem is that the rate of fare 
increase doesn't match the rate of the jet fuel price increase 
ultimately.
    Mr. Mica. Mr. Costello?
    Mr. Costello. Mr. Baggaley, you addressed the issue of 
capacity in your statement. In fact, you refer on I think the 
last page of your testimony to that where you say 
``Consolidations, either through bankruptcy or liquidation or 
mergers will help the industry but only if it is accompanied by 
the withdrawal of planes from the U.S. market and by 
competitive cost structures.'' What do you mean by that? In 
other words, regardless if you have mergers, if you have 
bankruptcies, whatever takes place, we have too much capacity? 
Is that what you are saying?
    Mr. Baggaley. Capacity is a partial problem. If you look at 
the percentage of seats filled, it is actually quite high and 
to the extent that some planes of a high cost carrier are 
simply moved out, low cost carriers will expand to fill the 
void.
    The thing that gives some hope for the current situation is 
that with strong demand overseas, some of these planes will be 
redeployed there and the legacy carriers are lowering their 
costs to be closer to the low cost carriers. Over capacity is a 
problem but it is not the sole problem and some of the changes 
that have been suggested as potentially helping the industry 
work only if it is accompanied by cost reductions.
    Mr. Costello. You also say that broader trends and changes 
could heal the industry. Elaborate on that.
    Mr. Baggaley. They could help somewhat but I think the 
industry is going to be financially stretched for the 
foreseeable future. The best case scenario is that the legacy 
carriers lower their costs, are modestly profitable in the best 
of times but still highly leveraged and at risk in a down turn. 
The best case is not terribly bright but it is certainly better 
than the worst case.
    Mr. Costello. The hub and spoke system, is it still an 
effective model for the legacy carriers?
    Mr. Baggaley. The hub and spoke system can generate more 
revenue and there are some very successful carriers overseas 
who use it. Also some of the low cost carriers use it, so it is 
not pure dichotomy between a Southwest model and an American 
Airlines or United model. The problem is that the extra 
revenues generated by the system have been shrunk by the low 
cost competition and that still leaves them with the higher 
costs. So they have been trying to shift more of their flying 
overseas, shift more to local markets and lower the costs at 
which they operate the hub and spoke system.
    All the low cost carriers, they don't have international 
operations, they don't have regional feeders so if we are to 
serve the Country, there is a place for a hub and spoke system 
but it has to operate at lower costs.
    Mr. Costello. Mr. Kiefer, I mentioned in my opening 
comments about the argument that the legacy carriers are 
operating under a business plan that may no longer be 
effective, in particular the business traveler, the premium 
ticket price made up in the past a major portion of the revenue 
going to the legacy carriers. I am wondering if you agree with 
that and if so, what changes will have to take place in the 
legacy carriers business plan in order for them to get back 
into the market?
    Mr. Kiefer. I think I would agree with it at least in part 
which is to say that the composition of the traveling public 
that now exists is fundamentally different than it was four or 
five years ago. There is much more price consciousness and so 
it is true if the business model is predicated on the ability 
to charge much higher fares on business travelers, it is 
proving problematic. I think there are business travelers 
willing to pay those higher fares out there; the problem is 
there are simply not enough of them to sustain the legacy 
carrier's profitability.
    At the same time, however, legacy carriers do offer certain 
premium services such as first class, airport clubs and so 
forth which are attractive to business travelers and provide 
benefits that are desirable to the extent I don't see them 
going away in the long term. They also offer international 
services which as we discussed because of their continued 
regulation largely do have much higher profitability than 
domestic services and so forth. I don't think the business 
model is completely broken but I think it is much more 
difficult to apply in the current environment.
    With respect to the operating model to address some of the 
comments of Mr. DeFazio earlier, I think the hub and spoke 
system likewise provides some very significant benefits to the 
traveling public. It allows the connection of far more origins 
and destinations than would be possible with strict point to 
point service, it allows the connection to international 
gateways which is vital to the air transport system and 
finally, perhaps most importantly, it provides connection for 
small communities to the air transport network that simply 
might not be possible otherwise. So I think it has a lot of 
