The commercial airline industry is at a crossroads and the regional carriers are now playing a much larger role in determining not only their future, but also the future of the legacy carriers.

As the Regional Airline Association (RAA) prepares to meet in Cincinnati on May 16, some things have changed in a year and much has remained the same.

For the second year in a row, the price of oil has remained dangerously high. Last year, the battle cry for the regionals and network partners alike was cost control, cost control, cost control. Unfortunately, with oil hovering at the $50 a barrel mark for an extended period of time, all the cost control gains have been swamped in the red ink of fuel bills.

In terms that may be a little dramatic for some, economist George Hamlin, of MergeGlobal, believes the industry is now at the edge of the Battle of Armageddon in the final battle of good and evil. "We are about as close to that as we have ever been," Hamlin told Regional Aviation News. "I think we will lose one or more legacy carrier in the near future."

Or put a little differently, "we are standing in a place where after the earthquake, we will be on the edge of a cliff. In geologic time, the earthquake is very near. In the way human beings measure time, it could be a relatively long, nerve-wracking wait."

The consensus among industry experts polled by Regional Aviation News is that the industry is on the verge of a long-awaited consolidation - and that consolidation may not be limited to the majors. In 12 to 18 months, there will be at least one less network carrier, many experts believe. The most nominated carrier to face liquidation - and not all wanted to name names - is US Airways [UAIRQ].

Consolidation could mean the reduction of excess capacity in the system, Hamlin said. "Consolidation can be both a problem and opportunity for the regionals," he said. "It can be a problem if the hub you serve goes away." The opportunity could be in flying point-to-point routes for local traffic out of the former hubs.

"There is a concern in the industry about the potential of consolidation within the major airlines," said Deborah McElroy, RAA's president. "Many regional CEOs have publicly stated they are developing contingency plans to ensure their airline is well positioned in the event of consolidation."

"The historic roots of the regional industry have slipped away and it is in a very uncertain environment right now. We have a situation were the supposed little guys - the regional - is in a position to take over the industry," said Michael Roach, an airline consultant with Roach and Sbarra. He was the founder of America West Airlines [AWAC]. "I think the solution for the regional carrier is driven in part by the solution for the legacy carriers. I don't mean they are dependent on letting the legacy carrier thing play out. No, they are taking an active role. They are making deals from strength with the financially weak-kneed carriers. Some will morph to replace legacy carriers in some complex ways."

In moves that were not expected, Air Wisconsin and then Republic Airways [RJET] agreed to invest $250 million in bankrupt US Airways in hopes of returning the carrier to profitability. Each regional carrier will own at least 19 percent of the carrier's post-bankruptcy stock. In addition, Republic for an extra $110 million could end up controlling all of US Airway's gates at both New York LaGuardia Airport and Washington Reagan National Airport and its fleet of Embraer [ERJ] 170s and future 190s.

Whether it is called "pay to play" or "upside vertical integration," Dan Kasper of LECG, a Cambridge, Mass., consulting firm, said "regional carriers are making some very cold-blooded calculations that if they make a major investment in their major code-share partner that they will continue to be able to fly as a regional partner."

Some of the regional carriers may "rise out of the ashes of the legacy carrier to do business in a another way," Hamlin suggested. With a lower cost structure and lower increments of capacity, Hamlin said a regional might step in and decide to fly larger RJs, or an Airbus 319 or Boeing [BA] 717 as the largest element in its fleet. "You may not have the same capacity situation that the legacy carriers have now."

As these regional carriers change, some will be better positioned to deal with the change and thrive, Kasper said. Regional carriers, such as SkyWest [SKYW] that have developed their brand and route system will be the survivors. These carriers have long provided point-to-point service without always passing passengers onto the network code-share partner. On the other hand, he said, carriers such as Mesa Air Group [MESA] and Republic that simply transfer passengers to the network carrier at a hub will have a harder time if one of its partners goes out of business, Kasper told Regional Aviation News.

