Taylor on Travel

The huge fines meted out to British Airways last year for collusion with Virgin Atlantic on the level of fuel surcharges were maybe not so huge after all. Time lends new perspective.

BA paid out £121.5 million to the UK's Office of Fair Trading after being fingered by Virgin, and a further $300 million to the US Department of Justice after admitting price-fixing in both its passenger and cargo operations.

Four more airlines received fines totalling $504 million in the US last week after agreeing to plead guilty to involvement in a conspiracy to fix surcharges on cargo.

Air France-KLM took the biggest hit - $350 million. Cathay Pacific will pay $60 million, SAS Scandinavian Airlines $52 million and Martinair - a carrier half-owned by Air France-KLM - $42 million.

According to the US justice department, Air France-KLM conspired with other airlines to suppress and eliminate competition by fixing rates for air shipments to and from the US for six years from January 2000.

Lufthansa played the role of Virgin, escaping a heavy US fine by being first to volunteer information to the justice department. No doubt this has not led to cordial relations between Paris and Frankfurt.

Fines so far imposed total $1.2 billion. Korean Air has paid out $300 million, Japan Airlines $110 million and Qantas $61 million. Up to 30 airlines are under the microscope in the US, individuals face criminal prosecutions and investigators in the European Union and elsewhere are at work - so expect further fines.

Qantas claimed the distinction of being the first airline to have a former executive sent to jail last week. Brian McCaffrey, ex-head of freight operations in the US, received an eight-month sentence and a $20,000 fine.

Then there are the class-action lawsuits. BA and Virgin Atlantic agreed a $200 million settlement with US lawyers acting on behalf of passengers in February, and Lufthansa settled a claim by cargo customers for $85 million in March.

None of this is handy going into the biggest aviation downturn in decades. As they say in the US - do the math.

But the most interesting question remains unanswered. How on earth did this come about? The industry was not especially in crisis at the point at which these acts of conspiracy or collusion commenced. The cargo conspiracy allegedly began in 2000. The fuel-surcharge collusion dated from 2004.

Was it due to ignorance of the law on a vast scale? Should we blame collective hubris at a senior level? Or have some of the habits of a generation of airline executives fallen foul of an unexpected zeal among enforcement agencies?

Fraud is a perennial concern to business and never more so than when times are hard.

Even a relatively minor fraud may be enough to push a small business under. So a report by accountants BDO Stoy Hayward, released this week under the headline 'As the credit crunch bites so do the fraudsters', makes alarming reading.

UK business fraud is booming, with reported fraud in the first half of the year up 74% over 2007 to a total of £705 million. April alone saw £317 million swiped.

Bankers and insurers bore the brunt of the first-half losses, to the tune of £636 million - which I at least find heartening, although I guess the cost will only be passed on. BDO reports this was a 15-fold increase on reported fraud in the sector during the same period last year.

The BDO fraud services team points out: "When you add in the fraud that has not yet been uncovered or which businesses have discovered but do not wish to expose, the real cost could be much, much higher." It is the known-knowns that get you as much as the unknown-unknowns, as Donald Rumsfeld would appreciate.

Some aspects of most reports should be taken with a pinch of salt. BDO Stoy Hayward's is no exception. We can dismiss its excitement at the fact that this is the biggest increase in fraud since the BDO FraudTrack service began, since we are talking about something that dates from 2005 here.

Other findings stand out, however. The biggest threat to businesses comes not from organised gangs but from their own management and those they do business with every day.

Management fraud accounted for 46% of the total and third-party fraud, usually involving suppliers, accounted for 32%. Employee fraud amounted to barely one-quarter of that perpetrated by management.

In the words of BDO fraud services team head Simon Bevan: "Management are robbing you blind and suppliers are ripping you off. My team has never been so busy."

The results are interesting in light of ABTA's long-running campaign to make members more aware of the danger of fraudsters, since the greatest danger lies within - as unfortunately ABTA should be only too aware.

In this respect, fraud is a bit like violence toward the person or the risks to children. Read the papers and you will be convinced the greatest risk comes from strangers. Look at the statistics and you will know otherwise.

