Fuel Prices Cloud Future for Airlines

For much of the last year, major airlines worked feverishly to bring down their labor costs in an effort to survive against lower-cost discount carriers.

Now, as the price of oil continues its sharp march higher, airlines are confronting another demon that threatens their solvency: out-of-control fuel costs.

After the worst four years in their history, with cumulative losses topping $30 billion, airlines had hoped 2005 would bring better results. Instead, some of the largest carriers could join US Airways and smaller carriers in using U.S. Bankruptcy Court protection to survive.

In recent weeks, the price of crude oil has floated between $50 and $56 a barrel. It closed Friday at $56.72, a sharp contrast to airline analysts' forecasts late last year that it would average closer to $42 a barrel this year.

Aircraft fuel prices for U.S. airlines increased 35 percent last year to an average of $1.15 a gallon, and in recent weeks carriers have reported paying from $1.45 to more than $1.55 a gallon.

"Nobody's business plan works very well when oil is at $50 a barrel," Joe Leonard, chairman and chief executive officer of AirTran Airways Inc., one of the few profitable carriers, said in an interview.

The higher fuel costs come as airlines have increased the number of flights they operate and low-fare competitors have started new routes. The additional availability of flights has helped pushed down airfares to their lowest levels in 25 years.

Major airlines received an average of 11.2 cents in revenue for each mile a passenger flew on domestic flights last year - the same as they were getting in 1980, though overall consumer prices have more than doubled since then.

By contrast, in 2000, the big airlines collected an average of 14.48 cents per passenger mile flown.

The soaring oil prices are turning some airlines' cost structures on their heads.

Fuel has traditionally been the airlines' second-largest expense, trailing only labor costs. But at US Airways, the relationship is changing as oil prices have climbed and the company has cut more than $1 billion a year in labor costs, largely through concessionary union contracts and layoffs since it entered Chapter 11 bankruptcy protection on Sept. 12.

US Airways Group Inc. has used the bankruptcy process to reduce its operating costs below those of most other major airlines, although they are still higher than those of newer discount carriers, including AirTran, JetBlue Airways Corp., and Southwest Airlines Co.

Every $1 increase in the price of crude oil pushes US Airways' costs up by $2 million a month, Bruce R. Lakefield, US Airways' president and chief executive, told employees in a recorded message this month.

"Fuel at this sustained level will replace labor costs as our highest expense item," Lakefield said. "That is a staggering statement of fact. I have no idea how airlines without our competitive cost structure are coping."

But analysts say that not even US Airways and the discount carriers will be able to cope without increasing fares or reducing capacity - the number of seats an airline offers for sale each day. "You can stimulate traffic with low fares, but that doesn't keep you financially healthy," said George W. Hamlin, a director of MergeGlobal Inc., an Arlington, Va., consulting firm, speaking about all airlines.

David Swierenga, a consultant and former chief economist for the Air Transport Association, said that most older airlines had reduced their labor costs but that competition was going to keep fares low. "The way back to profitability is on the cost side," he said. "I don't see airlines being able to significantly raise prices."

Not every airline is suffering as much as the large older carriers. AirTran, JetBlue and Southwest made money last year, largely because they have younger, lower-paid workforces, more flexible work rules, and operating strategies that enable them to get more daily use out of each airplane in their fleets.

Some executives of the healthier airlines, including Leonard, the AirTran CEO, say that the business ultimately may be better off if oil stays above $50 a barrel. "We think $50 is better than $40," Leonard said. "I think it's going to force some airlines out of the marketplace. At $30 a barrel, everybody makes money. At $40, no one makes money but it lets some of the others hang around."

But not every newer, low-fare airline is doing well. FLYi Inc., owner of Independence Air, which started last year, said in a regulatory filing last week that it was under pressure to boost revenue and cut costs to avoid a "liquidity crisis." Faced with fierce competition and high fuel prices, Independence said revenue was significantly below expectations and it was "expending cash at an unsustainable rate."

To their credit, some of the older airlines have taken steps in recent weeks to limit capacity this year. But others are sticking with their plans, a stance analysts say could undermine their finances.

As recently as January, Northwest Airlines Inc. said it would increase domestic capacity by 2 percent to 3 percent this year. Last week, it revised that to no increase while still planning to add seats on flights to Asia and Europe.

Continental Airlines Inc. said it would add no seats on U.S. flights, but its capacity on international flights would go up by 5 percent. American Airlines, owned by AMR Corp., is projecting a 1 percent decline in domestic capacity and 11 percent growth in international capacity for the year. UAL Corp.'s United Airlines, which is operating under bankruptcy protection, stands by its October plan to cut overall capacity by 3 percent by the end of March, compared with 2004 levels.

Delta Air Lines Inc., the major carrier that analysts say is closest to needing Chapter 11 protection, is projecting 6 percent to 8 percent growth in capacity for the year, mostly on international routes.

"The flights are full, and they're losing money," said Michael Boyd, an airline consultant. "Why fly more?"

"What's changed in the last six weeks is the stark realization that fuel prices are going to remain high indefinitely," said Boyd, who runs the Boyd Group in Evergreen, Colo. "That's changing everything. A lot of plans that were in the works three months ago are in the shredder."