benefits that will probably keep it around for some time.
    Mr. Costello. You also mention in your testimony that the 
low cost carriers are quite vulnerable to some of the 
challenges that face the legacy carriers, obviously high fuel 
costs being one. What other challenges do you see for the low 
cost carriers and what does the future look like for the low 
cost carriers?
    Mr. Kiefer. I think certainly fuel is the most significant 
of those challenges. Southwest hedges a significant 85 percent 
this year at I think $26 or $28 a barrel. Those hedges will 
subside in the next few years. They are only hedged I think 
about 28 percent on average. I could be corrected on that but 
for the other low cost carriers.
    I think the other big issue is labor costs. Ironically, 
just as we have talked about the very significant cuts in wages 
and benefits that the legacy carriers have instituted, if 
anything, low cost carrier wages are likely to increase. I 
don't ever see them instituting pension plans or post-
retirement, health insurance but it is likely that pay for 
those carriers, particularly as they grow and continue to be 
profitable, will increase. Labor being upwards of a third of 
the total operating costs of the carriers, that will begin to 
bear on their future profitability.
    Mr. Costello. Mr. Sokel, it is my understanding that a 
large percentage of the airlines hedges were in crude oil as 
opposed to their actual exposure which is jet fuel. Why was 
that?
    Mr. Sokel. I think there are a few reasons. The first is 
that there was the perception at the CFO level within many of 
the carriers that WTI, which is the benchmark in the United 
States, is the liquid most actively traded index and therefore 
because it is liquid and because it is screen based, New York 
Mercantile Exchange based, there was a belief that this would 
seem to be a benchmark that was more suitable versus something 
that was strictly traded over the counter.
    The problem in that perspective is that it doesn't 
recognize accurately the fact that in times of extreme demand 
or supply restriction or both, such as we have now, you can 
have this increasing basis risk and companies that are only 
hedged in crude oil lose out on this increase in price in the 
actual product. I think another reason is that once one airline 
hedges in WTI and another reports that they are hedging in WTI, 
it almost becomes the standard for the industry.
    Without going into specifics, I would debate that the jet 
fuel index as traded in the over the counter market is very 
liquid. It takes a little bit more of an understanding of how 
it is traded and what the basis is but clearly the difference 
between hedging in jet fuel or heating oil or crude oil 
probably makes the difference on the bottom line of tens of 
millions of dollars.
    Mr. Costello. Final question for the panel. Just a brief 
response, if you will.
    The Chairman asked the question about what Congress should 
be doing. I would ask, as I made mention in my opening 
statement that Mr. Crandall and others have asked, regarding 
the issue of bankruptcy, what he thinks should be done as far 
as the bankruptcy laws are concerned, capacity issues and so 
on. My question is, what if Congress does nothing? What if we 
take no action whatsoever with the issue of bankruptcy, with 
capacity, with fees and taxes, what happens to the industry? 
Mr. Kiefer?
    Mr. Kiefer. I think as I stated earlier, there are 
additional job losses that are likely, there is the real 
prospect of additional loss of pension benefits for significant 
numbers of employees and I should point out in the case of 
pilots, this is a very substantial reduction in benefits from 
perhaps as much as over $100,000 a year in benefits being 
reduced to less than $30,000 a year in benefits.
    Having said that, I think inevitably if Congress does 
nothing, I do believe this industry will right itself in the 
long term and perhaps additional consolidation whether it be 
liquidation or even just the renegotiation of benefits will 
ultimately provide for the long term financial health of the 
industry.
    Mr. Costello. Mr. Baggaley?
    Mr. Baggaley. If fuel prices gradually decline, that can be 
partly covered by fares, I think the legacy carriers will 
struggle through. They will shrink, some of them will merge and 
as I indicated earlier, they will be financially weak, but 
still flying. If there are further price shocks or other 
outside shocks, I could certainly see some major carriers 
shutting down in bankruptcy.
    Mr. Costello. Dr. Morrison?
    Mr. Morrison. What if Congress does nothing? I am an 
economist so the perspective that I take is one of is there a 
market failure that needs correcting? I am unaware of a market 
failure in the sense that economists mean it, that needs 
correcting. I would agree with my colleagues as to what would 
happen in the absence of action.
    Mr. Costello. Mr. Sokel?
    Mr. Sokel. If Congress does nothing, then the average 
American can expect to pay a lot more for their privilege to 
fly. In absence of that, you will have increased bankruptcies.