The Court of Appeal's rejection of the Federation of Tour Operators' case against the Treasury was hardly a major surprise.

Lawyers can argue about anything, but they agree on the importance of precedents - and in that light, it was unlikely the Lord Justices would decide the Treasury should repay £50 million in tax to anyone. Think where it might lead.

The FTO argued its members' human rights had been breached by having £50 million taken from them after Chancellor Gordon Brown, as he was, suddenly announced a doubling of air passenger duty in December 2006.

The rise was introduced within seven weeks, forcing tour operators to pick up the bill on holidays booked prior to the announcement. Airlines could simply surcharge passengers for the money, but tour operators were largely prohibited from doing so by the Package Travel Regulations.

The FTO's appeal rested on five points following the dismissal of an earlier challenge in the High Court last year.

First, the Treasury was ignorant of the impact on tour operators when it decided to double APD at short notice. Second, there could be no environmental justification for increasing tax on bookings already made.

Third, the government had previously delayed increases in APD out of recognition of the restraints on tour operators. Fourth, it would have been easy to exempt existing bookings and, fifth, the increase was retrospective.

The Treasury countered with five arguments of its own. First, that it took the impact on tour operators into account after this was pointed out and ministers decided to proceed anyway.

Second, the 'environmental benefit', whatever that might be, was not the only reason for the tax increase. It also aimed to raise revenue - and excluding pre-booked flights would have cost the Treasury £50 million.

Third, the previous postponements were not comparable. Fourth, the nature of a tour operator's business meant an increase in APD was always a risk. And fifth, governments have a right to determine tax measures.

In keeping with this legal-case-by-numbers approach, the FTO's case was dismissed on four counts.

First, the Lord Justices decided: "A postponement [of the tax rise] for tour operators alone would have been difficult to justify."

Second, postponement across the board would have involved 'substantial loss of revenue'.

Third, tour operators were not uniquely disadvantaged. "Airlines took a commercial risk in passing on the increase to passengers, and one [British Airways] chose not to."

Fourth, tour operators "were not unable to absorb the impact" - note the lawyerly double negative. They could mitigate the effect by increasing charges for passengers who booked subsequently, and at least one did.

So basically, this sudden rise in tax was justifiable because that is what it was. But I'm no lawyer.

People in the travel industry have enough to think about without 'peak oil', but bear with me. It is a notion that has been around for a while and refers to the point when world oil production will peak and then fall. Oil companies have routinely dismissed the concept. For better or worse, it may soon be upon us.

Chris Skrebowski, consulting editor to Petroleum Review, told a seminar organised by the Travel Foundation last week that the world will reach peak oil in 2011 - although he noted it could be earlier - and this is the major reason for the high oil price.

Skrebowski's argument is laid out in the current Travel Weekly and can be found at www.Travelweekly.co.uk. In essence, 25 of the world's major producers are already in decline, oilfields are depleting at a rate of 4.5% a year or more and there is little oil left to discover. This is reflected in the escalating costs of production and increasing delays in development.

Of additional concern to airlines, the greatest shortfall is in middle distillate or light, sweet crude oil - the type from which jet fuel and diesel are refined. According to Skrebowski, "We may already be at the peak for light, sweet crude."

The implications for travel are profound. Fuel prices may stabilise at some new level, but no one knows how high that will be.

Let's deal with alternative fuels another time. At this moment the world depends on oil. Why has peak oil come to the fore now? Oil was $20 a barrel in 2003 and $10 not long before that. Surely, if peak oil in 2011 was a realistic prospect it would have affected the price earlier?

Richard Miller, who retired from his job as a geochemist for British Petroleum this year and also addressed the Travel Foundation, can explain.

Oil reserves are included in oil company financial reports and listed among their assets. Their share prices and future profits depend on the amount of extractable oil in the ground.

As a consequence, says Miller, the oil giants do not give an accurate picture of what is there. "The oil companies' agenda is to maximise revenue and increase shareholder value and when they speak [of reserves] they do it to influence markets and governments," he says. "If they said peak oil is coming, what would happen to their stock price?"

