In the past month, each of the three top U.S. airlines -- American Airlines (NASDAQ:AAL), United Continental (NASDAQ:UAL), and Delta Air Lines (NYSE:DAL) -- have dramatically cut their flight schedules to Venezuela.
Indeed, airlines across the world have been complaining for months about the impact of currency manipulation and government regulations in Venezuela. Several other foreign carriers have stopped flying to Venezuela altogether this year. The U.S. legacy carriers have finally realized that they, too, need to cut their losses.
Venezuela's bizarre currency regime
Whereas most countries today operate with floating exchange rates that vary based on economic conditions across different countries, Venezuela has a fixed official exchange rate. For a long time, this official exchange rate has overvalued Venezuela's local currency (the bolivar), causing a shortage of foreign currency.
For a while, airlines benefited from this situation. A loophole allowed Venezuelan citizens to exchange bolivars for up to $3,000 dollars at the official exchange rate if they were traveling overseas. Those dollars were worth far more on the black market, which encouraged people to buy pricey airline tickets even if they didn't need to go anywhere!
However, while airlines have been banking huge nominal profits in Venezuela, there's a catch: Those profits are in bolivars, and they're stuck in Venezuela. That's because the government has been unwilling to exchange airlines' bolivars for foreign currencies like dollars and euros, which are in short supply in Venezuela.
In total, airlines have about $4 billion stuck in Venezuela. They can theoretically exchange this money through a new floating currency mechanism that Venezuela has established. However, this "Sicad II" rate is around 50 bolivars per dollar, compared to the official rate of 6.3 bolivars per dollar.
Thus, under the Sicad II rate, airlines would be taking pennies on the dollar. This would force big writedowns: particularly for market leader American Airlines. American has approximately $750 million trapped in Venezuela.
Time to cut flights
Several foreign airlines have reached deals to exchange their bolivars, but American, Delta, and United have not been so fortunate. As a result, American Airlines -- which has by far the largest presence in Venezuela of any U.S. airline -- decided last month to drastically cut capacity to Venezuela as of July 2.
American now operates just 10 weekly flights to Venezuela, down from 48 previously. Today, all of American's flights to Venezuela originate in Miami. Flights from New York, Dallas, and San Juan have been scrapped.
Delta Air Lines was next to cut back. Even though it only flew once daily to Venezuela, that was still more than the airline could stomach. Starting next month, it will fly just once weekly between Atlanta and Caracas.
On Friday, United Continental followed suit, although it is implementing the shallowest cuts. Beginning in mid-September, United will go from daily service on its Houston-Caracas route to four weekly flights.
No good alternative
American, Delta, and United are probably making the right decision by slashing their Venezuela flights dramatically. (Indeed, it might have been wise to bite the bullet even earlier.) Venezuela does not have enough foreign currency to pay everybody at the official rate, meaning that airlines are just guessing at how many dollars they will get from each ticket they sell in the country.
The main reason why U.S. airlines have been so slow to leave Venezuela has been the high fare environment, which has been encouraged by travelers' ability to exchange bolivars for dollars at the official rate. However, Venezuela is cracking down on this loophole, limiting the upside for airlines that maintain service.
Today, airlines have so many opportunities to profitably deploy aircraft in the U.S. that they have no reason to wait things out in Venezuela. Until they have certainty on when and at what rate they can repatriate their revenue from Venezuela, American, Delta, and United are better off staying away. That is exactly what they plan to do.