    Mr. Costello. Ms. Matesanz?
    Ms. Matesanz. Speaking from the standpoint of the airport 
sector, the capacity issues that are strained by the hub and 
spoke model are something that need to be focused on as far as 
facilitating airport expansion at those airports that are 
capacity constrained already. That is an area that potentially 
need some more study and some more scrutiny as far as how to 
expedite the building and development of additional capacity to 
support the efficiency and fuel economy by extension of the 
airport tenants that serve the airports.
    Mr. Costello. Mr. Chairman, I have another question or two 
but my time is up and there are other members here. Hopefully, 
we can come back.
    Mr. Mica. Mr. DeFazio?
    Mr. DeFazio. Thank you.
    Mr. Kiefer, you seemed to indicate a little sensitivity to 
the concern I raised about connectivity of the system. It 
obviously can profit the system if it works properly in dealing 
with small or mid-sized cities.
    What I would like to understand both from you and others is 
what do you think is a policy role? I am not sure that markets 
are enough to continue to serve those areas especially since, 
if we want to talk like economists, we don't take into account 
external diseconomies, the external diseconomy being the people 
who live in the second largest city in Oregon have to drive 120 
miles to the airport in Portland because all of the little 
planes that now fly out of our market are overbooked. They are 
100 percent full.
    So it is kind of a problem. You can't get there at night 
any more, but other than that, it is working pretty good. That 
is happening to people outside of virtually every major urban 
hub in America and most of us do not represent major urban 
hubs.
    If you look at the GAO studies, that is where the big drops 
in air fares have come but in a lot of your smaller, mid-sized 
cities, air fares have not been as generously discounted into 
those markets and the service is crummier.
    The question is as a policy maker, what is the vision for 
the system? Are we ultimately going to abandon everything but 
say SEATAC and San Francisco and LA on the West Coast and I 
don't know what it will be in the middle and a few on the East 
Coast because that is where the market takes us? So, you have 
to drive 400 miles, that is your problem if you want to fly? We 
are losing something here.
    Does anyone have any ideas on what we should do as policy 
makers as opposed to pointing fingers in terms of dealing with 
us?
    Mr. Kiefer. I think as policy makers, the Congress has 
already addressed the issue of service to small communities 
through the Essential Air Service Program.
    Mr. DeFazio. It is a pretty lame program and I keep asking 
people for a better model.
    Mr. Kiefer. I just offer that as context but I think you 
raise an important point that while at the same time the hub 
model allows more frequent service or connects to more 
destinations, the small community, often it does so through 
perhaps one airline. That is why I think you observe the much 
higher prices that you do in your community or elsewhere from 
these smaller communities to the large hubs and so forth.
    I am not sure I can offer a direct policy prescription for 
that issue but I agree with you that it is not to say that 
there are not other issues with respect to the hub and spoke 
system and its ability to serve small communities because it 
does indeed do it perhaps more frequently but more expensively 
as well.
    I don't see in the long term however, a reduction in the 
number of airports that serve passenger traffic or serve it at 
any significant volume because air travel is forecast to grow 
over time and if anything, the trend has been particularly 
through the advent of regional jets and so forth to add more 
point to point service to medium-sized airports rather than 
service at very large hubs.
    So I think the future is not necessarily bleak for the 
smaller or medium-sized cities with respect to their air 
service, but I agree that it may not be ideal at present and it 
may look a little different in the future. As for how to 
reinvent that from a policy perspective, I am not sure I have a 
prescription for you at this point.
    Mr. DeFazio. Thanks. Anybody else have a comment or idea?
    Mr. Baggaley. There is an interesting experiment which will 
be rolling out shortly and that is Jet Blue, a low cost 
airline, will be deploying large 90-100 seat regional jets and 
they expect to expand those throughout much of the eastern half 
of the Country. If that works and there are some new larger 
regional jets that are very efficient and the pilot unions at 
the major airlines, the contracts have been changed to allow 
that in many cases, you could see a greater seat capacity 
available to some of these communities and therefore, lower 
fares. They wouldn't be 100 percent booked anymore.
    Mr. DeFazio. Mr. Morrison?
    Mr. Morrison. The issue of service to small communities is 
something I looked at ten years or so ago and the issues may 