So they conceal the depletion of fields in the way they report reserves. "The companies talk about 'barrel-of-oil equivalents', which means oil and gas," he says. "But gas supplies are in good shape, so it obscures how bad the oil situation is. Or they talk about the reserves-to-production ratio and say there is 40 years of supply. It is entirely misleading. Oil fields decline soon after they come into production. It does not matter what is in the ground, but how quickly you can get it out."

Oil can be tricky to extract. Depending on the field, extraction may not easily be increased without compromising future production. It may even destroy a field, despite oil remaining in the ground. Miller points out the oil companies acknowledge this while avoiding drawing the consequences. For example, Shell has said the era of "easy-to-access oil" is over. "That implies difficult-to-access oil can replace existing supplies," says Miller. "But it cannot."

Peak oil has been predicted before - 1995 was once touted as a turning point and the prediction proved wrong. But the increasing number of experts convinced peak oil is imminent is striking.

Jeremy Leggett is a former seismologist who worked in the oil industry, advising companies on where to drill and training their personnel, before leaving to write a series of books exposing the workings of the industry and the coming of peak oil. Anyone who wants to know more could do worse than read Leggett's book Half Gone: Oil, Gas, Hot Air and the Global Energy Crisis, published in 2005, or The Carbon War (1999) - an expose of the oil industry's extensive efforts to deny the connection between carbon fuel and climate change.

By chance, at a recent industry lunch I sat next to a seismologist who works with an oil company in Houston advising on where to drill. I asked if he was aware of Leggett? "Yes, I've heard him speak." What did he think of Leggett's arguments? "Well, he is right." And is he right about peak oil? "Oh yes."

On Wednesday (July 9), the Financial Times reported: "Total and Eni, two of Europe's biggest oil and gas companies, plan to bring nuclear power to countries in the Middle East." The story referred to the United Arab Emirates and another unspecified country.

Read that again. Oil companies are to sell nuclear power to the world's greatest oil producers at a time when the oil price is at a record and they claim reserves are plentiful. Think about it.

The June inflation figure is a bit of a worry, and it should be. First, because inflation will eat into margins on advance holiday bookings priced when inflation was lower.

Second, because it will suck up consumer spending on necessities, leaving less money for travel - whatever the industry says to the contrary.

Third, because it nails the idea of a cut in interest rates - rising rates are more likely - and means an overall tightening in the economy.

The Consumer Price Index for June shows prices up 3.8% year on year following a 3.3% rise in May. The monthly increase is greater than the 3.3% to 3.7% economists were predicting. But the real picture is worse, since the CPI does not include the cost of housing. The more useful Retail Price Index shows a 4.6% rise last month.

If the price increases were on flat-screen televisions, gourmet meals, Burberry coats or stiletto heels it might be less of a problem. But the biggest rise was in the cost of food - up 9.5% on June 2007.

Unpick the increases and the figures are even more alarming. Price-comparison site mysupermarket led the Times to report pasta up 85% over 12 months, rice up 76%, bread 39%, eggs 36%, cheese 35%, tea 26% and milk also 26%. There is not much in that list that could be deemed discretionary.

The government is trying to enforce a 2.5% cap on pay rises in the public sector, remember - which no doubt includes a lot of people who book holidays and may be less likely to do so if they do not earn more - leading 650,000 council workers to strike tomorrow and Thursday.

Further price increases are on the way. The prices UK manufacturers charge for goods rose 10% in the year to June - the highest for 20 years. Strip out food and the increase was still 6.4%. This is not yet Zimbabwe, but you see where we are heading.

Latest figures from the British Retail Consortium reveal a 2.1% year-on-year increase in sales by revenue - less than half the RPI inflation rate - suggesting retailers are making less money when inflation is factored in.

The pain may not yet have reached the travel sector - the usual quota of "Bad weather sends travel bookings soaring" stories abound. But analyst Ernst & Young warns travel is not immune. Its latest quarterly report on UK quoted companies makes some important points.

First, profit warnings among general retailers are at record levels and clothing sales - largely discretionary spending - show the biggest decline since the early 1980s.

