Profit organization

C$1. 945 billion in 2002. All airlines have experienced a dramatic rise in the cost of aviation insurance since September 11th, 2001. Air Canada’s aviation insurance increased approximately C$70 million compared to insurance costs in effect prior to septemeber11th. Following September 11th 2001, the Canadian government took control of airport security and passenger screening, which up to that point had been the responsibility of the airlines at each airport.

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In order to pay for the new initiative, a security surcharge was levied by the Canadian government in the amount of C$24 per ticket. The effect of this surcharge was to increase the cost of passengers to fly, a move that further eroded passenger demand, particularly for shorter flights. The surcharge was reduced to C$14 per ticket for Canadian domestic travel only in last month of Canadian federal budget. Another major expense to Air Canada is aircraft fuel.

Based on 2003 projected volumes, a US per barrel movement in the average price of crude oil would result in an approximate C$31 million change in 2003 fuel expense for air Canada, net of fuel hedges, assuming flying capacity remains unchanged and that refining spreads between 6WTI and jet fuel as well as foreign exchange rates remain constant. Since the Iraqi crisis began in September 2002, the price of WTI crude has fluctuated from a high of C$20 per barrel range.

The price of crude oil continues to be extremely volatile. As the economic environment continued to deteriorate, Air Canada in conjunction with its advisors, begun to explore the framework of restructuring under the Companies’ Creditors Arrangement Act that would enable them to renegotiate their relationships with various of their stakeholders with a view to building an operational and capital structure that was more responsive to the immediate economic marketplace.

Through the introduction of initiatives such as 7Tango,8 Zip, Jazz, Destina. Ca, as well as the commercialization of Aeroplan, Air Canada has been an industry leader in innovation, in that it has consistently acted before other network carriers and is now being copied by other carriers. Air Canada has been in discussions with a potential equity investor of substantial resources. Hopefully, other players will also wish to become involved.

These discussions are continuing, but any agreement clearly will be conditional on a successful restructuring of the business and a viable business plan and balance sheet. Although, despite the carrier’s best efforts and intentions, these 9CCAA filing became necessary, and the accompanying stay of proceedings will provide the Applicants with the “breathing space” and hopefully enough stability necessary to complete their restructuring and with the additional power to clean up their balance sheet.

Any successful restructuring of the Foreign Debtors’ business models is dependent upon a significant reordering of the Foreign Debtors’ cost structure, particularly their labor costs. To this end, in early February 2003, Air Canada announced that it would require at least C$650 million of annual savings from its various labor groups, through a combination of measures including wage reductions and more efficient work rules. At present, Air Canada’s labor expenses are not competitive.

These savings would reduce such expense to a level of savings consistent with the labor expenses of its competitors, both in Canada and in the United States. Since February, Air Canada has attempted to negotiate various unions’ ways that could achieve these required costs savings. In March 2003, Canadian Union of Public Employees, Air Canada’s biggest union, announced that it did not intend to make any meaningful concessions until Air Canada had filed an application for the commencement of reorganization proceedings pursuant to the CCAA.

Air Canada’s competitive disadvantage resulting from its extraordinary labor costs are exacerbated by the national scope of its collective agreements resulting in wide discrepancies between Air Canada’s costs of labor in certain markets and the going rate for services in those markets. Without this reordering and the necessary concessions from the unions, Air Canada will not be able to survive and become a profitable enterprise. The business model that the Applicants are looking to build a Plan upon is one that it has been developing in response to the changing marketplace.