If last year could be dubbed the 'Year of New Alliances' for regional airlines, this year could be hailed as 'New Alliances: The Sequel."

In the closing days of 2005, Continental Airlines [CAL] gave notice that it is now seeking a second code-share partner to fly up to 69 50-seat regional jets. Continental is pulling 69 planes from ExpressJet [XJT] in order to find a cheaper operator.

As Continental seeks a new partner, Northwest Airlines [NWACQ] is also soliciting potential new partners to fly both 50-seat and 75-seat regional jets.

And then there is Independence Air; the operating unit of bankrupt FlyI [FLYIQ] that is on the auction block with its future very much in doubt. A court-supervised auction is to take place this week.

Last year, Air Wisconsin and Mesa Air Group [MESA] changed partners as the network carriers tried to sort out financial difficulties.

ExpressJet

Unable to come to terms on a long-term capacity purchase agreement with ExpressJet, Continental last week decided the rates offered by ExpressJet were not low enough for Continental to be competitive with other network carriers, or to protect its 42,000 employees. ExpressJet currently flies 274 Embraer [ERJ] 135s, 140s and 145s that Continental owns. Continental decided to pull the maximum permitted by its contract - 25 percent, or 69 planes, from the Embraer fleet.

Continental controls about 20 percent of ExpressJet's stock, according to its last proxy statement. The network carrier as recently as 2003 owned all of ExpressJet's stock. However, the Continental Retirement Plan Trust has been selling its ExpressJet shares this past fall and owns 5.3 million shares, according to a Dec. 13 filing with the U.S. Securities and Exchange Commission (SEC).

Under the terms of a 2002 operating agreement, ExpressJet has the option of continuing to lease the 69 airplanes - at a substantially higher rate - if the regional carrier can find another code-share partner. The agreement, however, precludes ExpressJet from flying these planes out of a Continental hub and it would need Continental's blessing beforehand. ExpressJet has until next October to affirm its continued use of these planes.

As Continental issues a new code-share solicitation to most other regional carriers, the new regional bidders need to have contingencies in place to supply their own aircraft if ExpressJet keeps the 69 planes, said David Messing, Continental's spokesman. Continental is not taking the opportunity to find a regional to fly larger RJs; those interested carriers need to submit their bids using aircraft similar to the Embraers now flown by ExpressJet, Messing said.

In an SEC filing, Continental expressed hope that a new contract with a new regional partner will produce cost savings, but admitted "there is no assurance that we will be able to achieve the savings."

The transition to a new partner will begin in December and be completed in the second quarter of 2007.

In its own announcement, ExpressJet noted that it is continuing to negotiate 2006 rates with Continental. The network carrier will continue to pay ExpressJet its December 2005 rates until a new accord is reached; however, the new rates will be retroactive to Jan. 1.

Independence Air

The lawyers for FlyI will hold an auction for the carrier's assets. The bidding is confidential so it is not clear if there is a suitor out there that wants to keep Independence flying. The two known suitors are interested in pieces of the company, but not the whole thing.

United Airlines [UALAQ], still operating under Chapter 11, has asked the court for permission to bid on undisclosed assets. In its former life, FlyI was Atlantic Coast Airlines and it was the Dulles operator of United Express. Unlike other regional operators, Atlantic Coast owned its gates and support facilities at Dulles, which it took when it left United Express and formed Independence Air. United had been forced to build and operate other facilities at Dulles.

FlyI also has a $500 million claim against United stemming from fee-for-service payments still owed from its code-share days. United's bankruptcy judge last month reduced FlyI's claim from $1 billion. FlyI now joins other unsecured creditors who will be paid pennies on the dollar when United exits its bankruptcy proceedings, now scheduled for next month.

Mesa, a United Express provider, has also expressed an interest in some FlyI assets, according to press reports. Mesa made an unsuccessful attempt to buy then-Atlantic Coast in the fall of 2003. In that bid, it had United's support.

As further evidence that the carrier won't be sold as an operating unit, FlyI sent its employees a letter last week notifying them that the airline would probably cease all operations between Jan. 7 and Jan. 21. "The company expects that is it is unable to secure significant external investment or a sale of all or substantially all of its operations before January 7, 2006," Jeff Rodgers, vice president for employee services, wrote to the carrier's employees.

Northwest Airlines

One or both of the Northwest Airlink partners, Pinnacle Airlines [PNCL] or Mesaba Aviation [MAIR], are likely to be in a new code-share arrangement this year, or facing the fate of FlyI.

Mesaba is already operating in bankruptcy and is trying to secure salary savings of 19 percent from each of its four unionized work groups. According to Northwest's bankruptcy filings, Mesaba, which once flew 100 planes, could be down to 16 planes if Northwest decides to return all of the Avro RJ85s and most of the Saab 340s.

Last month, Northwest told Pinnacle that instead of affirming its existing contract to fly 139 Bombardier [BBD] CRJ 200s, its entire jet contract would be put up for bid. Northwest has invited Mesaba and well as Pinnacle to compete for 124 regional jets - some of which could be as large as 75 seaters. The call for proposals has apparently been issued to a number of regional carriers.

Northwest owns the planes now flown by both Mesaba and Pinnacle.