Second, fuel hedging has seen many travel companies through till now but, "If the oil price remains high beyond the life of the hedges, failures look inevitable."

Third, tour operators say they have learned the lessons of past downturns, but the industry is not immune to falling consumer confidence.

Fourth, the new players in travel have no experience of a downturn. Fifth, retailers may drive sales by discounting only at the risk of "crippling effects on profits".

Ernst & Young describes the combination of factors facing the industry as "exceptionally toxic". Pick your poison.

Members of the travel industry can be remarkable for their optimism. But then they are not in coal mining. The sector has grown pretty-well continuously for decades.

Even those parts regularly consigned to the historical bin bag by commentators refuse to be taken away. Travel agents are used to hearing they are finished, but there are more on the high street now than in the early 1980s.

Yet there are times when optimism shades into whistling in the dark. Give me a pound for every time I have heard someone express concern about "talking the industry down" and I would be up there with Peter Long.

So a survey of the optimism among small and medium-sized companies makes interesting reading. The Entrepreneurs' Index compiled on behalf of Bowmark, a private-equity firm, aims to track how positive directors of companies in various sectors feel about their businesses.

It finds the confidence of travel company heads in their own business has fallen 10 percentage points in the last six months and confidence in the future of the sector as a whole has fallen by 16 points.

That leaves 62% of travel company directors still positive about their own business and 47% positive about the industry. But as Bowmark managing partner Charles Ind points out: "These are entrepreneurial firms and they tend to be bullish." The results are worse then expected, he says.

The contrast with other sectors - business services, manufacturing, healthcare and publishing and media - is revealing.

Travel and leisure has the lowest optimism ratings and only publishing and media suffered a greater fall in confidence over the past half year. The media is taking a hiding from cuts in advertising, but companies in the sector still appear more optimistic than those in travel. Remarkably, the survey suggests 42% of media firms expect revenue to grow by 20% or more over the next year. A mere 17% of travel companies expect similar growth.

A few words of caution - first, I do not have the full results of the survey, just six pages of highlights, so it is difficult to judge the findings. However, let us assume a private-equity company knows how to assess business confidence.

Second, the survey sample is small - involving only 163 small and medium-sized companies - of which 30 are travel and leisure firms.

Third, bracketing travel and leisure together is normal in the City, but is not entirely helpful here. The leisure sector includes hotel groups, which form part of the travel industry, and restaurants, bars and casinos which generally do not.

That said, at least two other findings are telling. Four out of five of the travel and leisure companies surveyed believe government intervention is damaging their business - up from 68% six months ago. The same four out of five say taxes are a burden, almost double the percentage last time out. In other sectors, government legislation is a problem to 70% and taxes an obstacle to two-thirds.

Is travel more heavily taxed than other sectors? It has not been subject to tax increases above those on other industries in the past six months - unless a higher proportion of travel directors are non-domiciles in the UK or were planning to cash in on the previous rate of Capital Gains Tax.

Could the explanation be that travel companies are hurting more than average and increasingly resentful of costs they cannot avoid or control?

A second point of note is that two-thirds of travel and leisure companies complain of a skills shortage - up from 45% six months ago.

Can there truly have been such a decline in skills in six months, or are the demands of a rapidly changing situation exposing the limitations of a workforce - and managers - schooled in ways of operating that fit an expanding industry? I'm only asking.

Ryanair's grounding of aircraft and sharp cut in capacity this winter can be looked at in two ways.

Take the airline's view - and that of most commentators - and it is a hard negotiating ploy. Airports everywhere take note - fail to bow to Michael O'Leary's demands and his aircraft will sit on the ground rather than fly tourists into and duty-free shoppers out of your terminals.

The contrary view is that Ryanair has been caught out. O'Leary banked on the oil price going down and did not hedge. Now he is paying the market rate - $128 a barrel last week for crude, $147 the week before - while British Airways pays $84 a barrel. When fuel makes up half your costs that hurts.

What do you do, especially when you have enough aircraft ordered to double the size of your fleet by 2012 and you know you won't fill the seats even at £1 a time? You ground some aircraft - and make someone else responsible.