well have changed or the situation may have changed, but what I 
found then was the level of service and the fares charged which 
are certainly higher than others, were based on the less demand 
and higher costs attended with lower capacity aircraft, that 
they are more expensive to fly, there are fewer passengers 
flying so frequency is less, service is definitely less but 
there are fewer passengers.
    As far as some regulatory type solution or a non-market 
solution, I know some local communities make contracts with 
airlines guaranteeing some minimum.
    Mr. DeFazio. My largest city pioneered that, so it is a 
market-based way of attracting people.
    If we could, someone referred to going to Europe, people 
are going overseas. The question is how are fares set overseas. 
My understanding is in Europe everybody is charging a fuel 
surcharge and somehow that happens.
    I guess it is not a market-based system or it is a market-
based system that somehow tolerates getting a premium for 
higher fuel costs and so American airlines have to go over 
there to operate so they can make money when the planes are 
full as opposed to losing money when their planes are full 
here. Can you help me out with that? What is the difference?
    Mr. Baggaley. The legacy carriers have expanded their 
flying to foreign destinations, they are not flying within 
those destinations but transatlantic flights, transpacific and 
so forth. There are as yet no true low cost carriers serving 
many of those markets, so the fares, at least in the summer, 
are higher, the planes are full there are fewer participants on 
each route, so they are more attractive.
    However, that has its limits. In the past, the 
transatlantic market airlines have dumped in too much capacity 
and the fares have fallen. At the moment that is the relatively 
good area.
    Mr. DeFazio. On the issue of fuel, Mr. Sokel, I have been 
looking at some analysis of what has happened to refining. It 
is pretty interesting. You talked about the historically low 
rates of return and I grant you from 1999 to 2004, refineries 
were making 22.8 cents for every gallon refined.
    By the end of 2004, they were making 40.8 cents, almost 
twice as much, and this year they are making $1.10 or somewhere 
between $1.00 and $1.10. That is up five times. Were you 
talking about the 22.8 cents for historically low rates of 
return, the 40.8 cents or were you talking about today's $1 
rate of return?
    Mr. Sokel. I was talking about really prior even to the 
22.8 cents because if we go back to the example of what took 
place in the mid-1990s and even in the late 1980s, the 
downstream sector has been in a period of significant 
consolidation probably for the better part of the last 15 years 
and it is really only in this last three or four years that 
companies such as Valero, Exxon-Mobil, British Petroleum are 
showing significant returns in the refiner sector.
    Mr. DeFazio. Would you say at $1 a margin per gallon that 
would be enough incentive economically to build a refinery?
    Mr. Sokel. That is a very interesting question but I guess 
if I listen to Lee Raymond or Sir John Brown, it would seem the 
logistics of actually building a refinery in a place that is 
commercially viable is still a question that needs to be 
answered. There are not too many people sitting in this room 
who would like to have a refinery or a terminal capacity put 
near where they live.
    I think it is a combination of things. How much 
environmental legislation needs to be passed if it is 
particularly in California, in New York, in Florida and in some 
of the major markets. I would imagine in the State of Oregon, 
it would also be difficult to hurt the pristine vantage point 
that people have by putting a refinery there.
    Mr. DeFazio. We are looking at several liquefied natural 
gas facilities in Oregon. We are connected to the gas lines. We 
aren't connected to the gasoline lines except for one very 
small pipeline. That is why they tell us we on average always 
pay more than Washington and California. So bringing it into 
Oregon wouldn't do you a lot of good because you can't get it 
out again.
    The point becomes as I understand the President's proposal 
which may or may not have been serious but he said that he 
would work to waive all environmental laws or could potentially 
in an executive manner waive environmental laws to put a 
refinery on a closed military base which could likely be in one 
of those areas.
    It seemed there was a resounding silence from the industry 
and when you see quotes like Valero's chief operating officer, 
a quote in the Post saying, basically it is working pretty well 
the way it is. It kind of reminds me a bit more of California 
in the days of the former Enron where our plants are down for 
maintenance, markets up, so if we run right on the edge of 
refinery capacity, when they shut down, we see a little blip. 
We went up 30 cents a gallon in Oregon, even though we are not 
in the East Coast network, because of Katrina. That was 
interesting.