The one regional that has apparently failed the morphing exercise is Independence Air [FLYI]. While analysts agree that Flyi did little right as its set out on its own when it rejected its code-share pact with United Airlines [UALAQ], there are some lessons for other carriers. A branded image and a niche are needed before establishing a new carrier and a carrier needs cost-efficient aircraft. "The 50-seat RJ is not a low-cost machine," Roach said. "It cannot compete against Southwest Airlines [LUV]."

The key to establishing a new low-cost carrier in the regional world, he said, is to create one and place it within an existing airline holding company. But don't pile onto the new carrier the high costs of the existing company and its business practices, Roach cautioned.

And never start a new carrier with as many as 80 planes, Hamlin added.

While Kasper does not see dramatic crossroads ahead for the regional industry, he does see harder times. The high profits of the last several years have been an "anomaly from history" with a confluence of one-time events fueling the high profits, Kasper said. The events include the widespread introduction of the RJ and the shift of flying from the network carriers to their regional code-share partners.

"The deals that gave the regional affiliates large sums of money without risk are no longer affordable. There will be a lot of pressure on the regional to change the deals, which will be less lucrative and shift economic risk to the regional carriers."

With a glut of 50-seat RJs now in use, Kasper said the major partners have the upper hand in selecting regional partners.

United's decision to bid out the Air Wisconsin routes and then award them to others is an example that the rules have changed, he said. Partner loyalty is no longer an important variable.

David Swierenga, an economist with AeroEcon, of Vienna, Va., is more hopeful than most.

Although Swierenga sees the airline industry losing $3.5 billion to $4 billion this year, he does not see any carrier failing. The carriers have enough positive cash flow to carry them through the next "dry" stretch between Labor Day and Easter.

"I am more optimistic than most," he admitted. Swierenga believes that the cost of oil this year will average $48 a barrel and dip next year to $44 a barrel. At the $44 mark, Swierenga said the industry should break even next year. A break-even average means some of the carriers will be profitable, he notes.

Every $1 shift in the price of crude creates a $634 million swing in the cost of fuel for the aviation industry, Swierenga said.

Kasper, who is not as optimistic about price of oil, noted that the high crude prices have already started to dampen the economy. There is a danger, he said, that the already long economic recovery could cool. The airlines are highly dependent upon the economy picking up steam to generate the revenues to cover the fuel bills, Kasper said.

With all the talk of new and large aircraft, Stuart Klaskin, of Miami-based KKC Aviation Consulting, is concerned the regional industry has lost it roots. "The talk of regional jets is sexy. The regional carriers have re-invented themselves. The trouble is who is providing service to the small communities?"

Service to cities once served by 19-seat or 30-seat aircraft has been scaled back or eliminated with the adoption of the RJ. It is economically difficult to provide the service to these communities with a 50-seat RJ, Klaskin said.

While a few carriers continue to profitably serve these communities with nine-seat or 19-seat aircraft, too many cities are now forced to do without a connection to the national air transportation grid. Klaskin noted that as regional carriers look to greener pastures they are leaving markets wide-open to new competitors. As the micro-jet industry develops, Klaskin said the next generation of charter companies or air taxi services will step in and serve the traveling business community from these smaller markets. These developments place downstream airline revenue in jeopardy. Instead of driving for hours to a major hub to get a flight on a national carrier, Klaskin said these travelers would bypass the commercial airlines entirely with the point-to-point service of these new micro-jet operators.

As part of the RAA general session on May 19, McElroy said there will be presentations on how to better serve these communities or the 476 airports that rely exclusively on regional carriers to be connected to the national grid. Likewise, McElroy said there will be suggestions as to how small airports can reduce their operating costs and in turn pass these savings onto the regional carriers.

>>Contacts: George Hamlin, MergeGlobal, (703) 526-6694; Deborah McElroy, RAA, (202) 367-1170; Michael Roach, Roach and Sbarra, (415) 244-0994; Dan Kasper, LECG, (617) 252-9994; David Swierenga, AeroEcon, (703) 255-3315; Stuart Klaskin, Klaskin, KKC Aviation, (305) 445-3103.<<

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