When Ryanair announced it was cutting services at Stansted by 14% this winter it blamed airport operator BAA for increasing charges, declaring Stansted was the most expensive airport it uses. Well it would be. Stansted is a major London airport. If BAA wanted to take the same line it might suggest, "Fly off somewhere else then."

Ryanair also raged against the Civil Aviation Authority and "the total failure of the CAA regulatory regime to control unjustified cost increases". At a press conference, O'Leary reportedly referred to the CAA as "twats" and Stansted as "rapists" (The Guardian, July 18). Leave aside the trivialisation of sexual violence, O'Leary's press conferences are generally entertaining in a Richard Littlejohn kind of way. But might he be rattled?

The carrier's announcements of cutbacks at Dublin and elsewhere were similarly bullish. A 12% reduction in weekly services at Dublin, where Ryanair will base four fewer aircraft than last winter, is the consequence of Dublin being "the second-most expensive of Ryanair's base airports" and Ireland's equivalent of the CAA being a "hopeless aviation regulator".

In both cases, the carrier had sought reductions in charges and been rebuffed. O'Leary told reporters BAA had dismissed Ryanair's "reasonable" request to cancel its fees. "We asked BAA for a 100% reduction in landing fees and we a received a two-word response, the second being 'off'," he said.

One analyst suggested the cuts represent "a new level of assertiveness in airport charges negotiations" - true at one level, but not the whole truth.

In announcing the temporary closure of seven bases in continental Europe, including Palma, Valencia, Salzburg and Budapest, Ryanair hinted at the real reason for the capacity reductions and fiery justifications. It argued: "Costs at these airports are among the most expensive in Europe and far outweigh the potential revenue passengers are prepared to pay."

In other words, Ryanair is struggling to maintain its business model with oil at the current price. O'Leary came close to being explicit on this point when he told reporters: "We are clearly not going to be selling millions of £1 fares on flights from Stansted if we are over-paying Stansted by £10 per passenger."

BAA took exception to the figures. A spokesman said: "Numbers and statistics have been banded around, many of which we simply don't recognise."

The figures are troublesome. The Ryanair release on Stansted refers both to a 25% reduction in aircraft and a 22% reduction. It says the number of aircraft will be reduced from 36 last winter to 28 this. However, the Financial Times, quoting O'Leary, reported 15 aircraft would be withdrawn. The Guardian decided 12 would be grounded.

Perhaps in exasperation, BAA suggested: "Surely this is a time for our industry to pull together, not spat by press release." Clearly, the airport operator has not been reading Ryanair's previous communications or paying attention to the way the airline is run.

Of course, Ryanair will seek to batter down airport charges. It will no doubt have some success. At Stansted, BAA hinted a compromise might be possible, revealing: "We have met with Ryanair to discuss how best to help each other and look forward to continuing to do so." That may or may not please rival carriers.

However, Ryanair may struggle to get its way at Stansted and Dublin - which are core to its operations, remember - since both are subject to regulatory bodies that are required by law not to listen solely to a chief executive in a rugby shirt.

If Ryanair were to extend its logic and withdraw from these airports, how would it pick up the traffic it requires to ferry millions around Europe to airfields most have seldom heard of and which therefore charge it nothing?

Why should airports served by other carriers slash charges to Ryanair to subsidise the give-away offers that may put rivals out of business?

Ah, the give-aways. There is no let up in the bargain basement. Last Wednesday Ryanair announced a three-day fire sale of one million seats at £1, including tax and charges, for travel between September 1 and the end of October.

Referring to the European Commission's recent announcement that all fares in Europe will have to include non-optional charges from next year, Ryanair said: "The European Union fat cats claim their decision on airline advertising marks the demise of £1 airfares. This is Rubbish."

Yes. It is.

British Airways is up to its neck in perhaps the biggest crisis the aviation industry has ever known.

That is quite a statement. But it is not mine. The words are BA chairman Martin Broughton's, from his address to shareholders at the airline's annual general meeting last week.

Broughton told the AGM the rapid rise in fuel costs had forced not just one but three revisions of the airline's business plan in the past four months. He warned it would be a "considerable achievement" to avoid reporting a loss this year.