    I guess I am questioning whether there is a market here and 
whether we need to look at a little bit of disaggregation in 
this industry when you look at the concentration. I would be 
curious if you think this is adequate that we have gone to the 
point now from 34.5 percent being the top five refineries in 
1993 to 56.3 percent and 83 percent in the top 10. I am 
beginning to wonder whether we have real market characteristics 
here or whether we are seeing a little bit of manipulation and 
excess rents or price gouging as some of us call it?
    Mr. Sokel. I would almost argue that price gouging occurs 
more when the price is low in terms of gasoline than when the 
price is high because the level of sensitivity is that much 
higher when the prices are high. I think there are more than a 
number of national oil companies that would love to be able to 
put a refinery in the United States if for no other reason than 
to have an outlet for their additional crude oil. Whether that 
would be Saudi Arabia or Kuwait or the Emirates, and I can name 
a host of others, I suppose it has 30 years or thereabouts 
since the last refinery was built in the United States, so most 
of the executives who have been with these companies for a long 
time can't even remember.
    Mr. DeFazio. They don't know how to build them any more.
    Mr. Sokel. They might have forgotten or if they do, the 
building prospects are mostly in the emerging market countries. 
That is kind of the perspective that I have. It is precisely in 
the countries that are considered emerging markets now where 
most of the refinery capacity has increased over the last 
decade.
    Mr. DeFazio. The interesting thing there is what are the 
profit margins over there?
    Mr. Sokel. They are good but they are not as good because 
of the simple fact that people don't drive in the same way that 
they do in the United States.
    The one point I would like to make is that in terms of the 
waiver of sulfur, that is an interesting proposal from the 
President because a number of the refineries in the Middle 
East, for example, produce a higher sulfur of gas oil that 
currently does not come into the United States in its natural 
form. Were sulfur requirements to be removed, a lot of that 
product by normal market forces would find its way into the 
United States.
    Mr. DeFazio. I think there is a problem with the outfall of 
burning the higher sulfur fuels particularly with catalytic 
converters and other things I don't think we are going to 
recommend we step back from.
    Mr. Sokel. The problem is, given the environmental 
legislation that would be needed to do that, that is probably a 
non-starter.
    Mr. DeFazio. Thank you.
    Mr. Mica. Mr. Larsen?
    Mr. Larsen. Thank you.
    A little more about hedges. We are doing our part in 
Washington State out of the four refineries located from 
northern California to Washington State to the border, four of 
them are in my district, so we are doing our part on 
refineries.
    Mr. Sokel, with regards to hedges, Mr. Costello asked a 
question about why hedge on crude oil and not jet fuel and it 
seems to me in terms of that regard, nothing government did 
stopped or prevented or forced people to hedge into the crude 
oil market versus jet fuel, that the decisions made by airlines 
based upon whatever advice they got, they made those decisions 
to go into crude oil and not jet fuel.
    Why make that choice versus Southwest Airlines, if I am not 
mistaken, has a better hedge in jet fuel versus crude. What is 
the decision-making process that takes place within an airline 
so we can understand that because it is not something we are 
going to be able to address, nor should we interfere in a 
market like that.
    Mr. Sokel. It is an interesting set of questions. I guess 
you could start by saying that unto each individual airline 
goes their own rationale of how to hedge, when to hedge, 
whether to hedge at all. There are a lot of concerns that go 
into the matter, not the least of which is what happens if we 
put on a hedge that loses money and Wall Street says, well, we 
didn't invest in your company because we thought you were a 
good oil traders, we wanted a pure view on the positive 
prospects of the industry.
    Just to step away from the aviation industry for a moment, 
that is exactly what happened recently with Valero. Valero lost 
$300 million on their refinery hedges and more than a few 
analysts did say to William Grehee, we didn't invest in your 
company because we thought you were good oil traders. We wanted 
a pure view on the refinery sector. It didn't matter that the 
stock price has gone from $40 to $120 in the last year, people 
always found something to moan and groan about.
    If I can make a comparison with one of the European 
carriers that Deutsche Bank does a great deal of business with, 
the way they set it up is they try to mirror the hedging 
program actually with their route structure. For example, if 
they know they are going to be refueling 70 percent in the 
northwest European market, that is where 70 percent of their 
