Airlines awash in red ink

Hit by rising fuel costs, major carriers may have to shrink services further, say analysts.

posted May 21, 2008 at 11:15 am EDT

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That trouble would translate into billions of dollars. Vaughn Cordle, an aviation analyst with AirlineForecasts, LLC in Washington, D.C., predicts that just this year the airlines could lose between $5 billion and $8 billion given predicted fuel costs.

"The industry will survive with $150, even $200 [a barrel] oil but will be 20 percent to 40 percent smaller at these price levels," Mr. Cordle wrote in an e-mail from Singapore. "The industry can only profitably support perhaps three major network airlines and a handful of point-to-point and hybrid airlines and commuter feeders."

The goal of shrinking is to allow the remaining airlines to raise prices. During the first quarter of this year, airlines have increased fares by an average of 7 percent. That's a hefty amount, but still not nearly enough to cover the unexpectedly high cost of oil.

Analysts contend prices will have to go up even higher to cover the cost of fuel.

"If we average $125 a barrel of crude for this year, that would take a 25 percent fare increase to cover that," says David Swierenga, an aviation economist with AeroEco in Austin, Texas.

Analysts disagree about how much capacity the airlines need to cut to raise prices that much. Calyon's Mr. Neidl and others believe the magic number is 20 percent. But Mr. Swierenga points out that most airlines are currently flying at 85 percent full. That means only 15 percent of their seats are now empty.

Usually, when there's a price hike, demand goes down. But despite the recent fare hikes over last year, demand has remained relatively strong. So there's a concern that if the airlines cut capacity too much, there will be some even more unhappy fliers fighting to find a seat.

"Carriers will not be able to cut back capacity enough to reduce their costs and still have enough seats available to meet the level of demand that we have today," says Swierenga. "I think what we'll have is some combination of the 25 percent fare increase and the 10 percent capacity cut."

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