Monday, August 10, 2015

Why the U.S. Airline Pilot Shortage Is So Hard to Solve

Regional airline pilots are playing a giant game of chicken with their employers.

The growing shortage of qualified airline pilots continues to claim victims in the U.S. regional airline industry.

Some regional airlines, such as SkyWest, still seem to be unaffected. But at its largest rival -- Republic Airways -- profit has plummeted due to the pilot shortage and a related labor dispute with its pilot union. As a result, Republic stock has lost nearly three-quarters of its value so far in 2015.

RJET Chart
Republic Airways YTD Stock Performance, data by YCharts

Unfortunately, the pilot shortage and the slew of labor disputes in the regional airline industry could get a lot worse before they get better. A variety of industry forces are combining to encourage stalemate rather than compromise.

Pilot shortage looms

The U.S. faces a potentially significant pilot shortage in the coming years. The military is training fewer pilots than it has in years.

Meanwhile, the cost of civilian pilot training has skyrocketed due to new regulations governing commercial airline pilots. Previously, co-pilots merely needed a commercial pilot certificate, which required 250 hours of flying time. Now, they need an Airline Transport Pilot certificate, which requires 1,500 hours of flying experience (or at least 1,000 hours if they have a bachelor's degree with an aviation major).

At the same time, the U.S. airline industry faces a huge wave of pilot retirements as pilots who entered the industry in the 1980s following deregulation reach the mandatory retirement age of 65.
Nearly 18,000 mainline pilots are expected to retire between 2013 and 2022, with the number of annual retirements increasing throughout that period.

Pilots are suddenly in demand

For most of the decade following 9/11, numerous pilots were on furlough from major airlines as the U.S. airline industry shrank. That labor oversupply has dramatically turned around in the past few years. Now, the combination of a growing wave of pilot retirements and stricter pilot training rules means that qualified pilots are in high demand.

Mainline carriers are mostly insulated from this issue so far. Since they fly relatively large planes, they can spread pilot labor costs over more passengers. As a result, mainline carriers can pay more than regional airlines, allowing them to reliably poach experienced pilots from the regional industry.

This means that regional airlines are seeing high attrition rates as their pilots move to mainline jobs with better pay and more advancement opportunities. At the same time, the new "1,500 hour rule" has made it vastly more difficult to find replacements.

Low pay is a problem with no easy solution

Raising pilot pay in the regional airline industry seems like an obvious solution to the pilot shortage. Higher pay would encourage more people to enroll in flight school, despite the high cost, while also convincing qualified pilots who are working outside the airline industry to return.

However, there are two big barriers in the way of giving regional airline pilots a big raise. The first is that regional airlines like Republic Airways and SkyWest have lots of long-term contracts with the legacy carriers locked in already. Unless they can convince their legacy carrier partners to amend these contracts, the regional airlines won't be able to meaningfully grow revenue per pilot to support higher pay.

These long-term contracts have been very helpful for regional airlines in the past, insulating them from swings in demand and oil prices. Now, they have become a burden, preventing them from taking a share of the vast increase in industry profitability.

The second problem is that to the extent that regional airlines can afford to raise pilot pay, if the pilots are unionized, they need to agree to the increase. This has created a "chicken" scenario, where regional airline pilots are turning down significant raises in the hopes of getting an even bigger payday.

For example, Republic Airways has offered to increase its entry-level pilot pay by 74%, while providing smaller increases higher on the pay scale. This proposal would have given first-year pilots a living wage -- but it was rejected by the union. (The union has also sued Republic for offering new pilots big bonuses to join the company.)

Republic Airways has tried to raise its pilots' pay, but the pilots want more.
(Photo: Republic Airways)

Meanwhile, the union's best offer would have added $1 billion to Republic's costs over the next three years. Increasing pilot pay by that amount would virtually guarantee bankruptcy for Republic Airways.

In short, the growing pilot shortage has encouraged the union to take a hardline stance. Since most pilots would be able to find new jobs -- possibly with better pay -- if Republic goes out of business, they have shown a willingness to drive the company under rather than compromise.

Is there any way out?

Traditionally, the big airlines have used regional carriers like Republic Airways as a pilot pipeline. The regional carriers would hire pilots with relatively little flying experience and train them. It was almost an apprenticeship, and so pilots tolerated the low starting wages because it offered entry into a good career path.

Today, the 1,500 hour rule means that pilots need to have more flying experience before they join a regional airline. (Much of the experience is often irrelevant, though, coming in single-engine planes.) This has driven up training costs, making the low starting wages more of a problem -- even though experienced mainline pilots are still paid very well.

SkyWest is better positioned than Republic Airways to confront this challenge, as many of the company's pilots are not unionized. On that side of the business, SkyWest can raise wages as the market demands in order to meet its pilot recruitment needs.

Nevertheless, the growing pilot shortage will eventually impact every regional airline. Based on the prevailing contracts in the industry, regional airlines likely won't be able to recruit the pilots they need while remaining profitable. The only question is whether the legacy carriers choose to proactively pay regional airlines more to keep them afloat, or if they wait for the pilot shortage to reach crisis proportions before they act.

(Adam Levine-Weinberg - The Motley Fool)

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