"I think they [Mesaba and Pinnacle] need to look at a lot of different options. I would be worried if I were either of them," said Daryl Jenkins, a visiting professor at Embry-Riddle Aeronautical University. "It can't be happy times for either of them."

Even as Northwest solicits an operator for larger aircraft - it is unclear who would own these larger planes - the Northwest pilots continue to fight any scope relaxation that would be necessary for a regional carrier to fly any aircraft larger than a 50 seater.

Faced with a Jan. 17 deadline to reach an accord with Northwest, the Northwest Air Line Pilots Association (ALPA) unit still objects to scope changes needed for a regional to fly the 70-seat or 75-seat class, or for the formation of new in-house carrier to fly 76-seat to 100-seat aircraft. Northwest had earlier asked its bankruptcy judge to void the current contract and impose new wages and work rules. The two sides have reached a temporary salary pact as they work toward reaching a permanent agreement by the Jan. 17 court hearing.

In a recent court filing, Northwest said that it now needs $2 billion - not $1.4 billion - to get out of bankruptcy and to buy new aircraft as part of its reorganization. Furthermore, Northwest will not be profitable until 2009 or 2010, as it needs to spend $5 billion to $7 billion to modernize it fleet over the next seven to 10 years.

"Northwest is in the most radical restructuring of all those we have seen," Jenkins tells Regional Aviation News. "I thought this is what would happen to everybody.

"I thought the relationship between the majors and the regionals would change in the first round of restructuring. It has not changed that much. Fundamentally, it is still the same. The absolute numbers have changed, but the rules by which they play have not changed that much.

"That part of my prediction from a couple of years ago did not come true. I called it wrong," Jenkins admitted.

Even as Northwest plays hardball unlike the earlier bankrupt carriers, Jenkins said that any regional carrier with planes needs to take a look at a potential contract with Northwest if it wants to grow.

Big Picture

The International Air Transport Association (IATA) predicts that the worldwide airline industry will return to profitability in 2007. In 2006, the industry is still expected to lose $4.2 billion - down form 2005's $6 billion. It is the U.S. carriers that continue to pull down the worldwide averages, as most other carriers have been profitable since 2002. Ray Neidl of Caylon Securities estimates that U.S. industry lost $4.8 billion last year. Even though more carriers are expected to be at least marginally profitable this year, Neidl estimates the U.S. industry will collectively lose $2.1 billion.

"The good news is that pricing power has returned," Jenkins said. In fact, he added, it is the "only good news out there."

Last year there were 30 attempts by carriers to raise fares and they were successful in 17 instances. "The amounts of the fare increases we are getting are small - in the $2 to $4 range. It is fairly easy to pump up prices by $4. The larger attempts at $20 and $30 all failed.

"I think fares will up 3 to 4 percent this year. If we can continue that, it will be a less bad year. I don't know if it will be a good year," he added.

Without a doubt, the escalating cost of fuel last year triggered a large share of the red ink. Northwest and Delta Air Lines [DALQ] directly attribute their bankruptcies to the high cost of jet fuel.

By the end of 2006, the price of oil will drop to about $52 a barrel, predicted Nigel Gault, an economist at Global Insight that specializes in the travel industry. At year's end, the price hovered at $60 a barrel. The lower price will not make a difference in the price of air travel, Gault added, but it will reduce the pressure that has been pushing up the fares.

The U.S. economy is expected to grow at a 3.5 percent pace - slightly slower than the pace of 3.7 percent recorded in 2005.

The biggest risk for the travel industry is not the fuel prices or the economy, he said, but the potential of an outbreak of the avian flu. "SARS in 2003 was very isolated, but the impact on travel and tourism was hugely out of portion to those that were infected. An outbreak of the avian flu would be a real disaster," he said.

Fleet Forecasts

The day of the 50-seat RJ is past. Both Bombardier and Embraer have scaled back production levels to a minimal number of planes - or suspended production outright. "We are seeing the demand for the 50-passenger RJ really falling off," said Bill Dane, an analyst with Forecast International. "I would expect to see them distributed to lower-tier operators as used aircraft."

Some of the 50 seaters will be parked, said Richard Aboulafia, an analyst at the Teal Group. Those still in use will be subject to lower lease rates. "The majors are trying to reinvent themselves. There is going to be a wholesale shakeout of the fleet."

With some relaxation of scope clauses, the network carriers are asking the regionals to fly more 70-seaters. "There is exactly the same potential for growth-think that went with the 50 seaters," Aboulafia said. "The production rates right now are pretty reasonable. If they decided to push metal out the door and everybody settles on the exact same strategy, it can result in another oversupply situation."

At this point, Dane said Embraer enjoys the long-term advantage over Bombardier. The Embraer 170/190 family offers commonality for carriers to grow with, he said, while Bombardier's CRJ 700 and 900 are tied to the smaller CRJ technology.

>>Contacts: David Messing, Continental, (713) 324-5080; Daryl Jenkins, Embry-Riddle, (540) 364-6913; Ray Neidl, Calyon, (212) 261-4057; Nigel Gault, Global Insight, (781) 301-9093; Bill Dane, Forecast International, (203) 426-0800; Richard Aboulafia, Teal Group, (703) 385-1992.<<