US Airways: Adding Fuel to the Challenge

March 28, 2005
Just as US Airways is starting to save money from its latest round of wage cuts, a familiar villain is re-emerging as a threat: high fuel prices.

Just as US Airways is starting to save money from its latest round of wage cuts, a familiar villain is re-emerging as a threat: high fuel prices.

Company officials have not said that the rising price of oil is enough to derail the airline's planned exit from bankruptcy protection, scheduled before the end of June. But the higher prices are focusing renewed attention at US Airways and other carriers on cutting costs.

In a message to employees two weeks ago, Chief Executive Bruce Lakefield said that if fuel prices remain high, US Airways for the first time will spend more on fuel than on labor this year. He said that was a staggering statement, given that until recently the airline had been criticized for having among the highest labor costs in the industry.

Crude oil for May delivery closed last week at $54.84 a barrel on the New York Mercantile Exchange -- more than 50 percent higher than a year ago and far above the low- to mid-$40 range most airlines had anticipated. US Airways' latest public financial projections, released last fall, were based on oil at $44 a barrel.

Spread out over a year, a $10-a-barrel increase in oil prices would cost the airline an extra $240 million. The airline's 2004 revenue was $7.1 billion, with operating expenses of $7.5 billion.

The surge in oil prices comes at a delicate time for US Airways, which has its largest hub in Charlotte. After cutting about $1 billion annually in labor costs and reaching key financing deals with creditors, US Airways seems poised to complete its plan to reorganize as a low-fare carrier.

But resurgent oil prices have created new obstacles.

Because US Airways flies mostly shorter routes as opposed to longer-haul flights, its fuel costs per mile tend to be high. In a bankruptcy filing last year, the airline said it is "more vulnerable to the rapid increases in fuel prices than its competitors."

In addition, high fuel prices could eat into the airline's cash, which it needs to keep in the bank. The airline's financial report for February is scheduled for release in the next week or two.

Some analysts have speculated that higher-than-expected oil prices are prompting the airline to try to raise more money than it had originally projected.

US Airways had been seeking $250 million in new investment to help it leave bankruptcy protection. It has pledges for that $250 million, but is still searching for another $100 million. That's because one of the investors, Republic Airways, is requiring US Airways to raise a total of $350 million before it kicks in its share.

If oil prices continue their rise, the airline might need even more than that, said aviation consultant Mike Boyd.

A US Airways spokesman declined to discuss the airline's strategy for raising money, or whether fuel prices are altering financial projections.

"It hurts us," said spokesman David Castelveter. "There's no other way to say it."

The airline is scheduled to file a reorganization plan with the bankruptcy court by April 15, which should provide a wealth of financial details.

John Heimlich, chief economist with the Air Transport Association, said US Airways and other airlines are retiring older planes and trimming unprofitable flights in response to high fuel prices."If you need a certain amount to live and your heating bill goes way up, maybe it's time to cut HBO or delay that new car you're going to buy," he said.

In fact, just last month, only a few weeks after starting new service to El Salvador and Panama, US Airways announced it is ending the service in May and will return 11 Boeing 737s. A company statement blamed the "revenue and fuel environment."

Earlier this month, Northwest Airlines said is it grounding 30 old DC-9s, which are less fuel-efficient than newer planes. It blamed the move on high fuel costs.

In addition, US Airways and others are trying to save fuel when they can. Planes are more likely than in prior years to taxi to runways on one engine instead of two, fly at altitudes that require less fuel and take fuel at stations that have the best price.

Airlines have been able to pass along a small portion of the cost through slight fare increases, although intense price competition often drives fares down.

Some of the stronger airlines are counting on weaker rivals grounding planes.

"I love high fuel prices," Stan Gadek, chief financial officer of AirTran Airways, told an investors' conference last week, according to Bloomberg News. "Fuel is going to be the single greatest catalyst in accelerating the restructuring of this industry."

Some airlines have long-term fuel contracts in place that will allow them to pay far lower prices. Southwest Airlines, for instance, has contracts to buy 85 percent of its fuel in 2005 at $26 a barrel. Entering such arrangements makes sense only for airlines in strong financial shape and when fuel prices are low.

In the fall, US Airways had lower-price contracts on 4 percent of its anticipated 2005 fuel needs, but it sold them for $46 million. At the end of the year, it had no such contracts, according to securities documents filed this month.

Entering into new contracts now is probably a poor idea for airlines, unless they believe prices are going to continue to rise, said Bill Veno, director of refined products with Cambridge Energy Research Associates, which studies the energy industry. He expects prices to fall slightly this year and next year.

Some analysts believe the high fuel prices make airline bankruptcies and liquidations more likely.

A week and a half ago, Merrill Lynch reduced its earnings outlook for 11 of the 18 carriers it follows, citing predicted high oil prices. It forecast oil averaging $51 a barrel in 2005, up from $45, and $45 a barrel in 2006, up from $40.

Every $1 per barrel translates to a $450 million swing in pretax profits for the industry, the Merrill Lynch report said. The Wall Street firm raised the amount of money it expects the industry to lose this year, to $5 billion from $3.4 billion.

Merrill Lynch also predicted Independence Air, a low-fare carrier that started service to Charlotte in October, would fail "in light of record high fuel prices and intense competition."

Industry CEOs have also sounded recent alarm bells.

American Airlines CEO Gerald Arpey said his airline might spend $1.4 billion more in jet fuel this year compared with last year. The airline is considering placing more seats on some aircraft to make more money, and an analyst said the company will probably have to reopen labor contracts to force more savings.

Delta Air Lines CEO Gerald Grinstein said Delta's fuel bill could rise as much as $1 billion this year, and that the airline is "examining every part of our operation" for new cuts.

Analysts believe Delta could file for bankruptcy protection this year if fuel prices remain high.

In his weekly message to US Airways employees on Friday, Lakefield said airlines are in a tough spot.

"Fuel prices are going up, and ticket prices have been coming down. It will be hard to change that."