hedges go. If it is 10 percent in the Gulf Coast or related 
pricing to the Gulf Coast, then that is where they would do it.
    In terms of the American carriers, I think Southwest is 
probably the best example of having instituted a hedge program 
at least that in percentage terms goes out to 2009, I believe 
between 30 and 40 percent hedged between 2007 and 2009. 
Ultimately it comes down to an individual or group of 
individuals saying, we really don't think there will be that 
much demand for jet fuel relative to crude and we are trying to 
place our hedge in something that will at least reflect the 
broader price of oil.
    Again, the question of liquidity and transparency typically 
is one reason because a typical CFO is not only hedging oil, 
they are hedging interest rates, currency, so familiarity may 
go to the heart of the matter of how hedges are placed and 
certainly when they are placed.
    Mr. Larsen. In your view, for future planning for 
individual airlines, has the econometrics model that has 
existed for the price of the barrel oil permanently shifted up, 
is the delta steeper now and should they be thinking about 
that?
    Mr. Sokel. I think it is a very delicate point because 
arguably most airlines are now on the more optimistic side of 
their view of what jet fuel prices will be for the next two 
years. I am a little bit conservative in my view but I believe 
you have to estimate the price of jet fuel as to what the price 
would be if you had to hedge 100 percent of your fuel today.
    Many in this room would argue that is not necessarily 
indicative because the analyst community did not expect to see 
$70 right now, they were forecasting much lower price and it is 
now for next year they are predicting $60 prices, so the 
contrarian in me says maybe there will be lower prices just 
because everyone now has suddenly gotten onboard that the 
prices of energy are high.
    Having said all that, an absent a recession, global 
reduction of growth, it is hard to see given the global 
situation in jet fuel and with global airlines. I did mention 
the demand for the marginal barrel of fuel. It is a fungible 
market, the barrel of jet from a Korean refiner to LAX airport, 
so on and so forth, has its way of when one market is in 
deficit, the other market in surplus provides that market but 
all that means an increasing demand period, it just means 
higher prices for the extended period.
    Mr. Larsen. Mr. Baggaley had some comments about hedging 
and Southwest. Do you want to comment on any of this?
    Mr. Baggaley. Yes. It is certainly the case that many 
airline managements are regretting that they didn't try to put 
more hedges in place but the biggest difference between 
Southwest Airlines and the legacy carriers is Southwest 
Airlines is rated A, a solid investment grade credit. They can 
do business in setting up hedges with others because counter 
parties will take their credit risk.
    For most of the legacy carriers, for all of the legacy 
carriers, they would have to put up cash collateral and they 
are trying to conserve their unrestricted cash. That is their 
last line of defense against bankruptcy. So their choices at 
this point have narrowed.
    Mr. Larsen. Thank you, Mr. Chairman.
    Mr. Mica. I thank all of our panelists. I think you have 
answered the question of what should Congress do and what if 
Congress does nothing.
    I guess that is sort of the question. It looks like we are 
headed toward some type of assistance with pension reform which 
is also spilling now into other aspects and segments of our 
economy. Regarding fuel, we must increase refining capacity and 
supply on an expedited basis. Not much is going to happen 
there. I think we are at sort of a standoff as to what Congress 
can do.
    I am glad you all raised the four cents and the ticket tax, 
and financing the infrastructure. We talked a bit about 
capacity of the airlines interns of seats but we also face a 
capacity crunch with airlines as far as a place to land planes. 
We can only fit so many planes in so much air space and we are 
back to the pre-September 11 capacity issues facing the 
industry.
    I am concerned about the impact of leaving airports and 
others holding the bag so to speak, particularly when it is 
necessary to continue increasing capacity for more planes to 
land. If you can't have more revenue and you can't do more 
business, there is not much hope for the future. That is just a 
couple final comments.
    I appreciate your participation. We may have some 
additional questions. Some of our members were called away for 
a conference but we do appreciate your insight and sharing your 
opinions, your knowledge, your experience with us. Again, on 
behalf of the Subcommittee, we thank you for your participation 
today.
    We will conclude the hearing. There being no further 
business before the Aviation Subcommittee, this hearing is 
adjourned.
    Thank you.
    [Whereupon, at 4:15 p.m., the subcommittee was adjourned.]
    [GRAPHIC] [TIFF OMITTED] T5912.001
    
