MIAMI – Powered by technology and venture capital, the San Francisco Bay Area has one of the hottest metropolitan economies in the world, let alone the United States.

Indeed the real Gross Domestic Product (GDP) of the Bay Area in 2015 was $666 billion, good enough for third place in the United States behind New York and Los Angeles. More importantly, said figure is 34% higher than it was in 2010, representing massive growth off of an already huge base.

It is no surprise then that the region’s airports, San Francisco International Airport (SFO), Oakland International Airport (OAK), and Mineta San Jose International Airport (SJC) have also seen massive growth during the same period.

Between 2010 and 2016, traffic at OAK grew 21.2% to 12.07 million and traffic at SJC grew 30.9% to 10.80 million. For 2016 versus 2015, those figures were 7.7% and 10.2% respectively.

But the real star was SFO, which grew 34.8% off a much higher base to 53.10 million between 2010 and 2016. Put another way, the added traffic at SFO in 2016 versus 2010 would by itself be an airport larger than Oakland. Over the last five to six years, the aviation market in the Bay Area has been sizzling.

In addition to the underlying economic growth, the air travel expansion in the Bay Area has also been powered by an increasingly pitched battle between a resurgent United Airlines under the stewardship of Scott Kirby and the newly merged Alaska Airlines (which acquired its SFO hub from Virgin America).

In the most recent round of expansion announced in May and June 2017, United added frequency from SFO to 11 destinations and up-gauged 10 destinations to mainline. This came in the wake of Alaska announcing 10 new routes from SFO (and 3 new routes from SJC) back in March 2017.

Between the two airlines, SFO will have close to 40 extra daily departures in Summer 2017 than they would have previously.

United dwarfs Alaska in SFO

On a peak summer day, United has roughly 327 departures to 95 destinations, while Alaska has 99 to 35 destinations. In terms of capacity (available seat miles), United is about six times as large (helped by its large portfolio of trans-Pacific flights) as the combined Alaska and Virgin America (data courtesy of masFlight).

One of these carriers is a global powerhouse, the world’s third-largest airline by passengers carried. The other is still a regional player in the consolidated US market, lacking even a focus city east of the Rockies. But as Alaska has proved in Seattle competing with Delta, that kind of head to head battle isn’t automatically won by the legacy carrier.

SFO is strategic for both United and Alaska

SFO is immensely strategic for both carriers involved, particularly for United. In an era when United’s domestic profitability lags behind that of peers, the high-value corporate traffic on short haul routes that it picks up at SFO is immensely valuable.

And of course, SFO serves as a massive trans-Pacific gateway for United to Asia, Australia, and Hawaii with nonstop service to two cities in Australia & New Zealand, four in Hawaii, and 12 in continental Asia.

In that role, however, it is difficult to see much upwards potential for Asian growth at SFO in the next 2-3 years, other than perhaps Melbourne and Guangzhou. Secondary China is not performing well at present, and the only credible destination left is probably Chongqing.

In the longer run, over a 5-7 year period, you could probably add Xiamen, Nanjing, and Changsha to the list of potential secondary Chinese destinations, along with Brisbane in Australia and Manila, Bangkok, Ho Chi Minh City, and Kuala Lumpur in Southeast Asia with the 787-9.

For Alaska, the entire purpose of the merger with Virgin America was to get access to Los Angeles and (in particular) San Francisco. Alaska’s growth avenues are mostly tapped out in Seattle (which is heavily gate constrained), Portland (which isn’t a huge market), and Hawaii (which only has so many markets accessible with 737NGs) so it has determined that growth in California is the future. Prior to the merger, that growth was focused on San Diego and SJC, but with the merger, Alaska now has two much more attractive markets to grow in.

At SFO, the initial expansion this March provides clues as to how Alaska will build its network. Thanks to gate space limitations, Alaska probably can’t grow past 100 daily departures at SFO, but we do expect Alaska to continue to substitute point to point flights to destinations around the country for pre-merger Virgin America’s frequency in more business-oriented markets.

Unlike that of Virgin America, Alaska’s model doesn’t require frequency sensitive business travelers to work (because the product isn’t so overblown). As a result, there are plenty of lucrative origin and destination (O&D) markets for Alaska to add in SFO.

But gate space is the ultimate constraint at SFO. United controls all of Terminal 3, which consists of 39 gates. That gives it the ability to add an additional 50-60 daily flights assuming full utilization.

Conversely, Virgin America has 7-8 gates (out of 14 common use gates at Terminal 2) while Alaska has an additional 2-3 in Terminal 1. That doesn’t leave it a lot of room to expand (maybe 10-15 additional daily flights), which means Alaska has to cut frequency to existing destinations in order to fund new ones.

Given the gate constraints, Alaska is fighting United with one hand tied behind its back.

Alaska should buy American out of Terminal 2

The answer is straightforward: Alaska should by American Airlines out of Terminal 2 and consolidate its operations. American does have a substantial investment in SFO, which is an important strategic market for its flagship transcontinental service from New York JFK, and an Admirals Club.

But for a fee of $150-200 million, American could probably be compensated for the cost of a new Admirals Club in Terminal 1 and for the hassle of moving out of SFO’s nicest terminal walking away with a nice chunk of change.

Conversely, such a move would be transformative for Alaska, allowing it to grow its SFO presence by 60% and consolidating the passenger experience at Terminal 2. Such a move would immediately elevate the battle at SFO to another level.

In the meantime, however, Alaska’s growth will mostly serve to hurt United on a route by route basis. The tradeoff for United will be less frequency competition from Alaska to major destinations, allowing it to win more business customers and offset the revenue impact from smaller destinations.

OAK could become a low-cost haven while SJC will grow long haul international flying

The other airports in the Bay Area are still trying to catch up with years passed, with Oakland in particular still lagging behind its traffic levels in 2007 (14.6 million) and San Jose behind its level in 2000 (14.2 million).

As a result, both airports have plenty of gate space available with Oakland’s 30 and San Jose’s 28, which could become more attractive for airlines given the constraints at SFO.

OAK is Southwest Airlines country (120 daily departures to 29 cities), which is a double-edged sword for the airport. On one hand, it ensures that the airport has plenty of nonstop connectivity.

On the other hand, however, it largely scares away other airlines from entering the market and Southwest isn’t really growing in California right now. The only avenue of route growth has been international flying with British Airways (to London Gatwick), Level (to Barcelona), and Norwegian (to Barcelona, London Gatwick, Rome, Stockholm, Copenhagen, and Oslo) all adding service in the last three to four years.

In the coming years, OAK may have to rely on such ULCCs (British Airways excluded) and domestic ones like Spirit Airlines and Frontier Airlines for growth. As an example, it would not be shocking to see Southeast Asian ULCC AirAsia X enter the Bay Area market via OAK if its Hawaiian sojourn is successful.

Despite its higher cost base, we are actually more optimistic about growth prospects at SJC, which is closer to an established corporate travel base in Silicon Valley and the southern San Francisco suburbs like Cupertino, Mountain View, and Palo Alto.

Despite gentrification in the city of Oakland, the area surrounding SJC is one of the wealthiest and fastest growing population wise in the country (and the world), which means that there is likely to be plenty of leisure-oriented passenger growth over the next few years.

Unlike OAK, Southwest Airlines is large at SJC (76 daily departures to 16 destinations) but not dominant. Alaska has built up a decent sized focus city at the airport as well, and this competitive situation should trigger more growth.

SJC could also be a secondary destination for long-haul growth, particularly from full-service carriers like Air France-KLM, Korean Air, and some of the Chinese giants.