Why major airlines aren't bouncing back

While much of the US economy is recovering, air carriers are dogged by high oil costs and tough competition.

The nation's already battered major airlines are in for an even harder few months ahead.

Mechanics are threatening a strike at Northwest. Analysts say even if it's averted, the carrier may still have to declare bankruptcy. Delta is busy selling off assets in an effort to avoid going into Chapter 11, but it acknowledges that bankruptcy is still a very real possibility.

Despite unprecedented cuts in labor and operating expenses, most of the nation's other major carriers are also racking up millions of losses every month.

Indeed, while the much of the economy is on the rebound, the airlines are still struggling. It's all thanks to the soaring price of oil and the brutal new competition ushered in by the success of low-cost carriers like Southwest and JetBlue.

For passengers, the transformation in the past few years has brought cut-rate fares, as well as trips without pillows and pretzels. So they've packed the planes but brought along bag lunches and bagels.

Yet as oil prices start to catch up with consumers as well, not only at the pump but also in electric and heating bills, experts say they're much less likely to take that trip to Disney, no matter how attractive the airfare. People just won't have the discretionary income. And that is expected to make things even rockier for the major carriers.

"It's usually a long cold winter, and this one, I suspect, will be even rougher than usual. In fact, it could be the worst," says aviation analyst Robert Mann of R.W. Mann & Co. in Port Washington, N.Y. "[Airlines] that usually lose money in the winter will lose even more."

As a result, passengers can expect fares to start climbing. Analysts predict between 4 and 6 percent in the next year. That's still a bargain, considering that jet fuel, a major expense, has almost doubled in some markets.

Even with their continuing losses, however, airlines are hesitant to pass the higher fuel costs along. The reason: They're terrified that more fliers will abandon them for the low-cost airlines, which have already made significant inroads into the major carriers' market share. From less than 10 percent prior to 2000, the low-cost carriers now have more than 25 percent of the market, and some analyst predict they will control 30 percent by the end of the year.

Still, why aren't low-cost carriers also passing along the increased fuel costs? In part, it's because they don't have to.

Take Southwest. It has the most aggressive fuel hedging program in the industry. While other carriers are paying for jet fuel based on as much as $60 a barrel of oil, Southwest is paying only $26 a barrel for as much as 85 percent of its fuel.

So it can keep its prices low and continue making money. In the second quarter, it reported a 41 percent profit. That's keeping the pressure on the so-called legacy carriers to keep their prices in check as well.

Just last weekend, Northwest raised some fares to reflect the higher costs, but it's already rolled them back. The airline needs to stay competitive, particularly with the potential strike looming this Saturday. But it also needs to cut costs, and it's looking for an additional $1.1 billion in labor savings. That's what has the mechanics upset. The company wants to lay off half of them and cut the pay of those remaining by 25 percent.

It may sound draconian, but other legacy carriers have had to make similarly drastic cuts in pay and benefits. That's adding another element to their woes: Many of their workers are just plain unhappy, and that's reflected in customer service. Passenger complaints to the Federal Aviation Administration have increased, particularly involving the airlines in the worse financial trouble. For instance, complaints more than doubled during the first six months of this year at US Airways, which is in bankruptcy.

"This is an industry with a history of anger and frustration between labor and management," says Rich Gritta, an aviation economist at the University of Portland in Oregon. "It's peaking now because of the pressure the major airlines are under to cut costs."

But despite all the problems, the major carriers keep flying, and most airline employees keep trying to do their best in very tough circumstances.

Indeed, no analysts are expecting any major liquidation anytime soon, but they do believe the next few months may bring a few more bankruptcies. On Oct. 17, the bankruptcy laws change in a way that makes it advantageous to file before then. Delta has said that isn't influencing its thinking, but some analysts doubt that.

"Delta has a probability of failing of 40 percent," says Professor Gritta. "No carrier in the last 15 years in my sample has hit that score and not filed for bankruptcy."

If Delta does file, it would mean that three of the nation's major carriers are in Chapter 11. (The third is United.) It's yet another indication of the far-reaching effect of high oil prices.

"This industry was never built to operate at this level of $70 a barrel," says Kevin Mitchell of the Business Travel Coalition in Radnor, Pa. "And that's what it appears it will cost for the foreseeable future."

There is a silver lining to the grim news, although Mr. Mitchell says it's "bittersweet."

"The sweet part of it is the American airline industry will come out of this crucible far more competitive than any single airline group in the world," he says. "The bitter part of it is that we're going to come out of the same crucible with the same [regulatory] shackles and constraints that keep the airlines from acting as a truly global industry."

Those constraints on foreign ownership of American carriers and the complex array of treaties that determine which airlines can fly where could take years to address. In the meantime, Mitchell and other analysts are hoping these current high fuel prices don't prompt an overall economic downturn.

"Right now these airlines should be coining money to repair their balance sheets from the bottom of the cycle. Instead they're losing millions of dollars, and everything is mortgaged," he says. "There's nowhere to hide in the next downturn."

If anything, he says, start listening for talk about even more mergers and consolidations come next spring.

"That's what the industry turns to as a logical solution for survival," he says.

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