    [GRAPHIC] [TIFF OMITTED] T5912.002
    
    [GRAPHIC] [TIFF OMITTED] T5912.003
    
    [GRAPHIC] [TIFF OMITTED] T5912.004
    
    [GRAPHIC] [TIFF OMITTED] T5912.005
    
    [GRAPHIC] [TIFF OMITTED] T5912.006
    
    [GRAPHIC] [TIFF OMITTED] T5912.007
    
    [GRAPHIC] [TIFF OMITTED] T5912.008
    
    [GRAPHIC] [TIFF OMITTED] T5912.009
    
    [GRAPHIC] [TIFF OMITTED] T5912.010
    
    [GRAPHIC] [TIFF OMITTED] T5912.011
    
    [GRAPHIC] [TIFF OMITTED] T5912.012
    
    [GRAPHIC] [TIFF OMITTED] T5912.013
    
    [GRAPHIC] [TIFF OMITTED] T5912.014
    
    [GRAPHIC] [TIFF OMITTED] T5912.015
    
    [GRAPHIC] [TIFF OMITTED] T5912.016
    
    [GRAPHIC] [TIFF OMITTED] T5912.017
    
    [GRAPHIC] [TIFF OMITTED] T5912.018
    
    [GRAPHIC] [TIFF OMITTED] T5912.019
    
    [GRAPHIC] [TIFF OMITTED] T5912.020
    
    [GRAPHIC] [TIFF OMITTED] T5912.021
    
    [GRAPHIC] [TIFF OMITTED] T5912.022
    
    [GRAPHIC] [TIFF OMITTED] T5912.023
    
    [GRAPHIC] [TIFF OMITTED] T5912.024
    
    [GRAPHIC] [TIFF OMITTED] T5912.025
    
    [GRAPHIC] [TIFF OMITTED] T5912.026
    
    [GRAPHIC] [TIFF OMITTED] T5912.027
    
    [GRAPHIC] [TIFF OMITTED] T5912.028
    
    [GRAPHIC] [TIFF OMITTED] T5912.029
    
    [GRAPHIC] [TIFF OMITTED] T5912.030
    
    [GRAPHIC] [TIFF OMITTED] T5912.031
    
    [GRAPHIC] [TIFF OMITTED] T5912.032
    
    [GRAPHIC] [TIFF OMITTED] T5912.033
    
    [GRAPHIC] [TIFF OMITTED] T5912.034
    
    [GRAPHIC] [TIFF OMITTED] T5912.035
    
    [GRAPHIC] [TIFF OMITTED] T5912.036
    
    [GRAPHIC] [TIFF OMITTED] T5912.037
    
    [GRAPHIC] [TIFF OMITTED] T5912.038
    
    [GRAPHIC] [TIFF OMITTED] T5912.039
    
    [GRAPHIC] [TIFF OMITTED] T5912.040
    
    [GRAPHIC] [TIFF OMITTED] T5912.041
    
    [GRAPHIC] [TIFF OMITTED] T5912.042
    
    [GRAPHIC] [TIFF OMITTED] T5912.043
    
                                    