It rather sounds as though BA shareholders, having recently received their first dividend payment in eight years, should expect to wait a while for another. At least one analyst believes the airline's payment of that dividend - equivalent to about a week's fuel costs - was "daft".

But how serious is the crisis?

Press reports focus on planned cutbacks by BA - a capacity reduction of up to 5% this winter and a partial freeze on recruitment. BA chief executive Willie Walsh was pretty explicit about the limits to this last week although details will not be announced until next month.

According to the Financial Times, "Walsh made clear BA would not be grounding any aircraft." Instead, the airline will "trim capacity by cutting the frequency on some short-haul routes". This week, head of corporate sales Richard Tams insisted: "The cuts will not have a significant impact on the business schedule. Any cuts will be where we have multiple services."

Walsh intends to keep operations broadly as they are instead of expanding by 2.5% or so in the current financial year as originally planned. "Given that expansion will not take place, we don't need to recruit people for the winter," he said. That is unfortunate for those hoping to get a job and will mean BA workers have to cover for departing colleagues, but it does not sound like the actions of a man reacting to the greatest crisis in aviation's history.

BA has been conducting a review of its operations under the codename Project Columbus. The title could be considered unfortunate. Columbus may be commemorated for stumbling upon the Americas, but his transatlantic ventures led to a good deal of destruction - well, genocide, actually. Let us hope that is not an omen.

Officials of the union Unite are concerned about impending job cuts. Walsh has played down their fears, saying there are no plans to cut jobs - although that could change.

He did warn again last week that fares will rise, but Walsh has consistently said that. In fact, BA raised most of its long-haul fares by 5% last month on top of a succession of increases in fuel surcharges. Walsh obviously means they have some way to rise yet.

The BA boss also repeated that fare rises "will have an impact on demand". He just thinks BA will be less affected than other carriers because half its passengers are business travellers who are generally less sensitive to price rises, particularly on long-haul routes.

If BA fails to match the "considerable achievement" Broughton spoke of, it will mean the high oil price wipes out a record profit of £883 million for the year to March.

But Broughton is right despite the strong position of BA - this probably is the biggest crisis the airline industry has faced.

Consider its rivals. We can rule out the crisis of 1929 and the hungry thirties when commercial flight was in its infancy. The Second World War wasn't a great time for commercial carriers, but the comparison does not help us.

Flying was big business by the time oil quadrupled in price in 1973-74, but the era of mass-market leisure travel was just beginning. When oil doubled in price in 1979-80 and the UK then suffered its worst post-war recession, some of the world's biggest economies - Germany, Japan - were barely affected. By the time recession hit again in the early 1990s the oil price had lowered. Airlines largely flew on through.

The attacks of September 11 2001 triggered a fall in demand in the US and a crisis for the country's airlines. But with the exception of Swissair and Sabena, Europe's major airlines carried on.

The situation is worse this time. In essence, there are two economic crises - a recession with its roots in the US and an inflationary crisis driven by rapid growth primarily in China. Hence we see economic downturn and rising inflation - or good, old stagflation to use the 1970s term. God forbid bell bottoms return, too.

For airlines, the oil price is a killer. BA has said it cannot make money with oil at $125 a barrel. Ryanair has said similar. Neither expect oil to remain at its current price, but no one knows what the future price will be.

At the same time, most airlines have cut close to the bone already - mainly in reaction to the low-cost carriers. There is not a lot of slack to take in.

Of course, BA is not buying most of its oil at $125 a barrel. It is paying nearer $84 for most of its fuel. So it should still be making money. The key will be what happens as the hedging deals - the advance agreements to buy oil at a cheaper price - run out.

No doubt there will still be bargains for some consumers, but average fares will have to rise in line with the fuel price. If fuel now comprises one third to half of airline operating costs and the oil price has doubled in a year, fares will broadly have to rise by between one-sixth and one-quarter. OK, I have vastly over-simplified the maths - but the general point stands.

Rather than hike prices to that extent in one hit, carriers will ground aircraft, conserve cash and hope rivals go bust.

Be ready for a bleak October when winter schedules kick in.