Airlines and Oil: A Lesson in Capitalism

Jared Dillian |

Every once in a while, I’ll be finger scrolling through Twitter (TWTR) and I’ll come across a tweet from a journalist about how oil prices are going down and airfares are going up, so something must be done. I mean, shouldn’t all businesses pass along windfall profits to their customers? Shouldn’t there be a law or something?

For a little history, let’s think about the fact that the entire airline industry has been through two big waves of bankruptcies in the last 20 years. Just about every airline has gone bankrupt at least once. They couldn’t control costs. They neglected to hedge fuel prices. Labor disputes. It’s been one thing after another, including 9/11, which induced the biggest travel slump in history.

Warren Buffett even quipped that someone should have shot Orville and Wilbur out of the sky, airlines have destroyed so much capital. Just to prove that Buffett is wrong about a lot, airlines have been one of the best bets in the stock market the last few years—breathtaking, actually. (My airline pick in Bull’s Eye Investor (not DAL) offers a great entry price right now.)

These days, Buffett doesn’t do much buying when people are fearful—he buys negative growth businesses at a 25 P/E if he can get preferred stock and defer his taxes, not a strategy that is available to most people.

Anyway, back to my original point: There’s this crazy talk about how airlines are some kind of public utility that should only be allowed an “acceptable” profit margin so you and I can continue to fly coast-to-coast for $300 round trip.

Next thing you know, we’re back in the 1970s (when tickets were much more expensive, imagine that).

I think we as a country need to have an honest talk about what the role of profit in society is. It seems these days we’d like to turn everything into a public utility. The utilities themselves deliver electricity the same way they always have for the last hundred years—no innovation whatsoever. Banks are essentially utilities now—we condemned “excessive” risk taking, but now we’re starting to have the opposite problem. The Internet is a public utility now, with consequences we can’t even comprehend.

Somehow American capitalism has devolved to the point where we’re okay with profits, as long as they’re small profits. Nobody is allowed to kill it anymore.

And admittedly, the airlines are killing it. There are now four major carriers in the US. They’ve squashed their cost structure after years of restructuring, and oil just took a giant dirtnap. It really couldn’t get much better. They’re rolling in dough.

So after going through 25 years of hell, people still have this reflex where they see oil go down and say, “Mr. Airline, you’re supposed to pass along those savings to me.”

No, they’re not.

They’re supposed to charge you as much as you can possibly bear, regardless of what their cost structure is. That’s business. The price of airline tickets is determined by supply and demand. The supply is restricted, after years of cutting unnecessary routes, and now everyone wants to fly again. It’s showtime for airlines.

This kind of economic illiteracy is pretty common (especially among journalists). Airlines are a notoriously volatile and risky business—one SARS virus and you’re done—and maybe the purpose of excess profits for a few years is so they can put something away for the inevitable lean times that will follow.

This is the sort of thinking that gets us in trouble, though. This is what gets entire industries nationalized, which is what happens when some congressman has his flight canceled and starts talking about how the airline industry is in the “national interest.”

Things that people think are too important to be left to capitalism are usually exactly the things you want left to capitalism.

On a side note, California could easily solve its water problem by letting the market take over and allowing variable pricing. I don’t like hearing the word “ration” in this country. If you give someone the opportunity to make stupid money solving a problem—guess what, the problem will get solved. If the idea of someone making stupid money offends you for whatever reason—I’m not really sure what to say.

As far as the investment merits of airlines go, well, for sure the easy money has been made. They say fortune favors the bold. As for Buffett, he’ll probably wait about five years and come in when the stocks are fully valued, buy one, and then work behind the scenes to get a gasoline tax hike passed.

I try to be cynical, but it’s hard to keep up.

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Companies

Symbol Name Price Change % Volume
DAL Delta Air Lines Inc. 48.31 0.54 1.13 8,870,335
TWTR Twitter Inc. 17.93 -0.10 -0.55 12,208,682

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